August 18, 2010 / 5:19 PM / 7 years ago

Bank of Canada sees new bank rules lifting economy

OTTAWA (Reuters) - Tougher new global banking rules would boost Canada’s economy, primarily because there would be less fallout from foreign financial crises, the Bank of Canada said on Wednesday.

The central bank estimated that gross domestic product would initially be cut by a maximum of 0.5 percent if capital ratios were increased by 1 percentage point over a two-year implementation period. The initial cost would be slightly smaller with a lengthier phase-in period.

But the long-term boost to the economy far outweighs any short-term pain, according to the bank’s models.

“This study finds that Canada should benefit significantly from the anticipated reduction in the likelihood of future financial crises as a result of strengthened capital and liquidity requirements,” the bank said in its report.

The assessment of the economic impact of proposed new bank capital and liquidity rules, known as Basel III, echoes two international studies that say the estimated costs of the changes are smaller than private banks have argued. Basel III is the cornerstone of the global effort to prevent future banking and financial crises.

The new standards have not yet been set, with G20 countries expected to endorse them in November.

By way of example, the bank said if bank capital ratios increase by 2 percentage points, gross domestic product would likely decrease by an average of 0.3 percent per year in the long run as higher financing costs for consumers and businesses dampen consumption and investment.

However, the economic gain arising from that same capital increase -- due to the decreased likelihood of financial meltdowns -- would be a 1.1 percent annual increase in GDP.

Therefore, the average net benefit to GDP in the long run is estimated at 0.8 percent, rising to 0.9 percent if capital ratios are increased by 4 or 6 percentage points .

“For Canada, three-quarters of the benefits arise from the decrease in the likelihood of foreign financial crises, while the remainder represents the gains to be achieved from the reduced probability of a domestic financial crisis,” the central bank said.

It acknowledged that its estimates were highly uncertain as central bankers still have little experience calculating the impact of financial sector performance on the economy.

The Canadian economy would gain even when conservative benefit assumptions are combined with the most extreme cost estimates, the bank said.

The cumulative benefit to the economy would amount to C$200 billion, or 13 percent of GDP, when calculated on a present-value basis.

Global banks have lobbied regulators for longer transition periods for implementing the new rules, arguing that would soften the impact on lending and help the recovery process.

Canadian banks survived the financial crisis without the huge government bailouts needed in the United States and Europe and have generally welcomed the proposed new rules.

The latest draft proposals on capital suggest Canadian banks would have to raise less capital than their foreign peers, or none at all, to comply with the new rules. At the end of the second quarter, the average Tier 1 capital ratio -- a key measure of stability -- of Canada’s seven biggest banks was 12.6 percent, while the total capital ratio was 15.2 percent.

Despite strong bank capitalization, the global meltdown still pushed Canada into a mild recession and fiscal deficit and policy makers have committed to beefing up bank standards.

The full scope of Basel III won’t be clear until later this year when regulators agree a new figure for a bank’s Tier 1 capital requirement -- currently set at 4 percent -- and how long the sector has to phase out lower quality capital.

The Canadian Bankers Association (CBA) welcomed the central bank’s projections but warned that the many details still not finalized could have an impact on cost.

“A significant degree of uncertainty related to the economic impact will inevitably remain until the final rules are in place,” said Terry Campbell, vice-president of policy at the CBA.

The Group of 20 leading countries, which is spearheading the reform, is set to endorse the complete Basel III package at a November summit in Korea, with implementation from the end of 2012.

Additional reporting by Jennifer Kwan and Howaida Sorour; editing by Rob Wilson

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