In a crisis, the bonds could be forcibly converted into bank equity.
With the new bail-in regime taking effect on September 23rd, Royal Bank of Canada is set to be the first bank to sell bail-in eligible securities.
According to Bloomberg, “The bail-in eligible securities are riskier than deposit notes because they can be converted into equity in case a bank gets into trouble. They will gradually replace deposit notes, the cheap and versatile source of funding for Canadian banks that’s become the backbone for the country’s corporate bond market.”
At this point, the report notes there are many uncertainties, including the interest rate that will be provided on the riskier bonds.
“My estimate was about 15 to 20 basis points over deposit notes, but banks argue it should be 5 to 10 basis points, because of how investor-friendly Canada’s bail-in regime is,” said Himanshu Bakshi, a Bloomberg Intelligence credit analyst. “However, it depends on investors if they are OK with getting five basis points more for a lower-rated security.”
While the bail-in regime is supposed to be about reducing the exposure of taxpayers in case there is another financial crisis, there are serious concerns about giving banks the power to recapitalize themselves with depositors money.
The unspoken issue is that top banks are still being treated as “too big to fail,” creating a moral hazard that threatens future crises down the road. And it’s not an idle concern. With Canada’s massive household debt, the possibility of a financial meltdown is something that must be kept in mind.