Finance Minister Jim Flaherty's fierce opposition to a global bank tax means he will begin a series of international meetings in Washington Thursday in a unique position for a Canadian official: isolated and completely at odds with the country's closest allies.
Too small to set the agenda, Canada has a long history of acting as a go-between in international talks, usually bridging the gap between the United States and European powers such as Germany, Britain and France. At other times, Canada offers diplomatic backing for the U.S. when its largest trading partner goes up against European countries.
But at a working dinner tonight with representatives from all four of those countries and Japan, Mr. Flaherty will be the odd man out. Facing massive bills and angry voters after hefty bailouts of their financial industries, the Americans and Europeans are united on the principle of taxing banks to recover the cost of most of the rescues and any future ones.
The push for a global bank levy gained momentum this week with an endorsement from the International Monetary Fund. It concluded in an interim report that governments could avoid taxpayer bailouts by charging banks a levy for a resolution fund. Governments could also tax dividends and compensation, the report said. And in a rebuke of Canada's stance, it said countries that avoided bailouts should consider a levy because “even with strengthened regulation and supervision, there will be failures of financial institutions.”
Mr. Flaherty wasted little time in rejecting the recommendations, telling a conference in Toronto Wednesday that “Canada will not go down the path of excessive, arbitrary or punitive regulation of the financial sector.” He proposes making financial institutions bear the cost of future bailouts by forcing them to hold more capital in reserve, a move that could potentially limit risk taking and leave banks better able to weather crises.
“I hope we are not distracted by issues relating to the proposed tax on banks,” Mr. Flaherty said, referring to talks between finance ministers and central bank governors in the Group of 20 major economies planned for tomorrow, ahead of weekend meetings of the IMF and World Bank.
Mr. Flaherty's stance against the tax represents an early test for the G20, which was promoted to become the new steering committee of the global economy last year on the notion that the established powers no longer lacked the authority to set the agenda.
If the Europe and the U.S. dig in on the tax, “I don't know if there will be a lot of room to manoeuvre,” said Daniel Schwanen, deputy executive director, programs at the Waterloo, Ont.-based Centre for International Governance Innovation. “If the G20 becomes a forum for one-upmanship, that would be very disappointing.”
The push for a bank levy is as much political as practical. British Prime Minister Gordon Brown endorsed the idea on the eve of an election, and his Conservative opponent, David Cameron, also has promised to enact a tax on banks. U.S. President Barack Obama and the Democratic Party are fighting to hold on to their lead in Congress ahead of mid-term elections in November.
But those governments need broad international support or their proposals could drive their banks to tax-free jurisdictions.
Canada's banks argue that they shouldn't be put in the position of having to pay for the mistakes of their rivals in the U.S. and Europe.
Gordon Nixon, chief executive of Royal Bank of Canada, said a global levy could have the perverse effect of making the financial system less stable and would be unfair.
"It would result in successful institutions funding the mistakes of unsuccessful or badly managed banks and well-regulated jurisdictions funding poorly regulated markets," he said in an interview.
Seeking to avoid a levy, banks would be tempted to manage their balance sheets in ways that increased risk, Mr. Nixon said. Failing that, they would simply pass the cost to their customers, he said. “Policy makers should focus on the root cause of the crisis by ensuring that banks have sufficient capital and appropriate leverage relative to the risks that they are taking."
Mr. Flaherty intends to offer a counter proposal to the promoters of a bank tax. He recently formed a united front with federal bank regulator Julie Dickson to promote the idea of using “embedded contingent capital,” something Ms. Dickson has been pushing for several months. It's a concept that would transfer much of the risk of a bailout from taxpayers to bank investors.
Essentially, it's a security that would automatically convert to common equity when a bank is in trouble, diluting shareholders but supplying the institution with some extra capital. Mr. Flaherty and Ms. Dickson say that such a solution comes with less moral hazard than a bank tax.
"We're not going to impose, as they call them, ex ante capital taxes on Canadian financial institutions," Mr. Flaherty told reporters in Ottawa Wednesday, after returning from Toronto. Canada's bankers have "demonstrated they are capable of managing their banks in a fiscal conservative way."
The CEOs of Canada's six largest banks want global policy makers to bring in needed reforms to the financial system, but caution that they need to get them right. This week, the CEOs sent a joint, signed submission to the Financial Times outlining their views. They are trying to make regulators in Europe and elsewhere understand that some of their proposals with respect to leverage and capital could do more harm than good if they aren't properly designed.