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The case for a second look at Canadian bank insolvency legislation Ruhl, Mary Louise 1985

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THE  CASE  FOR  BANK  A  SECOND  INSOLVENCY  LOOK  AT  CANADIAN  LEGISLATION  By MARY  B.A. L.L.B.  LOUISE  RUHL  The U n i v e r s i t y o f Toronto, 1981 The U n i v e r s i t y o f Toronto, 1984  A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF LAWS in THE FACULTY OF GRADUATE STUDIES ( F a c u l t y o f Law)  We accept t h i s t h e s i s as conforming  t o the  r e q u i r e d standard  THE UNIVERSITY OF BRITISH COLUMBIA OCTOBER, 1987 ©  Mary L o u i s e Ruhl, 1987  In  presenting  degree  at  the  freely available copying  of  department  this  publication of  in  University of  partial  of  thesis for by  his  or  the  British Columbia, I agree  her  representatives.  requirements that the  for  an advanced  Library shall make it  agree that permission for extensive  scholarly purposes may be It  is  granted  by the  understood  that  this thesis for financial gain shall not be allowed without  permission.  Department of The University of British Columbia 1956 Main Mall Vancouver, Canada V6T 1Y3  DE-6(3/81)  fulfilment  for reference and study. I further  this or  thesis  head  of  copying  my or  my written  i i  ABSTRACT  T h i s t h e s i s i s an a n a l y s i s of the bank process  i n Canada.  examined and forth.  The  The  insolvency  phenomenon of bank b a i l o u t s i s  t h r e e p o s s i b l e r a t i o n a l e f o r b a i l o u t s are  put  c o n c l u s i o n i s reached t h a t bank b a i l o u t s can  j u s t i f i e d on the b a s i s of these r a t i o n a l e , and, t h a t bank i n s o l v e n c y l e g i s l a t i o n should b a i l o u t process  and p r o v i d e  framework f o r t h i s p r o c e s s .  therefore,  recognize  an adequate and  be  the  appropriate  Three r e c e n t bank f a i l u r e s ,  Canadian Commercial Bank, Northland  Bank and  the Bank of  B r i t i s h Columbia, are d i s c u s s e d , w i t h p a r t i c u l a r emphasis on the d i f f e r e n t b a i l o u t t o o l s used by the government i n each case.  These case s t u d i e s are used as a framework w i t h i n  which t o assess legislation.  c u r r e n t Canadian bank i n s o l v e n c y  The  c o n c l u s i o n i s reached t h a t the  legislative  framework i s inadequate t o d e a l e f f e c t i v e l y w i t h bank insolvency. By examining the American approach t o bank and  two  reform  insolvency  r e c e n t Canadian s t u d i e s on the s u b j e c t , a model f o r i s proposed.  The  model contemplates a more h i g h l y -  s t r u c t u r e d l e g i s l a t i v e framework, with broad powers t o the d e p o s i t  granted  i n s u r e r t o implement a b a i l o u t i n  c i r c u m s t a n c e s which j u s t i f y t h i s form of government intervention.  F i n a l l y , t h i s model i s used as a b a s i s  which t o e v a l u a t e  r e c e n t f i n a n c i a l s e c t o r reform  made by the f e d e r a l government.  on  initiatives  i ii  TABLE  OF  CONTENTS  Heading  Page Number  Abstract  i i  Introduction Chapter  1.  1 Cause f o r Concern?  5  C h a p t e r 2. R a t i o n a l e f o r Bank B a i l o u t s 1. Consumer P r o t e c t i o n a) D e p o s i t o r s b) S h a r e h o l d e r s c) Bank C r e d i t o r s 2. S t a b i l i t y o f t h e F i n a n c i a l S y s t e m 3. P o l i t i c a l B e n e f i t 4. A d d i t i o n a l F a c t o r s i n t h e B a i l o u t Decision a) M a r k e t D i s c i p l i n e b) C o s t - E f f i c i e n c y  14 15 16 23 25 26 29 34  C h a p t e r 3. C a n a d i a n Bank I n s o l v e n c y Legislation 1. R e g u l a t o r y Framework a) T h e Bank o f Canada b) D e p a r t m e n t o f F i n a n c e c) O f f i c e o f t h e I n s p e c t o r G e n e r a l o f Banks d) C a n a d a D e p o s i t I n s u r a n c e C o r p o r a t i o n 2. L e g i s l a t i v e Framework a) Bank A c t b) W i n d i n g - u p A c t c) C a n a d a D e p o s i t I n s u r a n c e C o r p o r a t i o n Act 3. C a s e S t u d i e s a) C a n a d i a n C o m m e r c i a l Bank b) N o r t h l a n d Bank c) Bank o f B r i t i s h C o l u m b i a  39  C h a p t e r 4. E v a l u a t i o n o f Bank I n s o l v e n c y Legislation 1. P a y o f f o f U n i n s u r e d D e p o s i t o r s 2. M e r g e r 3. R e s c u e P a c k a g e s  63  C h a p t e r 5. A m e r i c a n A p p r o a c h t o Bank I n s o l v e n c y : The FDIC M o d e l 1. L i q u i d a t i o n and P a y o f f 2. P u r c h a s e and A s s u m p t i o n T r a n s a c t i o n 3. D i r e c t F i n a n c i a l A s s i s t a n c e  34 37  39 42 42 43 44 46 46 47 48 51 51 57 59  64 65 69 79 82 84 93  i v  Chapter 6. Canadian P r o p o s a l s f o r Reform 1. Wyman Report a) P r o p o s a l s r e : S t r u c t u r a l Reform b) P r o p o s a l s r e : F u n c t i o n a l Reform . 2. E s t e y Report a) S t r u c t u r a l Recommendations b) F u n c t i o n a l Recommendations C o n c l u s i o n : A Model f o r Reform  101 101 101 102 108 108 110 114  Chapter 7. Recent F e d e r a l Reform of Canadian F i n a n c i a l Market R e g u l a t i o n 1. L e g i s l a t i v e Framework a) O f f i c e of the Superintendent of Financial Institutions b) Canada Deposit Insurance C o r p o r a t i o n Act c) Bank A c t 2. E v a l u a t i o n of F e d e r a l Reforms a) S t r u c t u r a l Aspects of Reform _ b) F u n c t i o n a l Aspects of Reform  117 117 118 119 122 123 124 12 6  Conclusion  129  Bibliography  131  1  THE  CASE  FOR  BANK  A  SECOND  INSOLVENCY  LOOK  AT  CANADIAN  LEGISLATION  INTRODUCTION  In t h e f a l l  o f 1985, t h e Canadian f i n a n c i a l  system was  r o c k e d by i t s f i r s t bank f a i l u r e s s i n c e t h e c o l l a p s e o f t h e Home Bank o f Canada i n 192 3.  On September 1, 1985, t h e  Department o f F i n a n c e announced t h a t c u r a t o r s would be a p p o i n t e d t o s u p e r v i s e t h e b u s i n e s s and a f f a i r s o f t h e Canadian Commercial Bank and t h e N o r t h l a n d Bank. banks were e v e n t u a l l y l i q u i d a t e d . isolated  events.  1  Both  These f a i l u r e s were n o t  I n t h e l a s t two y e a r s , f o u r o t h e r Canadian  banks have been f o r c e d t o merge w i t h more v i a b l e institutions  i n order t o survive:  C o n t i n e n t a l Bank merged  w i t h a Canadian s u b s i d i a r y o f L l o y d s Bank o f London; M e r c a n t i l e Bank o f Canada merged w i t h The N a t i o n a l Bank o f Canada; Morguard Bank was t a k e n over by S e c u r i t y P a c i f i c Bank, a wholly-owned s u b s i d i a r y o f S e c u r i t y P a c i f i c Corp. o f California;  and t h e Bank o f B r i t i s h Columbia s o l d  s u b s t a n t i a l l y a l l o f i t s a s s e t s t o t h e Hongkong Bank o f 1 Canada, E s t e y Commission, R e p o r t o f t h e I n q u i r y i n t o t h e C o l l a p s e o f t h e CCB and N o r t h l a n d Bank (Ottawa: M i n i s t e r o f Supply and S e r v i c e s , August, 1986) a t 352 [ h e r e i n a f t e r "Estey"].  2 Canada.  For the f i r s t  time  i n many d e c a d e s ,  government has had t o e x e r c i s e o v e r banks is  faced  with  my t h e s i s t h a t  inadequacy  this  its legislative  o r threatened  federal regulatory  bank i n s o l v e n c i e s  It  i n the future,  legislation.  institutions a strong  insolvencies.  will  face  more  argument c a n be  In particular,  arrange and s u b s i d i z e mergers o f t r o u b l e d institutions which w i l l  proceed  insolvency.  b r o a d e r a n d more f l e x i b l e p o w e r s a r e r e q u i r e d t o  cope w i t h t h e s e  needed.  jurisdiction  experience has i l l u s t r a t e d t h e  o f C a n a d i a n bank i n s o l v e n c y  Assuming  made t h a t  actual  the Canadian  banks w i t h  o r t o e s t a b l i s h government a s s i s t a n c e  restore  i n s o l v e n t banks t o h e a l t h y  In arriving along  t h e power t o  at this  the following  conclusion, course:  this  viable  programs  operation i s paper  will  2  1. I t w i l l be argued t h a t t h i s a r e a o f l e g i s l a t i o n i s i n immediate need o f r e f o r m due t o t h e f a c t t h a t C a n a d a , i n a l l l i k e l i h o o d , c a n e x p e c t more b a n k failures i n the future;  2. J u s t i f i c a t i o n s f o r government r e g u l a t i o n o f banks and, i n p a r t i c u l a r , f o r g o v e r n m e n t i n t e r v e n t i o n i n c a s e s o f d i s t r e s s e d o r i n s o l v e n t banks w i l l be examined;  2 I t s h o u l d be n o t e d t h a t a r e c e n t s p a t e o f i n s u r a n c e and t r u s t company f a i l u r e s h a s p a r a l l e l e d t h o s e o f t h e b a n k s . See E c o n o m i c C o u n c i l o f C a n a d a , A Framework f o r F i n a n c i a l Regulation: A Research Report Prepared f o r t h e Economic C o u n c i l o f Canada:1987 (Ottawa: M i n i s t e r o f S u p p l y and S e r v i c e s , 1987) a t 47 ( t a b l e 4-1) [ h e r e i n a f t e r " E c o n o m i c C o u n c i l o f C a n a d a , 1987"] f o r d e t a i l s o f t h e s e f a i l u r e s . A l t h o u g h t h e powers needed by r e g u l a t o r y a g e n c i e s t o d e a l with the f a i l u r e s o f these other types o f f i n a n c i a l i n s t i t u t i o n s a r e i n many ways c o m p a r a b l e t o t h e p o w e r s n e e d e d i n t h e c o n t e x t o f b a n k f a i l u r e s , t h i s p a p e r w i l l be r e s t r i c t e d t o an e x a m i n a t i o n o f bank f a i l u r e s .  3  3. Canadian bank i n s o l v e n c y l e g i s l a t i o n as i t e x i s t e d p r i o r t o J u l y , 1987, w i l l be o u t l i n e d and i t s o p e r a t i o n examined i n t h e c o n t e x t o f c a s e s t u d i e s o f t h r e e banks: Canadian Commercial Bank ("CCB"), N o r t h l a n d Bank ("Northland") and t h e Bank o f B r i t i s h Columbia (Bank o f  B.C); 4. The adequacy and a p p r o p r i a t e n e s s o f Canadian bank i n s o l v e n c y l e g i s l a t i o n w i l l be e v a l u a t e d and t h e c o n c l u s i o n reached t h a t reform i s e s s e n t i a l ; 5. I n a t t e m p t i n g t o d e v e l o p a model f o r such r e f o r m , the American approach t o bank i n s o l v e n c y w i l l be examined and compared t o t h e Canadian approach; 6. The model w i l l be f u r t h e r d e v e l o p e d by examining p r o p o s a l s on t h e Canadian b a n k i n g sytem p u t f o r t h i n two s t u d i e s commissioned by t h e f e d e r a l government. C o n c l u s i o n s w i l l be reached on t h e d i r e c t i o n s which r e f o r m s h o u l d t a k e , and a model f o r such r e f o r m w i l l be proposed; 7. F i n a l l y , t h e c o n c l u s i o n s r e a c h e d i n c h a p t e r 6 w i l l be used t o a s s e s s f i n a n c i a l s e c t o r reforms i n t r o d u c e d i n two r e c e n t p i e c e s o f f e d e r a l l e g i s l a t i o n : An A c t t o Amend C e r t a i n A c t s Relating; t o F i n a n c i a l I n s t i t u t i o n s (S.C. 1987, c.26) and t h e F i n a n c i a l I n s t i t u t i o n s and D e p o s i t I n s u r a n c e System Amendment A c t (S.C. 1987, c.23) .  4 CHAPTER  1.  CAUSE  FOR  CONCERN?  U n l e s s t h e Canadian f i n a n c i a l system can be e x p e c t e d t o s u f f e r more bank f a i l u r e s  i n t h e f u t u r e , an argument i n  f a v o u r o f expanded government powers t o d e a l w i t h such f a i l u r e s becomes a moot p o i n t . been c i t e d 1985,  A v a r i e t y o f r e a s o n s has  f o r t h e bank f a i l u r e s which have o c c u r r e d  including:  since  inadequate management, l a c k o f  d i v e r s i f i c a t i o n i n loan p o r t f o l i o s , h i t Western Canada i n 1981. when examined on i t s f a c t s ,  3  and t h e r e c e s s i o n which  Undoubtedly, each f a i l u r e , can be e x p l a i n e d by t h e  i n t e r a c t i o n o f a number o f c o n t r i b u t i n g f a c t o r s . s u b m i t t e d , however,  It is  t h a t many o f t h e s e f a c t o r s a r e m e r e l y  symptoms o f an u n d e r l y i n g c a u s a l f a c t o r :  the federal  government's r e c e n t p o l i c y o f i n c r e a s i n g c o m p e t i t i o n among Canadian f i n a n c i a l  institutions.  Between  1923 and t h e mid-  1960 's, t h e Canadian b a n k i n g i n d u s t r y e x p e r i e n c e d stability.  relative  The number o f banks remained f a i r l y c o n s t a n t  (11  a t t h e end o f 1925 t o a low o f 8 i n 1961; w i t h t h e f o r m a t i o n o f o n l y one new b a n k — 1953).  4  t h e M e r c a n t i l e Bank o f Canada i n  I n t h e mid-1960's,  t h e f e d e r a l government  embarked  on a p o l i c y o f i n c r e a s i n g c o m p e t i t i o n i n t h e f i n a n c i a l sector—  a p o l i c y which remains a p r i o r i t y o f t h e  government's f i n a n c i a l of t h i s p o l i c y  s e c t o r p o l i c y today.  i s t r a c e d below.  The development  The approach has been t o  i n c r e a s e t h e number o f banks i n the m a r k e t p l a c e (and t h e r e b y 3 Economic C o u n c i l o f Canada, 1987, supra, note 2 a t 46-49. 4 E s t e y , supra, note 1 a t 359-363.  5 i n c r e a s e c o m p e t i t i o n among banks) and t o d e r e g u l a t e t h e financial pillars,  s e c t o r by b r e a k i n g down t h e t r a d i t i o n a l thereby  other f i n a n c i a l  four  i n c r e a s i n g c o m p e t i t i o n between banks and institutions.  i n c r e a s i n g number o f bank  The e f f e c t  has been an  failures.  I t i s t h e s m a l l banks which have tended  to f a i l ,  due t o  t h e tendency o f s m a l l banks t o l a c k adequate l o a n diversification  and a broad base o f d e p o s i t s .  characteristics  can be viewed as m a n i f e s t a t i o n s o f  5  These  c o m p e t i t i o n r a t h e r than t h e a c t u a l cause o f f a i l u r e . example, reasons  For  c i t e d by t h e E s t e y Commission i n i t s r e p o r t  of August, 1986 ( t h e " E s t e y Report") f o r t h e f a i l u r e o f t h e CCB  i n c l u d e d poor l e n d i n g p r a c t i c e s ,  6  and inadequate  diversification.  7  characteristics  o f t h e CCB were symptomatic o f t h e  competition  I t can be argued t h a t  loan  these  f a c e d by t h e bank when i t was formed. The bank  attempted t o occupy a n i c h e which was c o n s i d e r e d  unoccupied  by t h e e s t a b l i s h e d banks b u t , i n r e t r o s p e c t , was n o t .  8  In  o r d e r t o c r e a t e b u s i n e s s and t h e r e b y compete w i t h t h e e s t a b l i s h e d banks, t h e CCB was f o r c e d t o l e n d where t h e s e banks r e f u s e d t o l e n d It  i s submitted  unoccupied  (thereby c r e a t i n g i t s own  market).  9  t h a t i t was t h i s need t o compete and f i n d an  niche that necessitated the c r e a t i o n of a high-  5 Coopers and Lybrand, A Study t o Assess t h e C u r r e n t Mandate and O p e r a t i o n s o f t h e I n s p e c t o r G e n e r a l o f Banks (Toronto, 1986) a t 29 [ h e r e i n a f t e r "Coopers and "Lybrand"]. 6 E s t e y , supra, note 1 a t 11. 7 I b i d , a t 417. 8 I b i d , a t 2. 9 I b i d , a t 71.  6 r i s k l o a n p o r t f o l i o which c o u l d not w i t h s t a n d  the r e c e s s i o n  i n Western Canada and u l t i m a t e l y l e d t o t h e CCB's c o l l a p s e . . The r e g u l a t o r y approach o f i n c r e a s i n g c o m p e t i t i o n i n the  f i n a n c i a l s e c t o r emerged i n 1964 w i t h t h e p u b l i c a t i o n o f  t h e R o y a l Commission on Banking and F i n a n c e Commission").  The P o r t e r Commission proposed a  comprehensive r e f o r m  o f Canadian f i n a n c i a l markets,  s t r e s s i n g e f f i c i e n c y and i n n o v a t i o n . competition  (the " P o r t e r  among f i n a n c i a l  I t recognized  that i f  i n s t i t u t i o n s was t o be  encouraged, t h e r e s t r i c t i o n s on t h e a b i l i t y o f banks t o compete would have t o be  removed.  10  Many o f t h e P o r t e r Commission's p r o p o s a l s  were  implemented i n t h e 1967 r e v i s i o n s t o t h e Bank A c t .  The  e f f e c t o f t h i s A c t was t o g r a n t banks g r e a t e r freedom t o compete.  F o r example, i t p e r m i t t e d  conventional  banks t o make  mortgage l o a n s , a l l o w e d  f o r t h e removal o f t h e  c e i l i n g on bank l o a n r a t e s i n t h r e e s t a g e s ,  limited  i n v e s t m e n t s i n t r u s t companies i n o r d e r t o p r e v e n t c o n c e n t r a t i o n i n t h e f i n a n c i a l s e c t o r , and  bank further  prevented  i n t e r l o c k i n g d i r e c t o r s h i p s and c o l l u s i v e b e h a v i o u r between banks and o t h e r  financial  In 1976, t h e W h i t e  institutions.  1 1  P a p e r on t h e R e v i s i o n o f B a n k i n g  L e g i s l a t i o n r e a f f i r m e d the government's commitment t o increase competition  i n the f i n a n c i a l  sector:  10 H.H.Binhammer, Money, Banking & t h e C a n a d i a n F i n a n c i a l System (Toronto: Methuen P u b l i c a t i o n s , 1968) a t 137. 11 Canada, Department o f Finance, The R e g u l a t i o n o f C a n a d i a n F i n a n c i a l I n s t i t u t i o n s : Proposals f o r D i s c u s s i o n (Ottawa: M i n i s t e r o f Supply and S e r v i c e s , A p r i l , 1985) [ h e r e i n a f t e r the "Green Paper"] a t 22.  7  [Competition] remains t h e b a s i c u n d e r l y i n g o b j e c t i v e o f t h e government i n i t s approach t o banking l e g i s l a t i o n . . . An adequate l e v e l o f c o m p e t i t i o n w i l l h e l p t o ensure t h a t banking s e r v i c e s a r e p r o v i d e d , throughout t h e n a t i o n , a t t h e lowest c o s t t o borrowers and t h e h i g h e s t r e t u r n t o s a v e r s t h a t a r e c o n s i s t e n t w i t h t h e s u r v i v a l and h e a l t h y growth o f t h e c o u n t r y ' s f i n a n c i a l system. 2  . The r e v i s i o n s t o t h e 1980 Bank A c t f u r t h e r r e f l e c t e d t h i s p o l i c y o f i n c r e a s e d c o m p e t i t i o n by e a s i n g t h e b a r r i e r s o f e n t r y i n t o t h e banking  system.  The new A c t encouraged  t h e f o r m a t i o n o f new banks i n s e v e r a l ways.  F o r example, i t  made i t e a s i e r f o r Canadians t o s t a r t a bank by p e r m i t t i n g i n c o r p o r a t i o n by l e t t e r s p a t e n t p r i v a t e member's b i l l ) .  (no l o n g e r r e q u i r i n g a  I t a l s o p e r m i t t e d wholly-owned  f o r e i g n bank s u b s i d i a r i e s t o o p e r a t e  i n Canada as c h a r t e r e d  banks and a l l o w e d newly-formed domestic  banks t o be c l o s e l y -  h e l d f o r t e n y e a r s i n o r d e r t o g i v e them a chance t o grow and become new s o u r c e s o f c o m p e t i t i o n . 1980 The 1985  The e f f e c t o f t h e  Bank A c t was summed up i n t h e Department o f F i n a n c e ' s , R e g u l a t i o n o f Canadian F i n a n c i a l  Institutions of A p r i l ,  ( t h e "Green Paper") as f o l l o w s : A l l o f t h e s e measures had t h e e f f e c t o f making e n t r y i n t o banking e a s i e r and o f promoting c o m p e t i t i o n i n t h e f i n a n c i a l system.  12 Canada, Department o f F i n a n c e , White Paper on t h e R e v i s i o n o f Canadian Banking L e g i s l a t i o n (Ottawa: M i n i s t e r o f Supply and S e r v i c e s , August, 1976) a t 16. 13 Green Paper, supra, note 11 a t 22.  8 The  number o f  1967 of  to  the  a c t i v e banks  s i x t y n i n e by 1980  The  r e v i s i o n s to  sector  continued  since  Department  of  promotion of financial  1980.  scope to  i n the  increased  The  1 5  the  The  of  w o u l d be  that  some  (S.C.  1986,  legislation  this to  was  (section  Act  c.26). to  authority  Of  failure to  the  or  merger.  e v i d e n c e d by the  new Competition  this  new  encourage competition  pre-existing interbank  Director  C o o p e r s and L y b r a n d , s u p r a , G r e e n P a p e r , s u p r a . n o t e 11  of  increasing  s i g n i f i c a n c e i s the  scope of  services  financial  purpose of  and  given  a  policy  The  f o r example, of  reflect  i n 1986:  stated  of  in  fact  that  competition  agreements are  Investigation  note 5 at a t 2.  the  of  financial  introduced  19(1)).  banks—  further  "maintain  expanded the  include  under the  14 15  through  the  the  efficiency in  the  f e d e r a l g o v e r n m e n t ' s commitment  legislation  goal  i n s t i t u t i o n s w o u l d be  risk  competition  has  Green Paper,  some d e g r e e  long-term  among b a n k s was  Canada"  and  Green Paper d i d  competition  this  competition  important  innovation  would d i s a p p e a r ,  a result  pursue  i n the  one  financial  competition  institutions  example,  I t recommended  in  1 4  intention to  as  from n i n e  l a r g e l y as  o f f e r a wider v a r i e t y of  past. that  1985,  Act.  listed  whereby  increased  increasing  For  competition,  sector.  recognition  Act  of  the  p o l i c y of  Finance  deregulation,  than  end  f e d e r a l government's  financial  greater  the  i n Canada  22.  and  law now  9 R e s e a r c h r a t h e r than the O f f i c e o f the I n s p e c t o r G e n e r a l Banks.  of  1 6  A r e c e n t statement  o f the government's p o l i c y  of  i n c r e a s i n g competition i n the f i n a n c i a l s e c t o r i s contained i n New  D i r e c t i o n s f o r the F i n a n c i a l S e c t o r t a b l e d i n t h e  House o f Commons on December 18, of State f o r Finance  i n which t h e M i n i s t e r  s t r e s s e d t h e promotion o f  as a major p o l i c y g o a l . g o a l was  198 6,  One  way  competition  i t proposed t o a c h i e v e  t o i n c r e a s e t h e powers o f t r u s t ,  l o a n and  this  insurance  companies t o compete w i t h banks i n commercial l e n d i n g , a t r a d i t i o n a l stronghold of the b a n k s . r e s t r i c t i o n s on t r u s t ,  l o a n and  Similarly,  1 7  i n s u r a n c e companies i n the  f i e l d o f consumer l o a n s would be e l i m i n a t e d . paper a l s o recommended t h a t banks, t r u s t ,  1 3  The  l o a n and  companies be a l l o w e d t o o f f e r investment  advice  p o r t f o l i o management s e r v i c e s and  range o f  a c t i v i t i e s through  subsidiaries.  a full  insurance  securities powers  i n s t i t u t i o n s as w e l l as  an expanded range of f i d u c i a r y p o w e r s .  2 0  These p r o p o s a l s  were, f o r t h e most p a r t , implemented i n the D e p o s i t Insurance  policy  and  F u l l networking  1 9  would be made a v a i l a b l e t o f i n a n c i a l  I n s t i t u t i o n s and  portfolio  Financial  System Amendment A c t  An A c t t o Amend C e r t a i n A c t s R e l a t i n g t o  and  Financial  16 B a r r y R. Campbell, "The C o m p e t i t i o n A c t — The S p e c i a l Case o f Banks" (1987) 1 Banking and F i n a n c e Law Review 225 a t 22 6. 17 Canada, M i n i s t e r of S t a t e f o r F i n a n c e , New D i r e c t i o n s f o r t h e F i n a n c i a l S e c t o r ( t a b l e d i n the House of Commons on December 18, 1986) a t 12 [ h e r e i n a f t e r New D i r e c t i o n s ] . 18 I b i d , a t 12. 19 I b i d , a t 13. 20 I b i d , a t 13.  10 I n s t i t u t i o n s , p r o c l a i m e d on J u l y respectively.  2 and J u l y  3, 1987,  This l e g i s l a t i o n i s discussed i n f r a i n chapter  7.  At  t h e same time t h a t  t h e government has been  implementing a p o l i c y o f i n c r e a s e d c o m p e t i t i o n i n t h e f i n a n c i a l sector, the  i t has made some attempts t o c o u n t e r - a c t  e f f e c t s o f c o m p e t i t i o n by i n c r e a s i n g  regulation  supervision  and  of f i n a n c i a l i n s t i t u t i o n s i n order t o protect  t h e i r solvency.  The Green Paper r e c o g n i z e d  improved consumer p r o t e c t i o n  and c o n t r o l  solvency,  o f s e l f - d e a l i n g and  c o n f l i c t s o f i n t e r e s t as important g o a l s and advocated s t r i c t e r regulation  and s u p e r v i s i o n  of f i n a n c i a l  i n s t i t u t i o n s t o achieve these goals. Directions  f o r the Financial  Similarly,  S e c t o r , t h e government  recommended a s t r e n g t h e n i n g o f t h e d i r e c t o r s ' regulation auditors, and  i n New  r o l e i n the  o f f i n a n c i a l i n s t i t u t i o n s , an enhanced r o l e f o r and s t r i c t e r r u l e s w i t h r e s p e c t t o s e l f - d e a l i n g  c o n f l i c t s of interest.  I t a l s o proposed t h e c r e a t i o n o f  a s u p r a - r e g u l a t o r y body, t h e O f f i c e o f t h e S u p e r i n t e n d e n t o f Financial  I n s t i t u t i o n s , which would p o s s e s s more e f f e c t i v e  s u p e r v i s o r y and enforcement powers. The  object of s t r i c t e r supervision  proposed i n Financial  M  such as t h a t  t h e Green Paper and i n New D i r e c t i o n s  Sector  f o r the  (and implemented i n t h e r e c e n t l e g i s l a t i v e  21 The O f f i c e o f t h e S u p e r i n t e n d e n t o f F i n a n c i a l I n s t i t u t i o n s was c r e a t e d by t h e F i n a n c i a l I n s t i t u t i o n s and D e p o s i t Insurance System Amendment A c t . T h i s new r e g u l a t o r y body i s d i s c u s s e d i n c h a p t e r 7.  11  reforms),  i s to give greater capacity to regulators to  impending c r i s e s t h r o u g h g r e a t e r powers and  i n s p e c t i o n and  supervisory  t o p r e v e n t p o t e n t i a l i n s o l v e n c i e s t h r o u g h more  p o w e r f u l enforcement t e c h n i q u e s . t h a t the e f f e c t s o f c o m p e t i t i o n o f t h e r e g u l a t o r y regime.  I t i s s u b m i t t e d , however, are e s s e n t i a l l y  Regulation  r e l i e d upon t o p r e v e n t f a i l u r e s . by t h e Canadian B a n k e r s  1  System o f Bank R e g u l a t i o n  independent  can c o n t r o l c e r t a i n  e x c e s s e s which c o u l d l e a d t o i n s o l v e n c y ,  January,  spot  but  cannot  be  T h i s i s the approach taken  A s s o c i a t i o n i n i t s Comments on and  Supervision  The  i n Canada of  1986:  . . . r e g u l a t o r y s u p e r v i s i o n cannot p r e v e n t e i t h e r human o r i n s t i t u t i o n a l f a i l u r e . The market system must be a l l o w e d t o work t h r o u g h the f o r c e s o f competition. F a i l u r e i s an o c c a s i o n a l consequence o f t h e c o m p e t i t i v e adjustment p r o c e s s o f the market. 2 2  That i n c r e a s e d  s u p e r v i s i o n cannot be  considered  a  cure  f o r the e f f e c t s of competition  i s i l l u s t r a t e d by  the  American e x p e r i e n c e .  system employs an  intensive  The  U.S.  system o f bank s u p e r v i s i o n and successful record three on  i n preventing  i n s p e c t i o n but has bank i n s o l v e n c i e s .  f e d e r a l r e g u l a t o r y a g e n c i e s i n the U n i t e d  four supervisory  techniques:  p r u d e n t i a l reports provided o n - s i t e s a f e t y and  not had  a  The  States  rely  a wide v a r i e t y o f d e t a i l e d  by the banks on a r e g u l a r b a s i s ;  soundness examinations conducted  by  agency i n s p e c t o r s r e s u l t i n g i n a comprehensive bank r e p o r t 22 Canadian Bankers' A s s o c i a t i o n , Comments on the System of Bank R e g u l a t i o n and S u p e r v i s i o n i n Canada (January, 1 9 8 6 ) .  12  and  a rating  b e i n g a s s i g e d t o the bank;  computer-assisted  s u r v e i l l a n c e programs used t o d i s c o v e r s i g n s o f problems;  and  a v a r i e t y of enforcement powers t o remedy  u n s a f e p r a c t i c e s o r c l o s e problem b a n k s . comprehensive and  and  this  financial  138  in 1986.  2 4  i t i s n o t c e r t a i n t h a t more i n t e n s i v e s u p e r v i s i o n  w i l l p r e v e n t bank f a i l u r e s effects  Despite  2 3  onerous s u p e r v i s i o n , t h e U.S.  system s u f f e r e d 118 bank f a i l u r e s i n 1985 Therefore,  developing  i n the f u t u r e o r c o u n t e r - a c t  o f t h e government's p o l i c y  the  of i n c r e a s i n g competition  i n the f i n a n c i a l s e c t o r .  Conclusion T h e r e f o r e , t h e r e has been a d i s t i n c t t r e n d i n f i n a n c i a l sector policy financial  toward t h e p r o m o t i o n o f c o m p e t i t i o n among  institutions.  the r e s t r i c t i o n s  T h i s has been f a c i l i t a t e d  f o r e n t r y f o r new  the f u n c t i o n a l d i s t i n c t i o n s financial  institutions.  Canadian banks w i l l have e v e r f a c e d . strengthened,  As non-bank i n s t i t u t i o n s t r a d i t i o n a l banking  be  continue functions, they  Even i f the s u p e r v i s o r y p r o c e s s i s  as l o n g as t h e r e are i n c r e a s i n g numbers of  from o t h e r f i n a n c i a l  likelihood,  of  e x p e r i e n c e more c o m p e t i t i o n than  banks which a r e f a c i n g i n c r e a s e d c o m p e t i t i o n and  easing  banks and b r e a k i n g down  between v a r i o u s t y p e s  t o g a i n more power t o perform  by  institutions,  from each o t h e r  there w i l l ,  some f a l l o u t — p a r t i c u l a r l y  of small,  in a l l new  23 E s t e y , supra, note 1 a t 391-392. For more d e t a i l s on the American system of r e g u l a t i o n , see c h a p t e r 5 h e r e i n . 24 Gordon F.Boreham, "Banking i n Canada and t h e USA: Some Comparisons" (1987) 94 Canadian Banker 6 a t 11.  13 banks.  In f a c t ,  the M i n i s t e r of State  f o r Finance,  Thomas  H o c k i n r e c e n t l y i n d i c a t e d t h a t t h i s was t h e e x p e c t e d when he s t a t e d , i n t h e c o n t e x t financial should  o f h i s government's proposed  sector l e g i s l a t i o n , that:  p r e v e n t some r o t t i n g  This very  apples  real possiblity  "No l e g i s l a t i o n can o r from f a l l i n g o f f t h e  o f f u t u r e bank f a i l u r e s has  made i t i m p o r t a n t f o r t h e government t o have c l e a r , and  appropriate  powers t o d e a l e f f e c t i v e l y w i t h  o f a c t u a l o r imminent bank  result  a  adequate situation  insolvency.  25 Bruce C o n s t a n t i n e a u , " L e t ' R o t t i n g A p p l e s ' F a l l , Says", The Vancouver Sun (March 5, 1987) a t B - l .  Hockin  14 CHAPTER  2.  Before  RATIONALE  FOR  BANK  BAILOUTS  examining t h e r a t i o n a l e f o r government  i n t e r v e n t i o n i n c a s e s o f bank i n s o l v e n c y "bailout"),  i t i s important t o d e f i n e t h e t y p e s o f  i n t e r v e n t i o n t h a t w i l l be d e s c r i b e d "bailout".  Essentially,  afloat  resources  where:  a) government  a r e used t o keep a f a i l i n g  or to f a c i l i t a t e  i t s merger w i t h  o r b) c l i e n t s o f i n s t i t u t i o n s compensated o u t o f p u b l i c  Traditionally,  i n t h i s paper as a  t h e concept o f a b a i l o u t w i l l be  used t o i n c l u d e any s i t u a t i o n financial  ( i . e . a bank  institution  a viable institution  t h a t have f a i l e d a r e  funds.  1  t h e banking i n d u s t r y has been s u b j e c t t o  government i n t e r v e n t i o n i n t h e form o f r e g u l a t i o n and supervision. banks  T h i s has d e v e l o p e d o u t o f a p e r c e p t i o n  (and o t h e r  different  financial  institutions)  from o t h e r b u s i n e s s e s  differently.  2  I t i s basically  b a i l i n g o u t banks w h i l e  a r e somehow  and s h o u l d  be t r e a t e d  t h i s reason t h a t  l e t t i n g ordinary  that  justifies  i n d u s t r i a l and  1 The l a t t e r a s p e c t o f t h i s d e f i n i t i o n would i n c l u d e payouts of i n s u r e d c l a i m s under p u b l i c d e p o s i t i n s u r a n c e schemes. A l t h o u g h t h e d e p o s i t i n s u r a n c e fund i s funded by premiums a s s e s s e d a g a i n s t i n s u r e d i n s t i t u t i o n s , t h e premium, i s i n d i r e c t l y p a i d by t h e u s e r s o f f i n a n c i a l s e r v i c e s ( i n t h e form o f i n c r e a s e d c o s t f o r t h o s e s e r v i c e s ) . T h i s c l a s s i s as wide as t h e t a x p a y e r c l a s s and, t h e r e f o r e , t h e d e p o s i t i n s u r a n c e scheme i s u l t i m a t e l y funded by p u b l i c funds. 2 George B. Balamut, "A M o r a l i t y T a l e : E v e r y t h i n g ' s Got a Moral I f Only You Can F i n d I t " (1975) 27 Ad L Rev 343 a t 3 45, note 5.  15 commercial c o r p o r a t i o n s  succeed o r f a i l  as t h e market  dictates. Two  c h a r a c t e r i s t i c s o f banks d i s t i n g u i s h them from non-  f i n a n c i a l corporations treatment: supplied  a) t h e f a c t t h a t much o f t h e i r c a p i t a l i s  by d e p o s i t o r s  financial  system.  and b) t h e i r i m p o r t a n t r o l e i n t h e  Out o f t h e s e c h a r a c t e r i s t i c s , i t i s  s u b m i t t e d , f l o w two banks:  and j u s t i f y t h e i r d i f f e r e n t i a l  fundamental r a t i o n a l e f o r b a i l i n g out  1) consumer p r o t e c t i o n  and 2) maintenance o f t h e  s t a b i l i t y o f t h e f i n a n c i a l system. j u s t i f y t h e ongoing r e g u l a t i o n  These two r a t i o n a l e  and s u p e r v i s i o n  also  o f banks.  It  i s s u b m i t t e d t h a t t h e r e i s an a d d i t i o n a l r a t i o n a l e f o r b a i l i n g out b a n k s —  one t h a t  includes  s o c i a l and economic c o n s i d e r a t i o n s government described examined  1.  operating  i n the  b a i l o u t s o f any b u s i n e s s — which w i l l as " p u b l i c b e n e f i t " .  be  Each o f t h e s e r a t i o n a l e i s  below.  Consumer  Protection  The ground o f consumer suppliers  protection—  of c a p i t a l to b a n k s —  fundamental j u s t i f i c a t i o n capital suppliers depositors, holders  the type of p o l i t i c a l ,  i s often  the p r o t e c t i o n  of  c i t e d as a  f o r bank r e g u l a t i o n .  A bank's  a r e comprised o f t h r e e groups:  creditors  (secured and unsecured) and  ( i . e . shareholders).  Government i n t e r v e n t i o n i s  aimed a t b e n e f i t t i n g a bank's d e p o s i t o r s shareholders or c r e d i t o r s .  equity-  as opposed t o i t s  Depositors possess s p e c i a l  16 c h a r a c t e r i s t i c s which j u s t i f y t h e i r p r o t e c t i o n by t h e government w h i l e i n d u s t r i a l and commercial e n t e r p r i s e s a r e allowed t o f a i l .  The consumer p r o t e c t i o n c o n c e r n s which  j u s t i f y p r e f e r e n t i a l treatment o f d e p o s i t o r s suppliers of c a p i t a l to ordinary corporations  as compared t o  commercial and i n d u s t r i a l  w i l l be examined f i r s t .  Then, t h e consumer  p r o t e c t i o n r a t i o n a l e w i l l be a p p l i e d t o t h e o t h e r  suppliers  o f bank c a p i t a l ( i . e . s h a r e h o l d e r s and c r e d i t o r s )  i n order  t o d e t e r m i n e whether t h e s e same c o n c e r n s a r e a p p l i c a b l e .  a)  Depositors Depositors,  as a c l a s s , d i f f e r  f u n d a m e n t a l l y from  s u p p l i e r s o f debt and share c a p i t a l t o n o n - f i n a n c i a l corporations. "The  As R.C. C l a r k p o i n t e d  out i n h i s a r t i c l e ,  Soundness o f F i n a n c i a l I n s t i t u t i o n s " , i n v e s t o r s i n  ordinary  i n d u s t r i a l corporations  come " p r e d o m i n a n t l y from an  e l i t e group o f p e r s o n s who i n h a b i t t h e h i g h e r b r a c k e t s o f income o r w e a l t h " . intermediaries,  3  ' The s u p p l i e r s o f c a p i t a l t o f i n a n c i a l  on t h e o t h e r hand, come from a broad c l a s s  which c o n s i s t s o f v i r t u a l l y e v e r y a d u l t — Clark contrasts  4  capital suppliers to financial  intermediaries—a  t r u l y public class of c a p i t a l s u p p l i e r s —  w i t h t h e e l i t e c l a s s which s u p p l i e s industrial  r i c h and p o o r .  c a p i t a l to ordinary  corporations.  3 R.C.Clark, "The Soundness o f F i n a n c i a l I n s t i t u t i o n s " (1976) 86 Y a l e Law J o u r n a l 1 a t 11 [ h e r e i n a f t e r " C l a r k " ] . 4 I b i d , a t 11.  17 In Canada, C l a r k ' s d i s t i n c t i o n can be u s e f u l l y a p p l i e d t o bank d e p o s i t o r s and  i n v e s t o r s i n o r d i n a r y commercial  i n d u s t r i a l corporations. had  a personal  public c l a s s .  5  savings  In 1984,  o f Canadians  account i n a c h a r t e r e d b a n k —  In a d d i t i o n , the v a s t m a j o r i t y o f  a c c o u n t s were r e l a t i v e l y s m a l l . composition  85 p e r c e n t  of personal 18.1  savings  and  truly a  these  For example, i n 1984,  the  a c c o u n t s o f c h a r t e r e d banks  was  as f o l l o w s :  m i l l i o n accounts o f l e s s t h a n $1,000;  9.8  m i l l i o n w i t h amounts between $1,000 and  m i l l i o n t o t a l l i n g between $10,000 and w i t h amounts e x c e e d i n g $100,000.  6  In c o n t r a s t , o n l y 10 p e r c e n t equity i n corporations.  7  The  $99,999; and  With the average  account c o n t a i n i n g $3,429, i t can be d e p o s i t o r s a r e , on average, s m a l l  $9,999;  2.7 58,000 savings  s a i d t h a t Canadian  savers. o f Canadians own  share  Economic C o u n c i l o f Canada  d e s c r i b e d t h i s l a t t e r c l a s s as f o l l o w s : The owners o f shares i n p u b l i c l y t r a d e d companies...tend t o be i n h i g h e r - i n c o m e and h i g h e r e d u c a t i o n groups and r e s i d e m o s t l y i n l a r g e r urban centres.8  C l e a r l y , t h i s can be c o n s i d e r e d  an  "elite class" in  comparison t o the average bank d e p o s i t o r .  5 Economic C o u n c i l o f Canada, 1987, supra, c h a p t e r 1, note 2 a t 64. 6 Canadian Bankers' A s s o c i a t i o n , Bank F a c t s / 8 5 : The C h a r t e r e d Banks o f Canada (1985). 7 Economic C o u n c i l of Canada, supra, c h a p t e r 1, note 2 a t 64. 8 I b i d , a t 64.  18 A r i s i n g out o f the d i f f e r e n t c o m p o s i t i o n c l a s s e s , a r e s e v e r a l r e a s o n s e x p l a i n i n g why require special protection. the s a v i n g s savings,  First,  the  o f the  two  depositors  funds c o n t a i n e d  account o f the average d e p o s i t o r r e p r e s e n t  i . e . non-disposable  debt c a p i t a l  income.  Owners o f share  i n n o n - f i n a n c i a l c o r p o r a t i o n s , on the  hand, t e n d t o be  investing discretionary income—  they can more r e a d i l y a f f o r d t o I p s e .  life and  other income  As a r e s u l t ,  9  losses  caused by bank i n s o l v e n c y w i l l have a g r e a t e r d i s u t i l i t y d e p o s i t o r s t h a n s i m i l a r l o s s e s s u f f e r e d by o r d i n a r y investors.  1 0  d e p o s i t s can  To p r e v e n t inflict,  for  capital  the d e v a s t a t i n g e f f e c t s t h a t  depositors are p r o t e c t e d  in  lost  through  government i n t e r v e n t i o n . A second j u s t i f i c a t i o n  for protecting depositors arises  from t h i s p u b l i c c l a s s ' s l a c k o f a c c e s s i n f o r m a t i o n about d e p o s i t o r y to  adequate f i n a n c i a l  institutions.  information,  of Finance  T h i s c o n c e r n was  financial Without exposure  i t i s impossible  d e p o s i t o r s t o a s s e s s the r i s k i n e s s o f alternatives.  to  for  investment  r e f l e c t e d by the  Department  i n the Green Paper: M i l l i o n s of Canadians have e n t r u s t e d t h e i r s a v i n g s to f i n a n c i a l i n s t i t u t i o n s and a l a r g e p r o p o r t i o n o f them know l i t t l e , i f a n y t h i n g , about the r i s k s t h o s e i n s t i t u t i o n s are i n c u r r i n g i n the course of t h e i r business d e a l i n g s . 1 1  9 C l a r k , supra, note 3 a t 21. 10 I b i d , a t 21. 11. Green Paper, supra, c h a p t e r  1, note 11 a t  12.  19 Several  f a c t o r s c o n t r i b u t e t o the  f a c e d by d e p o s i t o r s : financial  information;  motivation  t o make use  informational  barrier  i ) the c o s t o f o b t a i n i n g and i i ) depositors' of f i n a n c i a l  assessing  l a c k of the  information;  necessary  and i i i )  r e l u c t a n c e on the p a r t o f r e g u l a t o r y b o d i e s t o compel financial  i n s t i t u t i o n s to d i s c l o s e pertinent  i ) Cost:  F o r s m a l l d e p o s i t o r s , the s i z e o f  information, their  investment does not w a r r a n t t h e c o s t s a s s o c i a t e d o b t a i n i n g and  assesssing  with  investment i n f o r m a t i o n .  As  Clark  put i t : ... t h e c o s t s of o b t a i n i n g a c c u r a t e , r e l e v a n t , i n t e l l i g i b l e , and p e r s o n a l l y u s a b l e i n f o r m a t i o n about the r i s k s o f a l t e r n a t i v e i n v e s t m e n t s i n f i n a n c i a l intermediaries i s excessively high for many p u b l i c s u p p l i e r s o f c a p i t a l , i n r e l a t i o n t o the amounts t o be i n v e s t e d . 1 2  It  i s not c o s t - e f f i c i e n t  investment a d v i c e due d e p o s i t and  f o r the d e p o s i t o r t o seek  t o the s m a l l s i z e o f the  average  the tendency o f f i n a n c i a l a d v i s e r s t o t i e the  s a l e of f i n a n c i a l products to f i n a n c i a l advice. investment a d v i c e for  expensive, i t i s probably  a s m a l l s a v e r t o o b t a i n than f o r an  Not  only i s  more d i f f i c u l t  investor:  F i n a n c i a l p l a n n e r s have shown l i t t l e i n t e r e s t i n t a k i n g b u s i n e s s from persons w i t h an annual g r o s s income o f l e s s t h a n $30,000 because of t h e i r l i m i t e d c a p a c i t y t o purchase more s o p h i s t i c a t e d f i n a n c i a l products. Thus persons o f more modest means may have more d i f f i c u l t y i n o b t a i n i n g adequate  12.  Clark,  supra,  note 3 a t  15.  20 i n f o r m a t i o n o r i n g a i n i n g access f i n a n c i a l p r o d u c t s . 13  t o c e r t a i n types  C e r t a i n l y the average d e p o s i t o r would l a c k the s o p h i s t i c a t i o n and/or the time t o make an  of  financial  assessment  themselves. In c o n t r a s t t o t h i s are t h e i n v e s t o r s i n n o n - f i n a n c i a l corporations—  the e l i t e s u p p l i e r s o f c a p i t a l —  i s c o s t - e f f i c i e n t to assess  (or t o have assessed)  f i n a n c i a l i n f o r m a t i o n d i s c l o s e d by c o r p o r a t i o n s making investment d e c i s i o n s due risk.  to assess  can j u s t i f y the c o s t o f f i n a n c i a l i i ) Motivation: depositors  before  financial  financial  information  or  advice.  An a d d i t i o n a l i n f o r m a t i o n a l b a r r i e r f a c i n g  i s the m o t i v a t i o n  t o make use  of  financial  I n t h e c a s e o t d e p o s i t o r s , tn.e. T ^ c ^ s s ^ c p j  information. motivation  the  t o the l a r g e amounts a t  These i n v e s t o r s e i t h e r p o s s e s s t h e  s o p h i s t i c a t i o n necessary  f o r whom i t  may  be l a c k i n g because they g e n e r a l l y do  not  p e r c e i v e themselves as r i s k - t a k e r s — they c o n s i d e r banks as s a f e p l a c e s t o keep t h o s e funds which they can to l o s e .  1 4  Investors  least afford  i n n o n - f i n a n c i a l c o r p o r a t i o n s , on  o t h e r hand, are more l i k e l y t o p e r c e i v e themselves as takers—  they  are i n v e s t i n g l a r g e r sums a t h i g h e r  o r d e r t o earn a h i g h e r  return.  the  risk-  risk in  These f a c t o r s i n s t i l  the  13 Economic C o u n c i l of Canada,1987 supra, c h a p t e r 1, note 2 a t 64. 14 T h i s m o t i v a t i o n a l problem may be on the d e c l i n e as more d e p o s i t o r s have been made aware of r i s k as a r e s u l t of r e c e n t bank (and o t h e r f i n a n c i a l i n s t i t u t i o n ) f a i l u r e .  21  motivation  t o assess  whatever i n f o r m a t i o n  i s a v a i l a b l e and  make investment d e c i s i o n s on t h e b a s i s o f t h a t iii)  Availability:  The t h i r d  f a c t o r c o n t r i b u t i n g to the  i n f o r m a t i o n a l problem f a c e d by d e p o s i t o r s institutional particularly  reluctance information  institutions.  1 5  assessment,  to disclose  i s government and  information—  relating to distressed  This reluctance  i s based on f e a r t h a t t h e  d i s c l o s u r e o f damaging i n f o r m a t i o n  will  cause d e p o s i t o r s t o  withdraw t h e i r funds, t u r n i n g a t h r e a t o f i n s o l v e n c y reality.  into a  D i s c l o s u r e o f b a n k i n g problems has t r a d i t i o n a l l y  been c o n s i d e r e d  by r e g u l a t o r s t o be i n c o n s i s t e n t w i t h t h e  p r o m o t i o n o f a sound and s t a b l e b a n k i n g system. Brainsilver,  general  Insurance Corporation  counsel  6  Edward  t o t h e American F e d e r a l  i n 1975 summed up t h a t  body's p o l i c y w i t h r e s p e c t  1  Deposit  regulatory  t o d i s c l o s u r e as f o l l o w s :  To have c o n t i n u o u s d i s c l o s u r e o f t h e bank's d e t e r i o r a t i n g c o n d i t i o n can, i n o u r o p i n i o n , r e s u l t i n l a r g e r losses to e v e r y o n e — the holders of u n i n s u r e d d e p o s i t s , FDIC's i n s u r a n c e fund, and u l t i m a t e l y t h e r e m a i n i n g s e c u r i t y h o l d e r s who must b e a r t h e b r u n t o f t h e l o s s and o b t a i n t h e i r r e c o v e r y out o f t h e a s s e t s l e f t a f t e r complete l i q u i d a t i o n , and w i t h o u t t h e b e n e f i t o f t h e s u b s t a n t i a l premium t h a t may be p a i d f o r t h e bank's g o i n g c o n c e r n v a l u e . In t h e l o n g run, we f e e l t h a t m e a n i n g f u l d i s c l o s u r e s o f a bank's d e t e r i o r a t i n g c o n d i t i o n would be c o u n t e r p r o d u c t i v e t o t h e b e s t i n t e r e s t s o f most o f t h e concerned persons. 1  7  15 The i s s u e o f d i s c l o s u r e i s d e b a t e a b l e and t h e r e a r e those who argue i n f a v o u r o f i n c r e a s e d d i s c l o s u r e : see, f o r example, John Evans, " D i s c l o s u r e Through a G l a s s D a r k l y " (1975) 27 Ad.L.Rev.357 a t 364. 16 John Evans, supra, note 15 a t 3 62. 17 Edward B r a i n s i l v e r , " F a i l i n g Banks: FDIC's O p t i o n s and C o n s t r a i n t s " (1975) 27 Ad.L.Rev. a t 340 [ h e r e i n a f t e r "Brainsilver"].  22  Therefore,  i f relevant information i s unavailable,  d e p o s i t o r s cannot be expected t o e v a l u a t e financial  i n s t i t u t i o n s a c c u r a t e l y and  decisions accordingly. c a r r y on b u s i n e s s  the r i s k s  base t h e i r  of  investment  T h i s l e a v e s bank management f r e e t o  i n a h i g h - r i s k manner, w i t h o u t  the  d i s c i p l i n e imposed by d e p o s i t o r investment d e c i s i o n s . the need t o p r o t e c t d e p o s i t o r s from such r i s k t h a t b a i l i n g out d e p o s i t o r s who  It is  justifies  l o s e t h e i r i n v e s t m e n t s due  to a  r i s k t h e y c o u l d not have a n t i c i p a t e d . The  Canadian government has  d e p o s i t o r p r o t e c t i o n by  responded t o t h i s need f o r  implementing a system of  deposit  i n s u r a n c e which i n s u r e s a maximum o f $60,000 f o r each d e p o s i t o r i n each i n s u r e d i n s t i t u t i o n . an a r b i t r a r y l i m i t , small  represents  The  $60,000 l i m i t ,  an attempt t o p r o t e c t  the  depositor.  The  d i s c u s s i o n t h u s f a r o f the consumer p r o t e c t i o n  r a t i o n a l e f o r government b a i l o u t s o f banks has  concentrated  on the needs o f average d e p o s i t o r s  depositors)  and  ( i . e . small  t h e comprehensive p r o t e c t i o n a f f o r d e d them by  insurance.  However, t h e r e  i s a subclass within  deposit  the  d e p o s i t o r c l a s s which s h o u l d be examined s e p a r a t e l y : large depositor with difficult  funds i n excess o f $60,000.  I t i s more  t o j u s t i f y p r o t e c t i n g t h e s e d e p o s i t o r s on  p r o t e c t i o n grounds.  This class consists largely  commercial d e p o s i t o r s w i t h d i v e r s i f i e d  the  consumer  of  investments,  and i t  23 i s s u b m i t t e d , t h e r e f o r e , t h a t i t i s more comparable t o C l a r k ' s c l a s s o f e l i t e s u p p l i e r s o f c a p i t a l t h a n the p u b l i c c l a s s he d e s c r i b e s .  1 8  They are b e t t e r a b l e t o w i t h s t a n d  f i n a n c i a l shock o f a bank f a i l u r e t h e i r deposits)  (and the r e s u l t i n g l o s s of  than small d e p o s i t o r s .  are more l i k e l y t o p o s s e s s the necessary to evaluate  financial sophistication  are  economically.  t o t h e s e d i f f e r e n c e s between i n s u r e d and  depositors, deposit  financial  i n v e s t i n g l a r g e enough sums  t h a t such e v a l u a t i o n can be performed Due  Furthermore, t h e y  the r e l a t i v e r i s k s o f  i n s t i t u t i o n s a c c u r a t e l y and  depositors,  uninsured  the consumer p r o t e c t i o n c o n c e r n s which  insurance  the  as a method o f b a i l i n g out  justify  small  do not j u s t i f y s i m i l a r p r o t e c t i o n f o r l a r g e  depositors.  b)  Shareholders Does the consumer p r o t e c t i o n r a t i o n a l e which  p r o t e c t i o n of small depositors shareholders? differ  The  holders  apply  t o a bank's  o f share c a p i t a l  i n fundamental r e s p e c t s  justifies  i n a bank  from i t s d e p o s i t o r s .  18 When C l a r k d e s c r i b e s h i s p u b l i c c l a s s of c a p i t a l s u p p l i e r s t o f i n a n c i a l i n t e r m e d i a r i e s , he does not d i s t i n g u i s h between i n s u r e d and u n i n s u r e d members o f t h i s class. He r e c o g n i z e s t h a t the p u b l i c c l a s s does c o n t a i n some e x t r e m e l y wealthy members (see C l a r k , supra, note 3 a t 11). However, f o r the purpose of t h i s paper, t h e s e l a r g e d e p o s i t o r s are examined s e p a r a t e l y . They are i d e n t i f i e d on the same b a s i s as the government has i d e n t i f i e d them f o r d e p o s i t i n s u r a n c e purposes. I t s h o u l d be noted t h a t t h i s b a s i s of i d e n t i f i c a t i o n i s p r o b l e m a t i c due t o t h e b r o k e r i n g o f d e p o s i t s , i . e . the b r e a k i n g of l a r g e d e p o s i t s i n t o p a r c e l s o f $60,000 and the d i s t r i b u t i o n o f them among a number o f f i n a n c i a l i n s t i t u t i o n s i n o r d e r t o o b t a i n the p r o t e c t i o n of d e p o s i t i n s u r a n c e .  24  Depositors  h o l d an unsecured c l a i m t o t h e i r funds and  s h a r e i n p r o f i t s earned by the bank. motivation  for supplying  money— t h e y are not profit.  1 9  do  not  T h e i r primary  c a p i t a l t o banks i s t o save t h e i r  i n t e n d i n g t o r i s k i t i n o r d e r t o make a  Shareholders,  on the o t h e r hand, do p r o f i t  from  the bank's s u c c e s s e s .  In t h e event o f e x t r a o r d i n a r y  gain,  it  who  rather  i s the shareholders  than the d e p o s i t o r s hand, any initial  (who  liability.  hold fixed claims).  l o s s i n c u r r e d by  investment due  reap e x t r a o r d i n a r y p r o f i t  shareholders  the  other  i s l i m i t e d to  t o the p r i n c i p l e o f  Limited l i a b i l i t y  On  their  limited  p l u s the h i g h debt t o  equity  r a t i o which i s c h a r a c t e r i s t i c o f the c a p i t a l s t r u c u t u r e  of  banks means t h a t more o f the d e p o s i t o r s ' w e a l t h t h a n t h a t the shareholders investments.2 0  i s on t h e l i n e when banks make r i s k y Shareholders,  unlike depositors,  b e n e f i t from e x c e s s i v e r i s k - t a k i n g .  government compensation o f s h a r e h o l d e r s L i k e the s h a r e h o l d e r s  corporations,  tend  to  2 1  Thus, consumer p r o t e c t i o n c o n c e r n s do not  failure.  of  justify  i n t h e event o f bank  of n o n - f i n a n c i a l  t h e y are r i s k - t a k e r s : i f the b u s i n e s s  t h e i r r i s k pays o f f ; i f i t f a i l s ,  thrives,  t h e i r investment i s l o s t .  19 From an economic p o i n t of view, d e p o s i t o r s , l i k e s h a r e h o l d e r s , are r i s k i n g t h e i r funds. Whenever t h e r e i s a r e t u r n , t h e r e i s an a s s o c i a t e d r i s k . However, from a p s y c h o l o g i c a l p o i n t of view, d e p o s i t o r s do not p e r c e i v e themselves as r i s k - t a k e r s . 20 Economic C o u n c i l of Canada, 1987, supra. c h a p t e r 1, note 2 a t 57. 21 C h a r l e s Freedman, "Comments" i n Jacob Z i e g e l , Leonard Waverman, David C o n k l i n , Canadian F i n a n c i a l I n s i t u t i o n s : Changing the R e g u l a t o r y Environment (Toronto: O n t a r i o Economic C o u n c i l , 1985) a t 88 [ h e r e i n a f t e r " Z i e g e l " ] .  25  c)  Bank The  Creditors consumer p r o t e c t i o n  protection its  Clearly,  protected  by  the event  of default.  their  secured c r e d i t o r s  security  rather  creditors  can are  they tend t o resemble  financially-sophisticated than  and  a public  elite  class  class.  realize  capital such,  i t has  required  I t i s more l i k e l y  funds  small depositors.  l o a n e d t o a b a n k by  discretionary unsecured  income r a t h e r  creditors the  disutility  f o r them t h a n  life  failure  o f one  creditor  the  event  o f bank  the  represent  savings. their  do  is  that  Furthermore,  investments  bank would have  and,  less  f o r a small depositor.  does not j u s t i f y  they  been argued,  an u n i n s u r e d d e p o s i t o r , t h e c o n s u m e r  rationale in  than  tend to d i v e r s i f y  therefore,  like  an u n s e c u r e d  in  unprotected  not need t h e p r o t e c t i o n which, by  to  Clark's  of As  2 2  apply  are already  upon w h i c h t h e y  Unsecured  i t i s submitted,  suppliers  justifies  o f a bank's s m a l l d e p o s i t o r s does not  creditors.  but,  r a t i o n a l e which  Therefore,  protection  t h e government b a i l i n g  them  out  failure.  Conclusion Therefore,  t h e r e a r e consumer p r o t e c t i o n  compensating  some s u p p l i e r s  bank f a i l u r e  or  of c a p i t a l  f o r preventing the  i n the  failure  rationale event  from  of  for a  occurring  22 I t s h o u l d be n o t e d t h a t t h e s t a t e m e n t s made v i s a v i s u n s e c u r e d c r e d i t o r s a r e n o t e v i d e n c e d by e m p i r i c a l d a t a — more e m p i r i c a l s t u d y i s r e q u i r e d on t h i s c l a s s o f c a p i t a l suppliers.  in  26 the  f i r s t place.  On. the b a s i s o f consumer p r o t e c t i o n ,  reformed bank i n s o l v e n c y  l e g i s l a t i o n should  p r o t e c t i o n of insured depositors failure.  This i s e f f e c t i v e l y  insurance.  The  2.  at  i n a l l s i t u a t i o n s of bank  achieved  through  deposit  consumer p r o t e c t i o n r a t i o n a l e , however,  cannot j u s t i f y the b a i l i n g out o f an uninsured  aim  depositors,  shareholders  i n s o l v e n t bank's  or  creditors.  S t a b i l i t y o f the F i n a n c i a l System The  second b a s i c j u s t i f i c a t i o n f o r b a i l i n g  d i s t r e s s e d banks l i e s s t a b i l i t y o f the essential  system,  importance o f m a i n t a i n i n g  f i n a n c i a l system.  i n order  c a r r y out t h e i r  i n the  for financial  as f i n a n c i a l  t r a n s f e r r i n g funds from s a v e r s safekeepers and  advice.  o f funds and 2 3  The  banks l e a d i n g t o the the  to  effectively  p a r t s o f the payments transactions  intermediaries ( i . e . t o borrowers) and  s u p p l i e r s of f i n a n c i a l  f e a r i s t h a t the  c r e a t e a domino e f f e c t :  destabilizing  institutions  f a c i l i t a t i n g expeditious  between p a r t i e s ) ,  as information  f a i l u r e o f one  bank w i l l  depositors w i l l lose confidence  f a i l u r e s o f o t h e r banks and  financial system.  2 4  23 2 24 25 2  capital  in  thereby  Banks are more  s u s c e p t i b l e t o f a i l u r e than n o n - f i n a n c i a l o p e r a t i o n s of t h e i r h i g h l y leveraged  the  This s t a b i l i t y i s  f u n c t i o n s as i n t e g r a l  (thereby  out  structure.  2 5  because  The  Economic C o u n c i l of Canada, 1987, supra, c h a p t e r a t 1. Green Paper, supra, c h a p t e r 1, note 11 a t 11. Economic C o u n c i l o f Canada, 1987, supra, c h a p t e r a t 50.  1,  note  1,  note  27 comparatively  small  threatened  any  by  percentage of liabilities Thus,  significant  p a y a b l e on  event of  can  the  forced  result  stability  s a l e of  in  Deposit  Because  insured  settled  promptly  incentive or the still  B.C.  and  suffered CCB  and  deposits,  at  "fire  i s of great  assistance  in  their  event  other  f u n d s on  the  to the  examples are  2 7  be  arising  f o u r months f o l l o w i n g t h e  This  out 1985.  runs.  will  strength  actions  of  of by  Both  be  rumour runs  uninsured the  Bank  of  banks  the  failures  of  the  For  example,  in  the  (representing  2 9  little  However, b a n k  d e c l a r a t i o n of t h e i r  billion  bank  they have  provided  of  maintaining  claims  ("Continental").  i n September,  $2.6  failure,  institutions.  Bank  from c o n t a g i o n Northland  of  in large part recent  time.  sale" prices.  know t h a t  Two  large  most o f i t s  a b a n k may  depositors i n the  a  a short  preventing  due  lost  while  s y s t e m by  Continental  Continental  illiquid  financial  c o l l a p s e of  depositors.  Furthermore,  2 6  is  2 8  t o withdraw t h e i r  occur—  capitalization  demands q u i c k l y e n o u g h , r e s u l t i n g  insolvency.  the  are  on  assets  insurance  of  loss.  this  demand o r w i t h i n  a run  u n a b l e t o meet d e p o s i t o r in  p o r t i o n of  a bank's a s s e t s  are  i n the  equity  insolvency,  almost  one  half  26 O n t a r i o T a s k F o r c e on F i n a n c i a l I n s t i t u t i o n s , F i n a l R e p o r t ( T o r o n t o : November, 1985) [ h e r e i n a f t e r "Dupre"] a t 30. 27 I b i d , a t 30. 2 8 E c o n o m i c C o u n c i l o f C a n a d a , s u p r a . c h a p t e r 1, n o t e 2 a t 46. 29 L a u r e n c e S.Goodman, S h e r r i l l S h a f f e r , "The E c o n o m i c s o f Deposit Insurance: A C r i t i c a l E v a l u a t i o n of Proposed R e f o r m s " (1984) 2 Y.J.Reg.145 a t 148 [hereinafter "Goodman"].  of i t s d e p o s i t s )  i n a bank r u n .  A l a r g e m a j o r i t y of  w i t h d r a w a l s were made by the bank's u n i n s u r e d  these  depositors:  U n l i k e some runs, where d e p o s i t o r s l i n e up a t the door, t h i s one was i n v i s i b l e . Money managers were l e a v i n g i n what's known as a ' f l i g h t t o q u a l i t y ' . They wanted t h e i r money i n l a r g e r , s a f e r i n s t i t u t i o n s and they moved i t i n l a r g e chunks. In the end, the $2.6 b i l l i o n i n l o s s e s came from o n l y 3000 o f t h e bank's 150,000 a c c o u n t s — an average p u l l o u t i n excess o f $ 8 5 , 0 0 0 . 31  Similarily,  the Bank o f B.C.'s d e p o s i t s p l u n g e d $355.6  m i l l i o n i n f i s c a l year  1984-85, e n d i n g O c t o b e r 3 1 .  Once  3 2  a g a i n t h e w i t h d r a w a l s were made almost e n t i r e l y  by  commercial d e p o s i t o r s ; i n f a c t d e p o s i t s h e l d by  small  d e p o s i t o r s i n c r e a s e d throughout t h e Bank o f B.C. Therefore,  t h e p o t e n t i a l f o r banks runs caused by  of d e p o s i t o r confidence C o n t i n e n t a l and  i s v e r y r e a l . , On  Bank o f B.C.  that deposit insurance runs.  crisis.  This observation  Canada i n i t s 1987  experience,  3 3  loss  the b a s i s o f  the  i t would appear  i s not s u f f i c i e n t t o p r e v e n t  bank  i s made by the Economic C o u n c i l  of  Report:  In the r e c e n t i n s o l v e n c i e s i n Canada, d e p o s i t i n s u r a n c e has l i m i t e d the l o s s o f c o n f i d e n c e . But i t has been unable t o p r e v e n t i t c o m p l e t e l y , as w i t n e s s e d by the s h i f t i n d e p o s i t s from s m a l l e r , regional i n s t i t u t i o n s to l a r g e r , n a t i o n a l firms. 4  30 Rod McQueen, "Showing the C o l o u r s " Canadian B u s i n e s s ( A p r i l , 1986) 16 a t 16. 31 I b i d , a t 81. 32 John S c h r e i n e r , " I s Edgar on a K a i s e r R o l l ? " F i n a n c i a l Post Magazine (March 1, 1986) 22 a t 26. 33 I b i d , a t 26. 34 Economic C o u n c i l o f Canada,1987, supra, c h a p t e r 1, note 2 a t 51.  29  It  i s submitted  bank  that i n circumstances  run i s a r e a l  bailing  o u t a bank  banking  community  may  well affect  financial  risk,  t h e government  i s closely  all.  there  i s value  conflicting  when t h e r i s k  important  never  Political  business explain and  entitled,  Michael  This  i s not t o  or that  out, but there which  i n the system.  The  Political  Economy o f  by t h e C a n a d i a n government  government  decisions to bail  The  study  for bailouts,  intervention  the market without  such  i n an e f f o r t  o u t some f a i l i n g  on a t h e o r e t i c a l  level.  for bailouts  in situations  Business  a number o f  examines economic and  t h a t t h e economic r a t i o n a l e  government  bank  subordinated  to f a i l  T r e b i l c o c k e t a l . examine  bailouts  rationale  be  Benefit  not others.  argued  i s high.  be a l l o w e d  i n them.  f o r avoiding the kind of i n s t a b i l i t y  In a study Bailouts.  bank  system should  h a v e t o be  w o u l d weaken d e p o s i t o r c o n f i d e n c e  3.  o f one  confidence  d e p o s i t o r s s h o u l d a l w a y s be b a i l e d  good r e a s o n  The  f u n c t i o n s and,  of the f i n a n c i a l  failure  in  players i n the  i n maintaining  interests  of systemic  t h a t banks s h o u l d  uninsured is  and f a i l u r e  g o a l o f t h e g o v e r n m e n t when r e s o l v i n g  failures—  say  destabilizing  stability.  Banks, as c e n t r a l  Maintaining the s t a b i l i t y a primary  linked  a  is justified  i n order to maintain  system, perform  therefore,  where  where  to  firms  political It is justifies  the operation of  i n t e r v e n t i o n would l e a d  to a  s o c i a l l y undesirable  outcome.  D  The  object of a b a i l o u t i s  t o improve economic e f f i c i e n c y by c o r r e c t i n g market imperfections.  3 6  The  political  r a t i o n a l e i s based on  p u r s u i t of s e l f - i n t e r e s t by p o l i t i c i a n s — intervene  decisions  the  to  are m o t i v a t e d by the d e s i r e t o i n c r e a s e e l e c t o r a l  s u p p o r t t h r o u g h g r a n t i n g b e n e f i t s t o groups o f m a r g i n a l voters.  3 7  When t h e s e t h e o r e t i c a l p r o p o s i t i o n s  a r e a p p l i e d t o case  s t u d i e s o f b u s i n e s s b a i l o u t s , the c o n c l u s i o n b a i l o u t s i n recent the p o l i t i c a l  i s reached  Canadian h i s t o r y a r e more c o n s i s t e n t w i t h  r a t i o n a l e t h a n the e c o n o m i c  3 8  —  i . e . that  b a i l o u t s a r e the r e s u l t o f a s t r a t e g y on the p a r t political  a c t o r s t o seek net p o l i t i c a l  t o maximize s o c i a l b e n e f i t s . summarized as  that  3 9  of  benefit rather  This conclusion  than  was  follows:  In summary, arguments s u p p o r t i n g government i n t e r v e n t i o n t h a t were based on p o l i t i c a l expedience a p p l i e d i n v i r t u a l l y a l l o f the b a i l o u t c a s e s . S e l f - i n t e r e s t e d u t i l i t y m a x i m i z a t i o n was more e v i d e n t on the p a r t o f p o l i t i c a l a c t o r s than was any d e s i r e t o i n c r e a s e economic e f f i c i e n c y . Thus, b a i l o u t s can b e s t be u n d e r s t o o d as p a r t o f p o l i t i c i a n s ' b a s i c s t r a t e g i e s t o enhance t h e i r p r o s p e c t s f o r s t a y i n g i n power by 'magnifying the g a i n and d e p r e c i a t i n g the p a i n ' o f income redistribution. 4  0  35 M i c h a e l T r e b i l c o c k , e t a l . , The P o l i t i c a l Economy o f B u s i n e s s B a i l o u t s : Volume 1 (Toronto: O n t a r i o Economic C o u n c i l , 1985) a t 270 [ h e r e i n a f t e r " T r e b i l c o c k e t a l . " ] . 36 I b i d , a t 276 37 I b i d , a t 348. 38 I b i d , a t 354. 39 I b i d , a t 353. 4 0 I b i d , a t 21.  31 P o l i t i c a l g a i n i s a c h i e v e d by r e c o g n i z i n g s p e c i f i c ( f o r example, t h e i n t e r e s t o f o r g a n i z e d jobs)  and p r o v i d i n g b e n e f i t s t o s p e c i f i c Evidence  political  interests  labour i n r e t a i n i n g groups.  o f t h e s t r o n g i n c e n t i v e s c r e a t e d by  the  system t o i n t e r v e n e i n banks f a c i n g p o t e n t i a l  or  a c t u a l i n s o l v e n c y i s p r o v i d e d by case s t u d i e s o f r e c e n t bank bailouts.  For example, p o l i t i c a l b e n e f i t can be used t o  e x p l a i n , a t l e a s t i n p a r t , t h e government's d e c i s i o n t o out u n i n s u r e d  d e p o s i t o r s o f CCB  given before the Standing State  and N o r t h l a n d .  In  bail  testimony  Senate Committee, t h e M i n i s t e r of  ( F i n a n c e ) , j u s t i f i e d h e r government's d e p a r t u r e  from  t h e g e n e r a l r u l e o f market d i s c i p l i n e as f o l l o w s : We cannot i g n o r e t h e r e a l i t y o f c i r c u m s t a n c e s t h a t , i n t h i s case, were not w i t h o u t s i g n i f i c a n c e . The government r e c o g n i z e d t h a t t h e r e were v a l i d reasons f o r d e p a r t i n g from t h e g e n e r a l r u l e . These d e p o s i t o r s j o i n e d w i t h the government i n d e m o n s t r a t i n g s u p p o r t and c o n f i d e n c e i n our banking system i n g e n e r a l and i n r e g i o n a l banks i n particular. We were concerned, as w e l l , about the impact i n western Canada i f h o l d e r s o f d e p o s i t s over t h e $60,000 i n s u r e d l i m i t had t o absorb t h o s e losses. Those d e p o s i t o r s i n c l u d e d many i n d i v i d u a l s and s m a l l b u s i n e s s e s , c h a r i t a b l e o r g a n i z a t i o n s , r e l i g i o u s o r g a n i z a t i o n s , c r e d i t unions, m u n i c i p a l i t i e s and s c h o o l boards, as w e l l as o t h e r groups. 1  Thus, t h e r e were a number o f i n t e r e s t s which i n f l u e n c e d the government's d e c i s i o n t o b a i l  out CCB  and N o r t h l a n d ,  in  a d d i t i o n t o t h e i n t e r e s t s o f consumer p r o t e c t i o n and financial  stability.  F i r s t , was  the i n t e r e s t of r e g i o n a l  41 P r o c e e d i n g s o f t h e S t a n d i n g Senate Committee on Banking, Trade and Commerce (Ottawa: November 19, 1985) a t 31:7 [hereinafter "Proceedings"].  32 economic d e v e l o p m e n t — developing  in particular,  the  interest in  r e g i o n a l banks i n western Canada.  i n p r o v i n c e - b u i l d i n g and  This  interest  r e g i o n a l development e x p l a i n s a  l a r g e p e r c e n t a g e o f the Canadian government's d e c i s i o n s t o bail  out b u s i n e s s e s  1970's.  between t h e l a t e 1950's and  commitment t o u n i n s u r e d  demonstrated t h e i r s u p p o r t  t h e i r deposits. detrimental i n the  C l e a r l y , i t would have been  maintaining  politically depositors lose,  f a c e o f government a s s u r a n c e s as t o the v i a b i l i t y A third  from t h e c o m p o s i t i o n  influential  institutions,  Political  of  i n c e n t i v e f o r b a i l i n g out the banks o f the u n i n s u r e d  depositor  which i n c l u d e d a l a r g e number o f v o t e r s and  The  and,  depositors  i n the banks by  f o r t h e government t o l e t t h e s e  the banks. arose  late  Secondly, t h e government r e a c t e d t o a moral  42  essentially political, who  the  concentrated  Economy o f B u s i n e s s  i n one  class,  politicallyregion.  B a i l o u t s , the  In  co-authors  d e t e r m i n e d t h a t government a s s i s t a n c e i n t h e form o f b a i l o u t s i s g e n e r a l l y granted any  riding  to marginal  districts  (i.e.  i n which a s i g n i f i c a n t number o f v o t e r s w i l l  a d v e r s e l y a f f e c t e d by the b u s i n e s s  f a i l u r e ) which have  effective political  ( f o r ex.,  a Cabinet  representation  minister).  4 3  for  a marginal  of  A s t r o n g argument can be made t h a t  the r e g i o n which b e n e f i t t e d from the CCB b a i l o u t s was  the support  be  district  and,  and  therefore, a  a bailout.  42 T r e b i l c o c k , e t a l . , supra. 43 I b i d , a t 349.  Northland  note 34 a t  72.  candidate  33  Therefore,  the  r a t i o n a l e of p o l i t i c a l b e n e f i t can  used t o e x p l a i n government d e c i s i o n s t o b a i l w e l l as n o n - f i n a n c i a l justification  corporations).  out banks  harder to j u s t i f y p r o t e c t i o n and  Whether i t i s a  short-sighted  premise, i t i s  t h a n the m o t i v a t i o n s o f consumer  financial stability.  For the purposes o f  t h i s paper, i t i s assumed t h a t government d e c i s i o n s some banks and  by c o n s i d e r a t i o n s  not  o t h e r s w i l l c o n t i n u e t o be  of p o l i t i c a l b e n e f i t .  submitted t h a t t h i s  extent that  p r o m o t i o n and national  i t a c t s as a v e h i c l e f o r t h e  i n t e r e s t s (other t h a n the  influenced  benefit  recognition, regional  and  In o r d e r t o  justify  control  i t s role in  the  b a i l o u t process,  i t i s submitted that  i t s i n f l u e n c e on  d e c i s i o n to b a i l  out  recognized  which the  a bank s h o u l d be  legislation— national  but  confined  interest calls  r i g h t o r i n t e r e s t which would be bank t o  to  i n t e r e s t s o f consumer  financial stability).  the p u b l i c b e n e f i t r a t i o n a l e and  insolvency  bail  a s p e c t o f the b a i l o u t d e c i s i o n —  p r o t e c t i o n o f important l o c a l ,  p r o t e c t i o n and  to  Furthermore, i t i s  i n f l u e n c e of the p o l i t i c a l  rationale i s a valuable the  (as  f o r such i n t e r v e n t i o n i s a r g u a b l e — because i t  i s based on a s e l f - s e r v i n g and  out  be  the  i n bank  to circumstances i n  f o r the p r o t e c t i o n o f a jeopardized  by  allowing  a  fail.  Conclusion Therefore, to b a i l  out  three  banks:  r a t i o n a l e e x p l a i n government  consumer p r o t e c t i o n ,  financial  decisions stability  34  and  political  bailing It  out  banks or  i s submitted  reflect  Each of  their  that  It  has  Factors  i n the  been argued t h a t  banks can  be  the  following  rationale:  the  explained  stability  benefit.  of  However,  the  would tend  to  two  be  of  Decision  presence of  s y s t e m and  one  addressed by  to  bail  o r more  maintenance  are  other  i n the  bailout  government,  b a i l o u t instrument  discussed  and c o s t - e f f i c i e n c y .  of  political  there  d e c i s i o n of whether or  concerns which are  resolving  with these r a t i o n a l e .  i f recognized  a f f e c t i t s choice  market d i s c i p l i n e  a)  the  should  for  government d e c i s i o n s  financial  These concerns,  The  techniques  Bailout  which should  underlying  circumstances.  consumer p r o t e c t i o n ,  decision.  bank.  by  justify  legislation  i t i s submitted that  interests/concerns  than the  provide  consistent  out  of  i n some  bank i n s o l v e n c y  which are  Additional  these r a t i o n a l e  clients  t h e s e r a t i o n a l e and  bank f a i l u r e s  4.  benefit.  not  rather  to b a i l  below  out  a  are:  4 4  Market D i s c i p l i n e Under the  argued small  that  discussion  the  depositors  government on  on  consumer p r o t e c t i o n ,  is justified  consumer p r o t e c t i o n  in  i t  was  compensating  grounds,  but  not  44 T h e r e a r e o t h e r c o n c e r n s and i s s u e s w h i c h , i t may be argued, should i n f l u e n c e the b a i l o u t d e c i s i o n . F o r example, i t i s a r g u e d i n T r e b i l c o c k , e t . a l . a t 354, t h a t d e c i s i o n m a k e r s s h o u l d be made more s e n s i t i v e t o t h e e c o n o m i c , l o n g term consequences of b a i l o u t p o l i c i e s . T h i s economic r a t i o n a l e f o r b a i l o u t s i s not developed i n t h i s paper but i s d i s c u s s e d , on a t h e o r e t i c a l l e v e l by T r e b i l c o c k e t a l . i n c h a p t e r s 3, 4, 5 and 6.  large  depositors.  distinguish  The government has attempted  t h e two c l a s s e s a n d a f f o r d  to  p r o t e c t i o n t o small  d e p o s i t o r s by t h e implementation  of a deposit  insurance  scheme w i t h  an i n s u r a n c e  o f $60,000.  This  legislative  response  also  reflects  discipline— protection  ceiling  t o t h e consumer p r o t e c t i o n c o n c e r n  t h e government's  i n market  l a r g e depositors are excluded  from  i n t h e expectation that they w i l l  degree o f d i s c i p l i n e market d i s c i p l i n e  i n t h e market.  i s found  i n Robert  "Bank R e g u l a t i o n a n d D e p o s i t for  interest  Reform:  4 5  insurance  maintain  some  A good d e f i n i t i o n o f 0. E d m i n s t e r ' s Some H a r d  article  Questions  Congress":  [ M a r k e t d i s c i p l i n e ] means t h a t i n v e s t o r s e v a l u a t e f i n a n c i a l i n s t i t u t i o n s on t h e b a s i s o f a v a i l a b l e i n f o r m a t i o n , d e c i d e which ones a r e o p e r a t i n g i n t h e i r ( t h e i n v e s t o r s ' ) i n t e r e s t , t h e n move f u n d s i n a p p r o p r i a t e d i r e c t i o n s d e p e n d i n g on r i s k and return expectations. I f an i n s t i t u t i o n f a i l s t o meet e x t e r n a l e x p e c t a t i o n s , i t i s ' d i s c i p l i n e d ' b; i n v e s t o r s who w i t h d r a w t h e i r f u n d s . 4  The  problem with  deposit insurance  aimed a t p r o t e c t i n g u n i n s u r e d  and government  as w e l l as s m a l l d e p o s i t o r s i  that  a l l d e p o s i t o r s would  lose  risk  a n d move t h e i r  according to that  funds  When m a r k e t d i s c i p l i n e institutional  failure  bailouts  their  incentive  t o assess  assessment.  i s eliminated, the risks of are shifted  to the deposit  insurance  45 D e p o s i t i n s u r a n c e i s a l s o a r e s p o n s e t o t h e n e e d t o m a i n t a i n f i n a n c i a l s t a b i l i t y by p r e v e n t i n g bank r u n s . 4 6 R o b e r t 0. E d m i n s t e r , "Bank R e g u l a t i o n a n d D e p o s i t R e f o r m - Some H a r d Q u e s t i o n s f o r C o n g r e s s " (1987) 104 T h e B a n k i n g L . J . 42 a t 43 [ h e r e i n a f t e r " E d m i n s t e r " ] .  fund and  the t a x p a y e r .  T h i s argument was  Report o f the O n t a r i o Task Force  made i n the  Final  on F i n a n c i a l I n s t i t u t i o n s  which s t a t e d t h a t a c t s o f b a i l i n g out u n i n s u r e d  depositors:  . . . e f f e c t i v e l y remove the i n f l u e n c e o f the market t o e n f o r c e the prudent management o f d e p o s i t taking institutions. They encourage p e r s o n s making d e p o s i t s which may be worth m i l l i o n s o f d o l l a r s t o do so w i t h l i t t l e c a r e , p e r c e i v i n g t h a t governments w i l l save them from the consequences o f t h e i r own imprudence.  Market d i s c i p l i n e becomes a c o m p e l l i n g denying uninsured  for  d e p o s i t o r s the p r o t e c t i o n o f a b a i l o u t  afforded to smaller depositors. investment d e c i s i o n s o f u n i n s u r e d an e f f e c t i v e degree o f market  The  expectation  Like uninsured  i s that  depositors w i l l  discipline.  the  maintain  4 8  Unsecured c r e d i t o r s a r e a n o t h e r source discipline.  reason  o f market  d e p o s i t o r s , c r e d i t o r s do  not  b e n e f i t from bank management assuming i n c r e a s e d r i s k due  to  t h e f i x e d r a t e o f r e t u r n earned on debt s e c u r i t i e s . 4 9 Furthermore, c r e d i t o r s  1  funds a r e l o c k e d i n and  cannot  withdrawn upon demand ( u n l e s s the debt s e c u r i t y can  be  be  47 Dupre, supra, note 26 a t 48. 48 The use o f b r o k e r e d d e p o s i t s d e c r e a s e s the p o t e n t i a l i n f l u e n c e o f u n i n s u r e d d e p o s i t o r s on market d i s c i p l i n e . In 1984, Canada's 6 l a r g e s t c h a r t e r e d banks had 74% o f t h e i r Canadian d o l l a r d e p o s i t s i n s u r e d . However, i n s m a l l e r banks, e s p e c i a l l y banks r e l y i n g on w h o l e s a l e d e p o s i t s , the p r o p o r t i o n of uninsured deposits i s higher: i n 1984, other Canadian banks averaged o n l y 31.1% i n s u r e d d e p o s i t s (see: Economic C o u n c i l o f Canada, 1987 a t 50). P r o p o s a l s have been made t o c o n t r o l b r o k e r e d d e p o s i t s and the adverse e f f e c t they have on market d i s c i p l i n e (see: F i n a l Report of the Working Committee on the Canada D e p o s i t Insurance Corporation (Ottawa: M i n i s t e r of Supply and S e r v i c e s , A p r i l , 1985) a t 30-32 [ h e r e i n a f t e r "Wyman"]. 49 Goodman, supra, note 29 a t 161.  37  sold).  T h e r e f o r e , unsecured c r e d i t o r s have a  i n c e n t i v e t o a s s e s s the  r i s k i n e s s of  i n s t i t u t i o n s before investing  —  5 0  alternative  an  i n c e n t i v e t h a t would  d i s a p p e a r i f t h e y expected t o be b a i l e d It an  i s submitted, t h e r e f o r e ,  important c o n s i d e r a t i o n  bailout decision. override and  t h a t market d i s c i p l i n e i s  an  reflected in  However, once t h e  t o p r o v i d e government a s s i s t a n c e  decision  the  is  suppliers  out).  Cost-Efficiency A second f a c t o r which s h o u l d i n f l u e n c e  implementation of the b a i l o u t d e c i s i o n Bailouts  are  funded by  government revenues.  the The  deposit  the  is cost-efficiency.  i n s u r a n c e scheme and/or  i n t e r e s t of c o s t - e f f i c i e n c y  d i c t a t e s t h a t governments r e s o l v e bank f a i l u r e s i n a that  involves  especially  the  l e a s t d r a i n on p u b l i c  important c o n s i d e r a t i o n  bank, t h e b a i l o u t of whose i n s u r e d c o m p l e t e l y exhaust the d e p o s i t the  Canadian d e p o s i t  for  government o f f i c i a l s  50  i s made  decision  ( i . e . which o f the bank's c a p i t a l  s h o u l d be b a i l e d  protection  t o a d i s t r e s s e d bank,  market d i s c i p l i n e s h o u l d a f f e c t the way implemented  the  i n t e r e s t which s h o u l d  more fundamental i n t e r e s t s o f consumer  financial stability.  b)  out.  which s h o u l d be  I t i s not  strong  Ibid, at  161.  funds.  i n the  This  case- o f a  depositors  i n s u r a n c e fund.  i s i n need of  i s an large  could  i n s u r a n c e fund i s a s u b j e c t and  way  At of  present, concern  replenishment.  38 For  example, a t the  $1.2  billion.  5 1  end  o f 1985,  the  fund had  a deficit  T h e r e f o r e , c o s t - e f f i c i e n c y s h o u l d be  a  c o n c e r n o f d e c i s i o n - m a k e r s when implementing a d e c i s i o n bail  out  of  to  a bank.  Conclusion Therefore,  i n a d d i t i o n t o the  three r a t i o n a l e  for  government b a i l o u t s o f banks, i t i s s u b m i t t e d t h a t t h e r e two  a d d i t i o n a l i n t e r e s t s which s h o u l d be  b a i l o u t d e c i s i o n and,  therefore,  i n bank  l e g i s l a t i o n : market d i s c i p l i n e and The o f an  f o l l o w i n g two  evaluation  l i g h t o f the  reflected in  the  insolvency  cost-efficiency.  c h a p t e r s o f t h i s paper c o n s i s t  o f Canadian bank i n s o l v e n c y  r a t i o n a l e f o r bank b a i l o u t s and  o f market d i s c i p l i n e and  are  legislation the  in  interests  cost-efficiency.  51 The Canadian Bankers' A s s o c i a t i o n , Response t o B i l l C-42: An A c t R e s p e c t i n g F i n a n c i a l I n s t i t u t i o n s and the D e p o s i t I n s u r a n c e System (Toronto: A p r i l , 1987) a t Appendix C.  39 CHAPTER  3.  CANADIAN  BANK  INSOLVENCY  LEGISLATION  On J u l y 2 and 3, 1987, l e g i s l a t i o n r e f o r m i n g t h e regulation of financial insurance The  institutions  system was p r o c l a i m e d  and t h e d e p o s i t  by t h e f e d e r a l government.  changes which t h i s new l e g i s l a t i o n have made t o t h e  legislative  framework p r e c e d i n g  chapter  However, i t i s t h e p r e - e x i s t i n g l e g i s l a t i o n  7.  i t w i l l be examined i n  which c o n t r o l l e d t h e government * s r e s p o n s e s t o t h e bank failures  experienced  the p r e - J u l y ,  i n Canada t o d a t e .  Therefore,  i t is  1987 l e g i s l a t i v e framework which i s t h e  subject of the following analysis. Before  examining t h e s o u r c e s o f t h e f e d e r a l  government's l e g i s l a t i v e a u t h o r i t y over bank i n s o l v e n c y , a brief  o u t l i n e o f t h e r e g u l a t o r y framework and t h e  institutions  responsible  be p r o v i d e d .  f o r bank r e g u l a t i o n i n Canada  will  A l t h o u g h t h e f o c u s o f t h i s paper i s government  power t o respond t o a c t u a l o r t h r e a t e n e d  bank  insolvency,  some u n d e r s t a n d i n g o f i t s u n d e r l y i n g powers t o p r e v e n t i n s o l v e n c y through r e g u l a t i o n and s u p e r v i s i o n i s i m p o r t a n t .  1.  Regulatory The  and  Framework  Canadian banking system i s governed by t h e terms  p r o v i s i o n s o f t h e Bank A c t (S.C. 1980, c.40).  e s t a b l i s h e s two c l a s s e s o f banks: B.  Schedule A and Schedule  Schedule A banks a r e w i d e l y - h e l d  individual  or corporation holding  The A c t  by t h e p u b l i c w i t h no  i n excess o f 10% o f t h e  40 s h a r e s o f any any  c l a s s and  c l a s s being  not more than 25%  o f the  s h a r e s of  h e l d by a Canadian o r f o r e i g n i n d i v i d u a l or  corporation. P a r t V o f the Bank A c t s e t s out the a u t h o r i z e d and  powers o f banks, which i n c l u d e a c c e p t i n g  business  deposits,  b o r r o w i n g money, a c t i n g as f i n a n c i a l agents, g u a r a n t e e i n g payment o r repayment of funds, l e n d i n g money (which making mortgages), and s e t s out  the  investing in securities.  merchandise o r engaging i n any authorized  by t h e A c t .  forms o f l i q u i d i t y r e q u i r e d by  o r b u s i n e s s except  Under P a r t V,  adequate and  appropriate  i n r e l a t i o n to i t s operations.  Banks  s e c t i o n 2 08 t o m a i n t a i n p r i m a r y r e s e r v e s  conducted i n s e v e r a l ways.  The  bank's d i r e c t o r s are  t h e bank, s u b j e c t t o the p r o v i s i o n s of the A c t 54  imposes a s t a t u t o r y duty of c a r e ,  d i r e c t o r s and  o f f i c e r s t o the bank.  Section  o b l i g a t i o n on the d i r e c t o r s t o a p p o i n t comprised of a t l e a s t t h r e e  system and  Internal regulation i s  the r e s p o n s i b i l i t y of managing the b u s i n e s s and  Section  if  reserves.  c o n s i s t i n g of i n t e r n a l r e g u l a t i o n , e x t e r n a l a u d i t i n g federal authorities.  are  and,  r e g u l a t i o n o f banks i s based on a t r i p a r t i t e  i n s p e c t i o n by  as  each bank i s r e q u i r e d  r e q u i r e d by the Bank o f Canada, secondary The  Generally,  i n goods, wares o r  trade  t o m a i n t a i n adequate c a p i t a l and  174  Section  l i m i t a t i o n s on the powers o f banks.  banks are p r o h i b i t e d from d e a l i n g  includes  given  affairs (section  of 34).  owed by 243  an a u d i t  imposes  an  committee,  independent d i r e c t o r s .  The  purpose of the a u d i t committee i s t o examine the work of  the  41  bank's i n t e r n a l and statements  e x t e r n a l a u d i t o r s , before the  a r e approved by the d i r e c t o r s  When informed  financial  (section  243(3)).  by t h e e x t e r n a l a u d i t o r s o f an e r r o r o r  m i s s t a t e m e n t i n a f i n a n c i a l statement,  the d i r e c t o r s  o b l i g a t e d to prepare  statements  otherwise  revised financial  Banks a l s o use  i n s p e c t i o n departments which t e s t the bank's c o n t r o l systems and The  the q u a l i t y of i t s l o a n s .  General  internal  internal 1  second a s p e c t o f bank r e g u l a t i o n i s performed  the shareholders' a u d i t o r s . must be a p p o i n t e d ( s e c t i o n 2 37) .  At l e a s t two  by  external auditors  a n n u a l l y by t h e s h a r e h o l d e r s o f t h e bank  These a u d i t o r s r e p o r t t o t h e s h a r e h o l d e r s  t h e f i n a n c i a l statements e x e c u t i v e o f f i c e r and may  or  i n f o r m t h e s h a r e h o l d e r s and t h e I n s p e c t o r  of the e r r o r ( s e c t i o n 243(8)).  are  a t each y e a r end  and t o t h e  on  chief  c h i e f g e n e r a l manager on m a t t e r s  which  a f f e c t t h e w e l l - b e i n g of t h e bank. The  t h i r d branch  structure,  o f the t r i p a r t i t e r e g u l a t o r y  i n s p e c t i o n by f e d e r a l a u t h o r i t i e s , w i l l  d i s c u s s e d below, under the heading, General The  " O f f i c e of the  be Inspector  o f Banks". f o u r governmental i n s t i t u t i o n s r e l e v a n t t o bank  s u p e r v i s i o n and  regulation:  Department of F i n a n c e , of Banks and  the Bank of Canada,  the O f f i c e o f the I n s p e c t o r  the Canada D e p o s i t Insurance  discussed b r i e f l y  1 E s t e y , supra,  below.  chapter  the  1, note  1 at  38.  General  Corporation,  are  42  a)  The  Bank o f Canada  The Act.  Bank o f Canada i s governed by.the Bank o f Canada  Canada's c e n t r a l bank, t h i s i n s t i t u t i o n  f o r monetary p o l i c y and fiscal  agent  a c t s as the Canadian government's  ( i . e . i t manages the p u b l i c debt) and  l e n d e r o f l a s t r e s o r t t o banks. r e g u l a t o r of l i q u i d i t y , advances  ( u s u a l l y one  In i t s r o l e as  as a  the  the Bank o f Canada p r o v i d e s  day)  i n t h e i r reserve balances s e c t i o n 208  i s responsible  t o banks e x p e r i e n c i n g  ordinary  shortfalls  o r i n the r e s e r v e s r e q u i r e d  o f the Bank A c t .  2  by  Under s e c t i o n 1 8 ( 1 ) ( h ) ,  Bank o f Canada i s empowered t o make e x t r a o r d i n a r y  the  (maximum  o f s i x months) l i q u i d i t y payments t o banks u n a b l e t o meet d e p o s i t o r w i t h d r a w a l s due  t o a run on d e p o s i t s .  It is  o b l i g a t e d t o r e p o r t a l l l i q u i d i t y advances made t o banks t o the M i n i s t e r o f F i n a n c e , t h e Canada G a z e t t e  which i n f o r m a t i o n i s p u b l i s h e d i n  (section 25(1)).  The  Bank o f Canada does  not p o s s e s s s u p e r v i s o r y powers over the banks.  b)  Department o f The  Finance  M i n i s t e r of Finance  under the Bank A c t .  i s granted  s u p e r v i s o r y powers  For example, under s e c t i o n 246(4),  the  M i n i s t e r can a u t h o r i z e an e x a m i n a t i o n of a bank when i t i s b e l i e v e d t h a t an o f f e n c e has Act.  been committed under the Bank  Under s e c t i o n 239(1), the M i n i s t e r has  revoke the appointment of a u d i t o r s and  the power t o  under s e c t i o n 2 29  r e q u i r e a bank t o f u r n i s h such o t h e r  i n f o r m a t i o n as he  2 Estey,  57.  supra,  chapter  1, note 1 a t  can  may  43  r e q u i r e i n a d d i t i o n t o t h e r e t u r n s r e q u i r e d by P a r t V I I . Under s e c t i o n 175(1), a bank s h a l l comply w i t h any r u l e s i n t h e form o f w r i t t e n d i r e c t i v e s from t h e M i n i s t e r w i t h r e s p e c t t o c a p i t a l adequacy and l i q u i d i t y .  I t i s the  M i n i s t e r who a p p o i n t s a c u r a t o r t o s u p e r v i s e t h e b u s i n e s s and a f f a i r s o f an i n s o l v e n t bank.  In p r a c t i c e , the M i n i s t e r  o f F i n a n c e r e l i e s h e a v i l y on t h e O f f i c e o f t h e I n s p e c t o r G e n e r a l o f Banks f o r d a i l y a d m i n i s t r a t i o n o f t h e A c t , w h i l e restricting  c)  i t s attention to policy  matters.  3  O f f i c e o f t h e I n s p e c t o r G e n e r a l o f Banks C r e a t e d i n t h e a f t e r m a t h o f t h e 1923 f a i l u r e o f t h e  Home Bank o f Canada, t h e O f f i c e o f t h e I n s p e c t o r G e n e r a l o f Banks ( t h e "OIGB") i s a b r a n c h o f t h e Department o f F i n a n c e and p o s s e s s e s t h e p r i m a r y s u p e r v i s o r y r e s p o n s i b i l i t y banks.  4  over  Under s e c t i o n 245 o f t h e Bank A c t , an I n s p e c t o r  G e n e r a l o f Banks i s a p p o i n t e d by t h e Governor G e n e r a l i n C o u n c i l on t h e recommendation o f t h e M i n i s t e r o f F i n a n c e . The  Inspector i s responsible f o r the a d m i n i s t r a t i o n of the  Act  (section 246(1)).  In f u l f i l l i n g h i s supervisory  f u n c t i o n s , t h e I n s p e c t o r i s r e q u i r e d by s e c t i o n 246(2) t o make o r cause t o be made, a t l e a s t once a y e a r , examination  such  o r i n q u i r y i n t o t h e b u s i n e s s and a f f a i r s o f each  3 E s t e y , supra, c h a p t e r 1, note 1 a t 56. 4 I t s h o u l d be noted t h a t t h e F i n a n c i a l I n s t i t u t i o n s and D e p o s i t Insurance System Amendment A c t r e p l a c e d t h e OIGB w i t h a new body: t h e O f f i c e o f t h e S u p e r i n t e n d e n t o f Financial Institutions. I t r e t a i n s much o f t h e powers and d u t i e s w i t h r e s p e c t t o banks as h e l d by t h e OIGB b u t i s g i v e n s e v e r a l new powers which a r e d i s c u s s e d i n c h a p t e r 7.  44  bank as t h e I n s p e c t o r deems n e c e s s a r y .  He i s t o s a t i s f y  h i m s e l f t h a t t h e p r o v i s i o n s o f t h e Bank A c t a r e b e i n g observed  ( f o r example, c a p i t a l adequacy and l i q u i d i t y ) and  t h a t t h e bank i s i n sound f i n a n c i a l c o n d i t i o n . o f such e x a m i n a t i o n  The r e s u l t s  a r e t o be r e p o r t e d t o t h e M i n i s t e r .  A c c o r d i n g t o s e c t i o n 246(4),  t h e M i n i s t e r , when he has  r e a s o n t o b e l i e v e t h a t an o f f e n c e under t h e A c t has been o r i s about t o be committed, s h a l l d i r e c t t h e I n s p e c t o r t o make such  i n q u i r y as i s n e c e s s a r y  t o determine t h e f a c t s and  report the r e s u l t s to the Minister.  The I n s p e c t o r i s g i v e n  t h e r i g h t t o a c c e s s t h e bank's books, documents, c a s h e t c . and  the r i g h t t o require the directors,  a u d i t o r s o f t h e bank t o p r o v i d e such require  (section 246(5)).  o f f i c e r s and  i n f o r m a t i o n as he may  In r e a l i t y ,  although t h e  I n s p e c t o r has f u l l powers t o i n s p e c t t h e banks, he r e l i e s h e a v i l y on t h e s h a r e h o l d e r s ' a u d i t o r s and t h e i n t e r n a l bank inspection  d)  system.  5  Canada D e p o s i t Insurance The  Corporation  Canada D e p o s i t Insurance  Corporation  (the "CDIC")  i s a Crown c o r p o r a t i o n and i s governed by t h e Canada Insurance  C o r p o r a t i o n A c t (R.S.C. 1970, c.C-3).  Deposit  It is  r e s p o n s i b l e f o r i n s u r i n g d e p o s i t s a t banks and o t h e r d e p o s i t - t a k i n g i n s t i t u t i o n s t o a maximum o f $60,000. CDIC's i n s u r a n c e  fund i s p r o v i d e d  The  f o r by t h e assessment o f  premiums on member i n s t i t u t i o n s a t t h e r a t e o f one-tenth o f 5 Coopers and Lybrand, supra, c h a p t e r  1, note  5 a t 21.  one  percent  of insured d e p o s i t s .  The  Board o f D i r e c t o r s of  the CDIC i s comprised o f a Chairman s e l e c t e d by the  Governor  G e n e r a l i n C o u n c i l , the Governor o f the Bank o f Canada, Deputy M i n i s t e r o f Finance, and  the Inspector Despite  the S u p e r i n t e n d e n t o f  Insurance  G e n e r a l of Banks.  i t s o b v i o u s i n t e r e s t as i n s u r e r i n a v o i d i n g  bank f a i l u r e s , the CDIC has  very  limited supervisory  I t i s e n t i t l e d t o have the a f f a i r s o f c h a r t e r e d examined on i t s b e h a l f by the OIGB but conduct i t s own i t s behalf,  the  inspection.  powers.  banks  i s not e n t i t l e d  to  A f t e r an e x a m i n a t i o n i s made on  t h e examiner i s t o r e p o r t t o the C o r p o r a t i o n  t o whether o r not any  changes have o c c u r r e d  i n the  c i r c u m s t a n c e s o f the bank t h a t might m a t e r i a l l y a f f e c t Corporation's  as  p o s i t i o n as i n s u r e r ( s e c t i o n 23).  the  I t has  a u t h o r i t y t o p r e s c r i b e s t a n d a r d s o f sound b u s i n e s s  the  and  f i n a n c i a l p r a c t i c e s when concerned about a bank's p r a c t i c e s but has  no c o r r e s p o n d i n g  Corporation  enforcement powers.  i s o f the view t h a t a member i n s t i t u t i o n i s  f o l l o w i n g unsound b u s i n e s s r e q u i r e d by  s e c t i o n 24  or f i n a n c i a l p r a c t i c e s , i t i s  t o r e p o r t the  o r chairman o f such i n s t i t u t i o n , who t o be p r e s e n t e d  f a c t s t o the  president  s h a l l cause the  t o a d i r e c t o r s ' meeting.  CDIC's powers t o r e g u l a t e and reach  When the  Although  the  s u p e r v i s e banks b e f o r e  i n s o l v e n c y are l i m i t e d , once i n s o l v e n c y  i t s powers t o a c t are s l i g h t l y b r o a d e r .  The  is  report  they  threatened,  specific  6 The F i n a n c i a l I n s t i t u t i o n s and D e p o s i t I n s u r a n c e Amendment A c t a l l o w s the premium l e v e l s t o be s e t by r e g u l a t i o n , s u b j e c t t o a s t a t u t o r y c e i l i n g of o n e - s i x t h of one p e r c e n t of insured d e p o s i t s .  46  p r o v i s i o n s o f t h e Canada D e p o s i t Insurance  Corporation Act  which g r a n t a u t h o r i t y t o t h e C o r p o r a t i o n t o d e a l w i t h insolvency or threatened  i n s o l v e n c y a r e d i s c u s s e d below  under t h e h e a d i n g " L e g i s l a t i v e  2.  Legislative  Framework".  Framework  The power o f f e d e r a l i n s t i t u t i o n s t o a c t i n a bank i n s o l v e n c y s i t u a t i o n i s d e r i v e d from t h r e e s o u r c e s : t h e Bank A c t , t h e Canada D e p o s i t Insurance  C o r p o r a t i o n A c t , and t h e  Winding-up A c t .  a)  Bank A c t Under s e c t i o n 276 o f t h e Bank A c t , a bank i s  c o n s i t u t e d i n s o l v e n t i f i t suspends payment f o r n i n e t y c o n s e c u t i v e days o f any l i a b i l i t y  as i t a c c r u e s .  Once  i n s o l v e n t , t h e bank may e x e r c i s e t h e powers c o n f e r r e d upon i t by t h e A c t o n l y f o r t h e purpose o f w i n d i n g up t h e b u s i n e s s o f t h e bank under t h e Winding-up A c t ( s e c t i o n 276(2)).  When a bank suspends payment o f i t s l i a b i l i t i e s ,  t h e M i n i s t e r s h a l l , under s e c t i o n 278, a p p o i n t a c u r a t o r t o s u p e r v i s e t h e b u s i n e s s and a f f a i r s o f t h e bank.  Similarly,  i f t h e I n s p e c t o r r e p o r t s t h a t i n h i s o p i n i o n a bank w i l l be unable t o pay i t s l i a b i l i t i e s  as they a c c r u e , t h e M i n i s t e r  may a p p o i n t a c u r a t o r ( s e c t i o n 2 7 8 ( 2 ) ) .  Once a p p o i n t e d , t h e  c u r a t o r i s r e s p o n s i b l e f o r s u p e r v i s i n g t h e b u s i n e s s and a f f a i r s o f t h e bank and has a l l powers and s h a l l take a l l steps necessary  t o p r o t e c t t h e i n t e r e s t s o f c r e d i t o r s and  47  s h a r e h o l d e r s o f t h e bank and t o c o n s e r v e ensure t h e i r p r o p e r d i s p o s i t i o n purposes,  i t s a s s e t s and  ( s e c t i o n 279) .  F o r such  the c u r a t o r i s e n t i t l e d t o free access t o the  bank's a c c o u n t s , r e c o r d s , cash, s e c u r i t i e s ,  etc.  The  c u r a t o r r e t a i n s i t s powers o f s u p e r v i s i o n o v e r t h e b u s i n e s and a f f a i r s o f t h e bank u n t i l he i s removed from o f f i c e by t h e M i n i s t e r o r u n t i l a l i q u i d a t o r i s a p p o i n t e d t o wind up t h e b u s i n e s s o f t h e bank ( s e c t i o n  279(2)).  • Upon i n s o l v e n c y , t h e p r i o r i t i e s o f c r e d i t o r s ' a r e determined  a c c o r d i n g t o s e c t i o n 277.  claims  Claims o f the  governments o f Canada and o f any p r o v i n c e (except debts e v i d e n c e d by bank debentures)  are the f i r s t  and second  c h a r g e s , r e s p e c t i v e l y , on t h e bank's a s s e t s .  Next, d e p o s i t  liabilities  a r e t o be p a i d i n f u l l ,  liabilities  o f t h e bank, f o l l o w e d by debentures  liabilities  r a n k i n g e q u a l l y w i t h debentures.  or  then a l l o t h e r and t h o s e  Finally,  fines  p e n a l t i e s c o n s t i t u t e t h e l a s t charge on t h e bank's  assets.  b)  Winding-up A c t (R.S.C.1970, c.W-10) An a p p l i c a t i o n f o r a winding-up o r d e r o f an i n s o l v e n t  bank i s t o be made by t h e bank ( s e c t i o n 11) o r by a c r e d i t o r of  t h e bank h a v i n g a c l a i m i n excess o f $1000 ( s e c t i o n 153).  Upon a p p l i c a t i o n f o r a winding-up o r d e r , t h e c o u r t may make t h e o r d e r r e q u e s t e d , d i s m i s s i t , a d j o u r n i t , o r make any i n t e r i m o r o t h e r o r d e r i t deems j u s t  ( s e c t i o n 13).  I f the  bank opposes t h e a p p l i c a t i o n on t h e ground t h a t i t has n o t  48  become i n s o l v e n t , t h e c o u r t may i n i t s d i s c r e t i o n  adjourn  t h e a p p l i c a t i o n f o r a maximum o f s i x months and o r d e r a person  t o i n q u i r e i n t o t h e a f f a i r s o f t h e bank and r e p o r t t o  the court  ( s e c t i o n 14).  B e f o r e making a winding-up o r d e r , t h e c o u r t must d i r e c t t h a t b o t h t h e s h a r e h o l d e r s and t h e c r e d i t o r s o f t h e bank h o l d meetings i n o r d e r t o a s c e r t a i n t h e i r wishes as t o t h e appointment o f a l i q u i d a t o r  ( s e c t i o n 153(2)).  The chairman  of  each meeting i s t o r e p o r t t h e r e s u l t s o f t h e p r o c e e d i n g  to  t h e c o u r t and i f a winding-up o r d e r i s made, t h e c o u r t  will  a p p o i n t a maximum o f t h r e e l i q u i d a t o r s from among those  nominated by t h e s h a r e h o l d e r s and c r e d i t o r s . liquidator(s), all  once a p p o i n t e d ,  necessary  appoint  and l i a b i l i t i e s  f o r winding  distributing  i t s assets  The c o u r t may  i n s p e c t o r s t o a s s i s t and a d v i s e t h e l i q u i d a t o r i n Once a winding-up o r d e r i s  t o c a r r y on b u s i n e s s except as  f o r i t s b e n e f i c i a l winding-up  Canada D e p o s i t Insurance The  o f t h e bank's  and g e n e r a l l y do a l l t h i n g s  ( s e c t i o n s 33-35).  made, t h e bank s h a l l cease required  a statement  up t h e a f f a i r s o f t h e bank and  t h e l i q u i d a t i o n o f t h e bank.  c)  i s t o take i n t o h i s c o n t r o l  p r o p e r t y o f t h e bank, p r e p a r e  a s s e t s , debts  The  ( s e c t i o n 19).  Corporation Act  fundamental r e s p o n s i b i l i t i e s o f t h e CDIC under t h e  Canada D e p o s i t Insurance  Corporation Act are to insure  d e p o s i t s and t o compensate d e p o s i t o r s when t h e i r i n s u r e d d e p o s i t s a r e l o s t as a r e s u l t o f t h e f a i l u r e o f a member  institution. the CDIC. all  Generally, the Corporation  things necessary  objects. and  S e c t i o n 11 o f t h e A c t s e t s o u t t h e powers o f  or i n c i d e n t a l t o the pursuit of i t s  The C o r p o r a t i o n ' s  o b j e c t s are s e t out i n s e c t i o n 8  a r e as f o l l o w s : t o p r o v i d e ,  having  i s a u t h o r i z e d t o do  f o r the b e n e f i t o f persons  d e p o s i t s w i t h member i n s t i t u t i o n s ,  of deposits; t o provide  against the loss  the deposit insurance  r e q u i r e d by  t h e A c t f o r f e d e r a l i n s t i t u t i o n s ; t o examine i n t o t h e a f f a i r s o f member i n s t i t u t i o n s f o r t h e purpose o f o b t a i n i n g information r e l a t i v e t o deposit insurance;  and t o  accumulate, manage and i n v e s t a d e p o s i t i n s u r a n c e S e c t i o n 11 goes on t o p r o v i d e Corporation's  fund.  a non-exhaustive l i s t  of the  powers, which i n c l u d e s t h e f o l l o w i n g powers:  i) t o a c q u i r e a s s e t s from a member i n s t i t u t i o n and make, o r guaranteee l o a n s , advances o r d e p o s i t s w i t h a member i n s t i t u t i o n f o r t h e purpose of reducing a r i s k o r threatened l o s s t o the Corporation; ii) and  t o borrow money from t h e Government o f Canada i s s u e bonds and debentures t h e r e f o r ;  iii) t o a c t as a c u r a t o r o f a bank o r l i q u i d a t o r o r r e c e i v e r o f a member i n s t i t u t i o n when d u l y a p p o i n t e d as such; iv) t o assume t h e c o s t s o f w i n d i n g up a member institution; v) t o guarantee t h e payment o f t h e f e e s o f and t h e c o s t s i n c u r r e d by a l i q u i d a t o r o r r e c e i v e r o f a member i n s t i t u t i o n ; v i ) t o a c q u i r e a s s e t s o f a member i n s t i t u t i o n a l i q u i d a t o r or r e c e i v e r thereof;  from  v i i ) t o make an advance f o r t h e purpose o f p a y i n g a c l a i m a g a i n s t a member i n s t i t u t i o n f o r which t h e C o r p o r a t i o n i s a c t i n g as r e c e i v e r o r l i q u i d a t o r i n r e s p e c t o f any i n s u r e d d e p o s i t and becoming  50  s u b r o g a t e d as an unsecured c r e d i t o r f o r t h e amount o f such advance; and v i i i ) t o make o r cause t o be made such i n s p e c t i o n o f member i n s t i t u t i o n s as i s a u t h o r i z e d under t h e Act or the p o l i c y of insurance.  Under s e c t i o n 13(4), any  the Corporation  i s r e q u i r e d t o pay  c l a i m i n r e s p e c t o f an i n s u r e d d e p o s i t as soon as  possible a f t e r the o b l i g a t i o n arises.  The C o r p o r a t i o n i s  e n t i t l e d t o make such payment where a winding-up o r d e r has been made o r t h e member i n s t i t u t i o n i s u n a b l e t o make any payment i n r e s p e c t o f t h e d e p o s i t by reason c o u r t o r where t h e C o r p o r a t i o n institution  o f an o r d e r o f a  i s s a t i s f i e d t h a t t h e member  i s u n a b l e t o pay immediately and i n f u l l any  insured deposits  (section  13(4.1)).  The CDIC has t h e a u t h o r i t y t o i n i t i a t e t h e winding-up o f a bank i f t h e C o r p o r a t i o n  i s o f t h e view t h a t t h e bank i s  o r i s about t o become i n s o l v e n t ( s e c t i o n 29).  When a bank  ceases t o t a k e d e p o s i t s , o r i s , i n t h e o p i n i o n o f t h e CDIC, i n s o l v e n t , t h e CDIC may c a n c e l i t s i n s u r a n c e 27 o f t h e A c t .  When i t s d e p o s i t i n s u r a n c e  member i n s t i t u i o n that fact.  under s e c t i o n  i s cancelled, the  i s obligated to notify i t s depositors of  Furthermore, t h e C o r p o r a t i o n may g i v e p u b l i c  n o t i c e o f such c a n c e l l a t i o n i f i t i s o f t h e o p i n i o n t h a t such n o t i c e would s e r v e t h e p u b l i c i n t e r e s t . Therefore,  t h e CDIC has some powers t o a c t i n t h e event  of t h e t h r e a t e n e d However,  o r a c t u a l i n s o l v e n c y o f a c h a r t e r e d bank.  i t w i l l be argued t h a t t h e s e powers a r e inadequate  51 i f t h e CDIC i s t o be a b l e t o f u l l y p r o t e c t i t s i n t e r e s t  as  insurer.  3. Case S t u d i e s As a framework i n which t o a n a l y z e t h e  federal  government's l e g i s l a t i v e a u t h o r i t y t o d e a l w i t h bank i n s o l v e n c y , case s t u d i e s o f CCB, B.C.  N o r t h l a n d and t h e Bank o f  w i l l be employed, w i t h p a r t i c u l a r emphasis on  government's response  the  t o the a c t u a l or threatened  i n s o l v e n c i e s o f t h e s e t h r e e banks.  The  case s t u d i e s w i l l  used t o examine and a s s e s s t h e adequacy of t h e  be  legislation  under which government a g e n c i e s have been empowered t o d e a l w i t h bank  a)  failure.  Canadian Commercial Bank O r i g i n a l l y i n c o r p o r a t e d i n 1975  as t h e Canadian  Commercial and I n d u s t r i a l Bank, t h e CCB predominantly  operated  i n A l b e r t a and B r i t i s h Columbia, c o n c e n t r a t i n g  on r e a l e s t a t e and energy  loans.  7  From i t s i n c e p t i o n , i n  o r d e r t o compete w i t h t h e b i g s i x banks, t h e CCB to f i l l  what i t p e r c e i v e d t o be an unoccupied  attempted  niche,  making h i g h e r r i s k l o a n s t o the commercial middle The bank was  designed  by  market.  8  as a b u s i n e s s bank r a t h e r than as a  consumer bank and u n t i l  198 3 r e l i e d on f u n d i n g from  the  w h o l e s a l e money market r a t h e r than r e t a i l d e p o s i t s , t h e r e b y a v o i d i n g t h e expense of e s t a b l i s h i n g a c h a i n of 7 E s t e y , supra, c h a p t e r 1, note 8 I b i d , a t 405.  1 at  72.  retail  branches. that:  In t h e E s t e y Report,  "The  bank was  t h e Commission  observed  seen i n t h e West as w e l l as by  f e d e r a l government as b e i n g one which would  the  ' l e n d money  where t h e e s t a b l i s h e d banks r e f u s e d t o l e n d ' " .  1 0  In i t s e a r l y y e a r s , t h e bank grew q u i c k l y , as d i d t h e Western economy. expansion  In o r d e r t o f i n a n c e t h i s growth,  o f i t s l o a n p o r t f o l i o was  necessary,  rapid  which  i n c r e a s e d t h e r i s k o f making u n s a t i s f a c t o r y l o a n s . bank's t r o u b l e s , which became e v i d e n t i n 1982,  The  1 1  were  t r i g g e r e d by t h e r e c e s s i o n which h i t Western Canada i n The  e f f e c t o f t h i s economic downturn was  percentage  that a high  o f t h e l o a n s i n t h e CCB's e x c e s s i v e l y  c o n c e n t r a t e d p o r t f o l i o became n o n - p e r f o r m i n g . was  1981.  12  By 1983,  it  c l e a r t h a t t h e CCB's d e p o s i t base, dependent as i t was  on t h e u n s t a b l e , v o l a t i l e and c y c l i c a l w h o l e s a l e  market  was  dangerous and management attempted t o s h i f t t o t h e more stable r e t a i l market. r e t a i l d e p o s i t s had  By t h e f i s c a l y e a r end o f  1 3  r i s e n from a n e g l i g i b l e p e r c e n t a g e  2 0% o f t o t a l d e p o s i t s .  1 4  However, the number o f bad  i n CCB's p o r t f o l i o c o n t i n u e d t o r i s e between 1984 1985.  1 5  Adding to i t s d i f f i c u l t i e s ,  to d i v e r s i f y  9 10 11 12 13 14 15  1984,  i t s investments  I b i d , a t 426. Estey, supra, chapter I b i d , a t 74. I b i d , a t 11. I b i d , a t 71-72. I b i d , a t 81. I b i d , a t 83.  was  1, note  1 at  71.  loans  and  the c o s t l y  by the a c q u i s i t i o n o f  to  attempt an  53  i n t e r e s t i n Westlands B a n k — a p r o b l e m - r i d d e n bank.  California  1 6  Management, r e c o g n i z i n g  t h a t the bank was  trouble, resorted to several s u r v i v a l t a c t i c s ,  i n serious i n an  attempt  t o t i d e t h e bank over u n t i l the economy improved. Management p l a c e d u n s a t i s f a c t o r y l o a n s  i n t o a workout  arrangement which e n t a i l e d the a d o p t i o n o f a v a l u a t i o n standard  r e f e r r e d t o by management as  B a s e l i n e v a l u e was  "baseline  the a n t i c i p a t e d value  value".  o f the  loan,  on an assumption t h a t the economy would r e c o v e r . t h i s v a l u a t i o n , management r e c o g n i z e d i n t e r e s t as received,  income a l t h o u g h i t had  values  questionable  not  on the b a s i s o f f u t u r e  than present  loans  and  1 9  t e c h n i q u e s had  the e f f e c t o f s h o r i n g up  statements.  By t h e  2 0  statements no  longer  d e l a y e d the u l t i m a t e  end  accrued  These  rather  accounting  the bank's the  financial financial  the bank's t r u e s t a t u s , which  insolvency.  2 1  Meanwhile, n e i t h e r the bank's e x t e r n a l a u d i t o r s nor OIGB put Estey  on  established security  of f i s c a l y e a r 1984,  revealed  Based  in i t s  ( i . e . higher) values  ( i . e . depressed) v a l u e s .  based  i n f a c t been  f a i l e d t o make s p e c i f i c p r o v i s i o n s  f i n a n c i a l statements f o r bad  1 8  1 7  a s t o p t o management's q u e s t i o n a b l e  practices.  the The  Report c o n c l u d e d t h a t the CCB's e x t e r n a l a u d i t o r s were  aware o f t h e s e management p r a c t i c e s and 16 I b i d , a t 81. 17 I b i d , a t 86. 18 I b i d , a t 91. 19 I b i d , a t 91. 20 I b i d , a t 83-93. 21 I b i d , a t 100.  a c c e p t e d them  54  a l t h o u g h by 1983  they were e x p r e s s i n g concern t h a t  the  a c c o u n t i n g p r a c t i c e s were not as c o n s e r v a t i v e as t h e y might wish."  D e s p i t e t h e i r concern, t h e y c o n t i n u e d t o  t h e bank's f i n a n c i a l statements,  feeling their  certify  professional  d u t y had been d i s c h a r g e d by communicating t h e i r concerns t h e bank's A u d i t C o m m i t t e e .  The  23  E s t e y Report  to  concluded  t h a t t h e a u d i t o r s d i d not a p p l y s t a n d a r d p r i n c i p l e s of bank a u d i t i n g t o the f i n a n c i a l s t a t e m e n t s .  2 4  Furthermore,  f a i l e d to report unsatisfactory conditions a f f e c t i n g  the  w e l l - b e i n g o f t h e bank t o t h e c h i e f e x e c u t i v e o f f i c e r c h i e f g e n e r a l manager as r e q u i r e d by s e c t i o n 242 Act.  they  and  o f the Bank  2 5  The E s t e y Report a l s o c o n c l u d e d t h a t t h e OIGB knew o f t h e bank's d e t e r i o r a t i n g c o n d i t i o n between 1982 o f t h e u n c o n s e r v a t i v e p r a c t i c e s adopted i g n o r e d a l l warning  signals.  2 6  and  1983  and  by management, but  I t r e l i e d on t h e f a c t  that  the e x t e r n a l a u d i t o r s c o n t i n u e d t o c e r t i f y t h e bank's f i n a n c i a l statements i t s l a c k of  action.  On March 14,  as w e l l as statements  o f management f o r  2 7  1985,  r e p r e s e n t a t i v e s o f the CCB  t h e OIGB and t h e Bank o f Canada t h a t the CCB operate without  financial assistance.  2 8  informed  c o u l d no  In response,  longer the  Bank o f Canada made s u b s t a n t i a l l i q u i d i t y advances t o the 22 23 24 25 26 27 28  Ibid, Ibid, Ibid, Ibid, Ibid, Ibid, Ibid,  a t 137-149. a t 151. a t 153. a t 151. a t 164. a t 158. a t 105.  55  CCB  i n March and  negotiations  early April.  At the  began, the o b j e c t o f which was  s u p p o r t program t o r e s t o r e the CCB ultimately, healthy negotiations,  operation.  the p r e s i d e n t  loss provisions t o t a l l i n g T h i s assessment was an  same time, to instate a  to solvency  and,  In the c o u r s e o f t h e s e  o f the CCB  indicated that  loan  $244 m i l l i o n were n e c e s s a r y .  c o n f i r m e d by the OIGB, on the b a s i s  i n c o m p l e t e i n s p e c t i o n o f the bank's l o a n p o r t f o l i o .  s u p p o r t package i n the amount o f $255 m i l l i o n was  m i l l i o n ) , the  m i l l i o n ) , the Province  f e d e r a l government  of A l b e r t a  ($60  of A  3 0  ultimately  agreed upon, w i t h the p a r t i c i p a n t s c o n s i s t i n g o f the ( c o n t r i b u t i n g $75  2 9  CDIC ($60  m i l l i o n ) and  a  b a n k i n g group comprised o f the b i g s i x banks ( c o n t r i b u t i n g a t o t a l o f $60 authorized  million).  3 1  The  government o f Canada  t o p a r t i c i p a t e i n the r e s c u e p l a n by the  o f t h e Canadian Commercial Bank A s s i s t a n c e 1985,  was  c.9).  negotiations  The  b a n k i n g group had  insisted  o f the r e s c u e p l a n t h a t CCB  Act  passage  (R.S.1984-  during  debenture  holders  waive t h e i r r i g h t t o p r i n c i p a l o r i n t e r e s t u n t i l the plan p a r t i c i p a n t s recovered debenture h o l d e r s  refused  Canada, A l b e r t a and i n debentures. before  their contributions.  B r i t i s h Columbia purchased $39  Thus, CCB  debenture h o l d e r s implemented.  million  were p a i d o f f The  the b a n k i n g group r e c e i v e d warrants t o a c q u i r e a t 110-111. a t 110. a t 499. a t 111.  When the  t o so agree, the Governments o f  the r e s c u e program was  29 I b i d , 30 I b i d , 31 I b i d , 32 I b i d ,  3 2  support  members of  s h a r e s of  the  56  CCB  i n the f u t u r e ,  contribution.  The  i n exchange f o r t h e i r  financial  e f f e c t o f t h e s e warrants when e x e r c i s e d  would have been t o v i r t u a l l y e l i m i n a t e t h e i n t e r e s t s of the existing shareholders. to  3 3  In a d d i t i o n , t h e CCB  obliged  pay one h a l f o f t h e bank's p r e - t a x income t o t h e  p a r t i c i p a n t s i n t h e r e s c u e p l a n and suspend CCB  was  a l l d i v i d e n d s on  s h a r e s u n t i l t h e $255 m i l l i o n c o n t r i b u t i o n was A f t e r t h e r e s c u e p l a n was  instituted,  comprehensive p o r t f o l i o examinations OIGB.  As a r e s u l t ,  repaid.  f u r t h e r and more  were conducted  s u p p o r t group had d e v i s e d t h e i r r e s c u e p l a n w i t h inaccurate i n f o r m a t i o n .  3 5  In was to  J u l y and August o f 1985,  was  3 7  grossly dim.  was  willing  w i t h o u t a s u b s t a n t i a l government  On September 1, 1985,  t h e OIGB informed  the  M i n i s t e r of Finance t h a t a c u r a t o r should be.appointed t h e CCB  was  came due.  3 6  t h e p o s s i b i l i t y o f a merger  c o n s i d e r e d but no p a r t y c o u l d be found who  subsidy.  the  inadequate  and t h e CCB's f i n a n c i a l o u t l o o k appeared  merge w i t h t h e CCB  the  I t q u i c k l y became o b v i o u s  t h a t t h e $255 m i l l i o n i n f u s e d i n t o the CCB inadequate  by  i t became c l e a r t h a t many of t h e CCB's  l o a n s were o v e r v a l u e d on t h e b a l a n c e s h e e t and t h a t  and  3 4  no l o n g e r a b l e t o pay The bank was  its liabilities  as  as they  u l t i m a t e l y l i q u i d a t e d , with insured  and u n i n s u r e d d e p o s i t o r s r e c e i v i n g f u l l  compensation  and  the  33 I b i d , a t 116-118. 34 I b i d , a t 499. 35 I b i d , a t 121. 36 I b i d , a t 126. 37 P r o c e e d i n g s of the S t a n d i n g Senate Committee on Banking, Trade and Commerce (Ottawa: November 19, 1985) a t 31:7 [hereinafter "Proceedings"].  57  members o f t h e s u p p o r t group  (who were n o t c l a s s i f i e d as  depositors) l o s i n g t h e i r c o n t r i b u t i o n s .  b)  3 8  N o r t h l a n d Bank I n c o r p o r a t e d i n 1975, N o r t h l a n d was, l i k e t h e CCB, a  Western-based bank d e s i g n e d t o l e n d t o h i g h e r - r i s k midmarket commercial borrowers and t o r e l y e s s e n t i a l l y on f u n d i n g from w h o l e s a l e money m a r k e t s . grew s t e a d i l y from geographic  1975 u n t i l  Although  3 9  1982, i t s u f f e r e d  concentration, a l a c k of experienced  t h e bank  from management,  and a n o n - d i v e r s i f i e d l o a n p o r t f o l i o which c o n c e n t r a t e d on the c y c l i c a l  energy  and r e a l e s t a t e i n d u s t r i e s .  Due t o  4 0  i t s l e n d i n g p r a c t i c e s and r e l i a n c e on t h e w h o l e s a l e  money  markets, N o r t h l a n d was v u l n e r a b l e t o t h e r e c e s s i o n which h i t Alberta i n 1981.  4 1  By 1983, i t was c l e a r t o management t h a t  i t was f a c i n g a l a r g e number o f nonperforming  loans.  response,  (much l i k e  management adopted  survival tactics  t h o s e used by CCB's management) i n an attempt  4 2  In  to maintain a  h e a l t h y appearance u n t i l t h e Western economy r e c o v e r e d . One t a c t i c adopted  by management was t o t u r n t o t h e  r e t a i l market f o r a more s t a b l e c o r e o f d e p o s i t s .  4 3  A n o t h e r s t a t e g y was t o p l a c e u n s a t i s f a c t o r y l o a n s i n t o a workout which management f e l t of t h e l o a n o r i t s c o l l a t e r a l , 38 39 40 41 42 43  justified  i n f l a t i n g the value  capitalizing  E s t e y , supra, c h a p t e r 1, note I b i d , a t 2. I b i d , a t 181. I b i d , a t 186. I b i d , a t 187. I b i d , a t 189.  1 a t 530.  i n t e r e s t and  t a k i n g accrued  but u n r e c e i v e d  e f f e c t of these  interest  i n t o income.  t a c t i c s was summarized  i n the Estey  The Report:  The F i n a n c i a l Statements became g o l d f i l l i n g s c o v e r i n g c a v i t i e s i n t h e a s s e t s and i n t h e e a r n i n g s o f t h e bank. By c o n v e n t i o n a l standards o f b a n k i n g and bank a c c o u n t i n g t h e bank would have been shown as s h o r t on a s s e t s and e a r n i n g s . The c o n f i d e n c e o f t h e money market would have been l o s t and d e p o s i t s withdrawn. The bank, w i t h o u t o u t s i d e a s s i s t a n c e , would have had t o c l o s e i t s doors as e a r l y as 1983. 5  As i n t h e c a s e o f t h e CCB, N o r t h l a n d ' s e x t e r n a l a u d i t o r s accepted  managements's p r a c t i c e o f t a k i n g i n t o  account t h e i r e x p e c t a t i o n s  o f f u t u r e improved economic  c o n d i t i o n s when v a l u i n g a s s e t s .  4 6  They were not  c o n s e r v a t i v e when r e v i e w i n g management workouts o f unsatisfactory loans. a u d i t o r s expressed  4 7  The E s t e y Report c o n c l u d e d  c o n c e r n t o t h e A u d i t Committee  o c c a s i o n a l l y and i n e f f e c t u a l l y .  4 8  became aware o f t h e d i s c r e p a n c y o f N o r t h l a n d ' s l o a n s and t h o s e management.  49  In 1982-1983,  between p r e s e n t future values  t h a t the only  t h e OIGB day  values  a s c e r t a i n e d by  However, i t r e l i e d on t h e e x t e r n a l a u d i t o r s  and management and d i d not d i r e c t the bank's problems u n t i l  1985.  i t s powers t o d e a l  with  50  N o r t h l a n d ' s problems were compounded by t h e h i g h l y p u b l i c i z e d b a i l o u t o f the CCB i n March, 1985. 44 45 46 47 48 49 50  Ibid, Ibid, Ibid, Ibid, Ibid, Ibid, Ibid,  at at at at at at at  4. 5-6. 242. 248. 244. 253. 262.  The two banks  59  were seen by d e p o s i t o r s as b e l o n g i n g t o t h e same c a t e g o r y and as a r e s u l t , N o r t h l a n d s u f f e r e d a l o s s o f d e p o s i t s and a fall  i n share p r i c e s .  totalled  5 1  L i q u i d i t y advances which u l t i m a t e l y  $500 m i l l i o n were made by t h e Bank o f Canada t o  replace these l o s t d e p o s i t s .  5 2  On September 1, 1985,  OIGB i n f o r m e d t h e Bank o f Canada t h a t N o r t h l a n d was to  meet i t s l i a b i l i t i e s as t h e y came due  l i q u i d a t i o n p r o c e s s was  unable  and recommended t o  t h e M i n i s t e r o f F i n a n c e t h a t a c u r a t o r be The  the  appointed.  d e l a y e d due t o management's  b e l i e f t h a t N o r t h l a n d c o u l d be r e h a b i l i t a t e d o r merged w i t h a viable institution. each  Four p r o p o s a l s were put f o r t h  but  i n v o l v e d s u b s t a n t i a l open-ended i n d e m n i t i e s from  government and were, t h e r e f o r e , r e j e c t e d by government officials.  5 3  The bank was  l i q u i d a t e d i n e a r l y 1986  with  i n s u r e d and u n i n s u r e d d e p o s i t o r s h a v i n g r e c e i v e d f u l l compensation.  c) Bank o f B r i t i s h  Columbia  Formed i n 1967  and promoting  Western Bank", the Bank o f B.C. market, b u i l d i n g f o r t y one Columbia it  and A l b e r t a .  itself  was  retail  as "Canada's  s u c c e s s f u l i n the  branches  retail  in British  However, l i k e the CCB  and  Northland,  s u f f e r e d from the economic downturn which h i t t h e Western  economy i n 1982. m i l l i o n and  In 1983,  i n 1984  51 I b i d , a t 6. 52 I b i d , a t 6. 53 P r o c e e d i n g s ,  had  i t posted loan l o s s e s of  $122  $51  m i l l i o n worth o f o u t s t a n d i n g  supra, note 37 a t  31:9.  l o a n s on which i n t e r e s t payments had Despite  an i n f u s i o n o f new  capital  ceased t o be made.  i n 1985,  dropped d r a m a t i c a l l y i n t h a t y e a r due a r e s u l t o f t h e c o l l a p s e s o f CCB 1986,  i t s deposits  to confidence  and N o r t h l a n d .  lost By  5 5  l i q u i d i t y advances from the Bank o f Canada had  a maximum h e i g h t o f $975 m i l l i o n .  and  o r merger p a r t n e r .  search  In the  informed  for a  198 6,  t o c o n s o l i d a t e i t s o p e r a t i o n s by c l o s i n g  some Western branches and In November, 1986,  Bank  second  q u a r t e r o f the f i n a n c i a l y e a r e n d i n g O c t o b e r 31, management d e c i d e d  reached  Northland,  management conducted an u n s u c c e s s f u l  p o t e n t i a l purchaser  April,  5 6  F o l l o w i n g the f a i l u r e s o f the CCB o f B.C.  as  reducing  foreign  operations.  5 7  the Bank o f B.C.'s e x t e r n a l a u d i t o r s  management t h a t they would be u n a b l e t o p r o v i d e  an  u n q u a l i f i e d a u d i t o p i n i o n on the f i n a n c i a l statements due c o n c e r n o v e r the bank's f u t u r e v i a b i l i t y .  5 8  The  to  OIGB  conducted f o u r reviews of the bank's l o a n p o r t f o l i o between September, 1985 bank was  and  September, 198 6,  i n a precarious p o s i t i o n .  concluding  i n t h e f o u r t h q u a r t e r of 198 6.  t o c o n t r i b u t e f i n a n c i a l support  the  5 9  Management conducted a renewed s e a r c h purchasers  that  for prospective The  CDIC o f f e r e d  t o a proposed t r a n s a c t i o n  54 John S h r e i n e r , " I s Edgar on a K a i s e r R o l l ? " , F i n a n c i a l Post Magazine (March 1, 1986) a t 22. 55 I b i d , a t 22. 56 Bank of B r i t i s h Columbia, Management I n f o r m a t i o n C i r c u l a r (December 12, 1986) a t 8 [ h e r e i n a f t e r " I n f o r m a t i o n Circular"]. 57 I b i d , a t 8. 58 I b i d , a t 10. 59 I b i d , a t 10.  61 a f t e r c a l c u l a t i n g t h a t l i q u i d a t i o n o f t h e Bank o f B.C. would r e s u l t i n an immediate payment o f $1.3 b i l l i o n t o i n s u r e d depositors.  The Hongkong Bank o f Canada (a s u b s i d i a r y o f  6 0  the Hongkong and Shanghai Banking C o r p o r a t i o n ) was t h e o n l y p a r t y w i l l i n g t o c o n c l u d e a t r a n s a c t i o n w i t h t h e amount o f subsidy 98.6%  o f f e r e d by t h e C D I C .  6 1  I t agreed t o purchase  o f t h e Bank o f B.C.'s t o t a l a s s e t s  majority for  being  (including the  o f i t s domestic and i n t e r n a t i o n a l l o a n p o r t f o l i o )  $63.5 m i l l i o n and assumed s u b s t a n t i a l l y a l l o f i t s  liabilities  ( i n c l u d i n g a $400 m i l l i o n debt t o t h e Bank o f  Canada and a l l o f i t s d e p o s i t contributed  liabilities).  6 2  The CDIC  $200 m i l l i o n t o c o v e r any p o s s i b l e f u t u r e  a s s o c i a t e d w i t h t h e Bank o f B.C.'s l o a n p o r t f o l i o .  6 3  losses As a  r e s u l t o f t h i s purchase assumption arrangement, a l l o f t h e bank's d e p o s i t o r s  were p r o t e c t e d  from p o t e n t i a l l o s s e s .  the c o u r s e o f w i n d i n g up i t s b u s i n e s s , r e a l i z e upon t h e r e m a i n i n g a s s e t s liabilities.  t h e Bank o f B.C.  In will  and s a t i s f y t h e r e t a i n e d  The amount which s h a r e h o l d e r s  will  receive  upon l i q u i d a t i o n w i l l depend upon t h e r e a l i z a t i o n o f t h e remaining assets,  the progress of l i t i g a t i o n  Bank o f B.C., t h e s e t t l e m e n t  i n v o l v i n g the  of the retained l i a b i l i t i e s  and  whether o r n o t t h e Bank o f B.C. i s e n t i t l e d t o an e x i s t i n g p e n s i o n fund s u r p l u s .  6 4  I t i s l i k e l y that shareholders  s u f f e r a s u b s t a n t i a l but not complete l o s s — 60 61 62 63 64  Ibid, Ibid, Ibid, Ibid, Ibid,  at at at at at  11. 15. 5. 5. 7.  will  Bank o f B.C.'s  management e x p e c t s p r e f e r e n c e s h a r e h o l d e r s t o be p a i d out f u l l y and  common s h a r e h o l d e r s t o r e c e i v e between $0.55 and  $1.20  p e r share  $1.85  p e r share i f the bank i s e n t i t l e d t o withdraw the  pension  (which would i n c r e a s e t o between $1.20  surplus).  and  6 5  The p r e c e e d i n g t h r e e examples o f bank f a i l u r e s / m e r g e r s a r e u s e f u l because a l t h o u g h t h e f a c t u a l s i t u a t i o n s o f the banks i n v o l v e d a r e r o u g h l y comparable, i n each case government responded insolvency.  d i f f e r e n t l y t o the threatened or a c t u a l  The government's responses  provide insight  i n s o l v e n c y l e g i s l a t i o n and a s s i s t  65 I b i d , a t  7.  i n these  cases  i n t o the o p e r a t i o n o f Canadian bank  e v a l u a t i o n of t h a t  the  legislation.  i n the f o l l o w i n g  63  CHAPTER 4.  EVALUATION  OF  BANK  INSOLVENCY  LEGISLATION  The the  legislative  three  Acts  course of and  o u t l i n e d i n chapter  a c t i o n i n the  payoff  response  approach t o bank i n s o l v e n c y  of  insured  i s to b a i l  government  face  of  an  depositors.  out  insured  i n t e r v e n t i o n which  most a p p r o p r i a t e are  i n need  other  is justified  options  open t o t h e  of  restrictive  overly at the  alternative government  was  case  studies  time of the  a  form the  grounds  a l w a y s be  studies  and  of  show  that  i n some of  the  limited  Bank A c t ,  Act,  and  the  the Winding-up  to  the  bank i n s o l v e n c y  to  for  r e s p o n s e s t o bank i n s o l v e n c i e s w h i c h  the  CDIC h a v e made i n t h e  reform  legislation the  the  By  need  examining  and  the  a c t i o n i t deemed  point  failures.  of  interests  p a s s e d when n e c e s s a r y  government t o t a k e the The  force  case  Insurance Corporation  appropriate. the  The  one  this  what o t h e r  government under the  Special legislation  empower t h e  1  of  on  not  implemented—regardless  Canada D e p o s i t Act.  may  on  in  liquidation  effect  depositors,  have been c o n s i d e r e d  circumstances,  insolvency:  s o l u t i o n d e p e n d i n g on  of p r o t e c t i o n .  options  3 concentrates  The  c o n s u m e r p r o t e c t i o n . However, t h i s  embodied  context  of  the  in  CCB, ~  1 C l e a r l y , a p r i v a t e s e c t o r s o l u t i o n w o u l d be more d e s i r a b l e t h a n any f o r m o f g o v e r n m e n t i n t e r v e n t i o n . However, t h i s p a p e r a s s u m e s t h a t s u c h a s o l u t i o n w o u l d be unobtainable— w h i c h i s g e n e r a l l y t h e c a s e due t o d e t e r i o r a t i o n o f t h e bank's l o a n p o r t f o l i o . See R i c h a r d M. R o s e n b e r g , D o n a l d B. G i v e n , " F i n a n c i a l l y T r o u b l e d B a n k s : P r i v a t e S o l u t i o n s and R e g u l a t o r y A l t e r n a t i v e s " (1987) The B a n k i n g Law J o u r n a l 234 a t 285 { h e r e i n a f t e r " R o s e n b e r g " ] .  64  N o r t h l a n d and Bank o f B.C.,  the s p e c i f i c  l i m i t a t i o n s of the l e g i s l a t i v e  framework  disabilities  and  become e v i d e n t .  These a l t e r n a t e c o u r s e s o f a c t i o n i n c l u d e d : a) p a y i n g o f f u n i n s u r e d d e p o s i t o r s ; b) s u b s i d i z i n g mergers w i t h institutions;  viable  and c) a r r a n g i n g and c o n t r i b u t i n g t o r e s c u e  packages d e s i g n e d t o r e s t o r e i n s o l v e n t banks t o h e a l t h y operation.  a)  Payoff of Uninsured Although  Depositors  t h e CDIC i s o b l i g a t e d t o pay c l a i m s o f o n l y  i n s u r e d d e p o s i t o r s i n the event o f l i q u i d a t i o n , circumstances  i n some  t h e government has d e c i d e d t h a t t h e c l a i m s of  u n i n s u r e d d e p o s i t o r s s h o u l d be p a i d as w e l l . justifications  f o r t h e government's d e c i s i o n t o b a i l  u n i n s u r e d d e p o s i t o r s o f CCB supra  (chapter2).  for this  t y p e o f complete payout,  authority existed  the F i n a n c i a l  (R.S.C. 1985  c. 51)  a u t h o r i z i n g t h e government t o pay t h e c l a i m s ,  T h i s h i g h l i g h t s a d e f i c i e n c y i n the l e g i s l a t i v e p l a c e a t t h e time o f the f a i l u r e o f t h e s e banks:  yet  this  form of government response  t h e government was  financial  compelled  Institutions was  passed,  including  o f t h e u n i n s u r e d d e p o s i t o r s o f t h e two  contemplate  out  and N o r t h l a n d were d i s c u s s e d  Because no l e g i s l a t i v e  D e p o s i t o r s Compensation A c t  interest,  The  banks. structure in i t d i d not  t o bank  failure  by the i n t e r e s t s o f  s t a b i l i t y and r e g i o n a l economic development t o  make such a response.  Although  t h e r e are c i r c u m s t a n c e s  in  which t h e b a i l out of u n i n s u r e d d e p o s i t o r s and c r e d i t o r s i s  65  justified, efficient result  i t will and  be  beneficial  i n t h e CCB  techniques  and  be  set forth  clearly  that  t h e r e a r e more  cost-  techniques f o r achieving  than the l i q u i d a t i o n  government  2.  argued  and  and  p a y o f f approach  Northland cases.  the c r i t e r i a  for their  this  t a k e n by  These  alternate  implementation  i n r e v i s e d bank i n s o l v e n c y  the  should  legislation.  Merger Merger  not  i s a second  contemplated  If  a troubled  no  need  for  Canadian  bank can  f o r government  authorizing  that  by  arrange  c a s e and  The  was  and  However,  bank cannot  find  merger approach  was  there i s no  i t i s often  a willing  used  i n b o t h t h e CCB  is  legislation.  therefore,  o f a government  contemplated  which  a merger p r i v a t e l y ,  intervention  the c o n t r i b u t i o n  indemnity.  t o bank f a i l u r e  bank i n s o l v e n c y  legislation.  a distressed  without  response  need  the  case  merger p a r t n e r  subsidy or i n t h e Bank o f and  B.C.  Northland  situations. The  purchase  assumption  of s u b s t a n t i a l l y  Bank o f B.C. by  by  team r e v i e w e d  a l l o f t h e a s s e t s and  a l l of the l i a b i l i t i e s  t h e H o n g k o n g Bank o f C a n a d a was  a s u b s i d y from  t h e CDIC.  1986,  precarious  and  i t concluded that  encouraged  financial  2 Information Circular,  the  facilitated  2  in  t h e bank's p o s i t i o n  t h e bank t o a r r a n g e  institution.  of  the  When t h e I n s p e c t o r G e n e r a l ' s  t h e Bank o f B.C.'s l o a n p o r t f o l i o  September,  viable  of substantially  I t was  clear  s u p r a , c h a p t e r 3,  a sale that  note  56  the  at  was  to a CDIC  10.  66 would i n c u r a s u b s t a n t i a l l o s s i f t h e Bank o f B.C. were forced to l i q u i d a t e . looming  Therefore,  i n order t o avoid the  p r o s p e c t o f l i q u i d a t i o n and p a y o f f  e s t i m a t e d payout o f $1.3 b i l l i o n ) , provide s i g n i f i c a n t  3  (and an immediate  t h e CDIC agreed t o  f i n a n c i a l support  i f a t r a n s a c t i o n could  be a r r a n g e d which would a v o i d i n v o l u n t a r y l i q u i d a t i o n o f t h e Bank o f B.C. entered  The purchase assumption t r a n s a c t i o n which was  i n t o by t h e Hongkong Bank o f Canada was s u b s i d z e d by  t h e CDIC i n t h e amount o f $2 00 m i l l i o n .  There does n o t  appear t o e x i s t any l e g i s l a t i v e a u t h o r i t y f o r t h e CDIC t o have made such  financial assistance.  t h e Canada D e p o s i t Insurance  Under s e c t i o n 11 o f  Corporation Act, the  C o r p o r a t i o n i s a u t h o r i z e d t o do a l l t h i n g s n e c e s s a r y o r incidental to i t s objects.  I t s objects are t o provide  d e p o s i t i n s u r a n c e and make payments .to i n s u r e d d e p o s i t o r s i n accordance  w i t h t h e A c t ; examine i n t o t h e a f f a i r s o f member  i n s i t u t i o n s f o r t h e purpose o f o b t a i n i n g i n f o r m a t i o n r e l a t i v e t o d e s p o i t i n s u r a n c e ; and t o accumulate, manage and i n v e s t a d e p o s i t i n s u r a n c e fund  (section 8).  I t would be  s t r e t c h i n g t h e language o f s e c t i o n 8 t o f i t t h e CDIC's a c t i o n s i n t h e Bank o f B.C. case w i t h i n one o f t h e s e subsections.  The A c t goes on i n s e c t i o n 11 t o p r o v i d e a  non-exhaustive  list  o f t h e C o r p o r a t i o n ' s powers  (see c h a p t e r  3 supra) b u t none appear t o encompass t h e payment o f a s u b s i d y t o an a c q u i r i n g i n s t i t u t i o n .  3 I b i d , a t 10.  67  Therefore, insolvency  the  of the  CDIC's s o l u t i o n  Bank o f B.C.  was  authorizing  legislation.  However,  appropriate  solution  the  contemplated subsidizing of  $2 00  by  than  million,  the  thereby  arguably  liquidation  approach  The  b a n k was  maintaining  For  the  almost  billion  concern  value.  any  investment  were s a v e d  (and p o s s i b l y The  t h e b a n k was  only p a r t i a l  bank's s h a r e h o l d e r s  avoided been t h e  loss  of t h e i r  likely  suffered  entire  outcome o f  Therefore,  the  inadequacy  of the present  some  of the  d i d not  i s a clear  legislative liquidation  hardship  claims.  loss,  example o f  have 5  the  s t r u c t u r e and payoff  4  but  which would  and  lose  satisfaction  of t h e i r  a significant  investment  the  involuntary liquidation.  Bank o f B.C.  inappropriateness  Furthermore,  liqudated f o r the  satisfaction)  insured  i n operation,  creditors  of waiting u n t i l  amount  inevitable  d e p o s i t o r s and and  by  i n the  the bank's u n i n s u r e d p o r t i o n of t h e i r  a more  t o the bank's  able t o remain  i t s going  example,  Bank o f B.C.  CDIC a v o i d e d $1.3  scope of i t s  i t was  of the  payment o f a p p r o x i m a t e l y  threatened  beyond the  that legislation.  the purchase  depositors.  to the  the  approach  in  situations.  4 I t w i l l be a r g u e d t h a t t h i s e f f e c t o f a p u r c h a s e and assumption ( i . e . o f b a i l i n g o u t u n i n s u r e d d e p o s i t o r s and c r e d i t o r s ) i s n o t d e s i r a b l e i n a l l c i r c u m s t a n c e s due t o i t s a d v e r s e e f f e c t on m a r k e t d i s c i p l i n e ( s e e c h a p t e r 5, s e c t i o n 2). However, i f t h e c i r c u m s t a n c e s a r e s u c h t h a t t h e government i s j u s t i f i e d i n p a y i n g out the c l a i m s of u n i n s u r e d d e p o s i t o r s i n any e v e n t , a p u r c h a s e and assumption h a s many a d v a n t a g e s o v e r a l i q u i d a t i o n and p a y o f f . 5 I n f o r m a t i o n C i r c u l a r , s u p r a , c h a p t e r 3, n o t e 56 a t 22.  68 The merger o p t i o n was contemplated  by t h e government i n  t h e CCB case as a method o f d e a l i n g w i t h t h e bank's insolvency.  looming  The OIGB i n v e s t i g a t e d t h e p o t e n t i a l o f a merger  i n August o f 1985 and r e p o r t e d t o t h e M i n i s t e r o f S t a t e as follows: No bank would be w i l l i n g t o amalgamate w i t h them u n l e s s some t h i r d p a r t y ( i . e . , t h e CDIC o r t h e government i n some form o r other) pays t h e l a r g e r bank. Payment c o u l d be by p u r c h a s i n g bad and nonearning l o a n s a t f a c e v a l u e o r by f u n d i n g t h e n o n e a r n i n g l o a n s and p r o v i d i n g an indemnity a g a i n s t l o s s e s . . . Obviously, there i s l i t t l e to d i s t i n g u i s h t h i s from a l i q u i d a t i o n approach...6  The merger o p t i o n was u l t i m a t e l y  abandoned.  The p o s s i b i l i t y o f a merger was a l s o c o n s i d e r e d i n t h e Northland case.  However,  l i k e t h e CCB, t h e bank's a s s e t s  had d e t e r i o r a t e d t o such an e x t e n t t h a t government s u b s i d i e s r e q u i r e d t o amke t h e bank a c c e p t a b l e t o proposed were u n a c c e p t a b l y  large.  partners  F o r example, t h e OIGB asked t h e  N a t i o n a l Bank t o c o n s i d e r a merger w i t h N o r t h l a n d . r e f u s e d a f t e r examining  t h e bank's l o a n p o r t f o l i o .  National 7  When  t h e government f a i l e d t o f i n d a w i l l i n g merger p a r t n e r , i t had no a l t e r n a t i v e but t o use i t s power under s e c t i o n 278 o f t h e Bank A c t t o a p p o i n t a c u r a t o r t o oversee t h e bank's operations.  F u r t h e r merger e f f o r t s were made a f t e r t h e  appointment o f t h e c u r a t o r :  the l i q u i d a t i o n process  d e l a y e d and t h e government r e t a i n e d a c o n s u l t a n t who w i t h N o r t h l a n d management t o come up w i t h a v i a b l e 6 E s t e y , s u p r a . c h a p t e r 1, note 1 a t 521. 7 P r o c e e d i n g s , supra, c h a p t e r 3, note 37 a t 31:9.  was worked  r e o r g a n i z a t i o n o r merger.*  Merger p a r t n e r s were  sought  among major i n t e r n a t i o n a l banks b u t a l l r e q u i r e d f e d e r a l commitment  t o c o v e r l o s s e s on t h e bank's l o a n p o r t f o l i o .  The government r e f u s e d t o make such a commitment  9  and on  September 30, announced i t s d e c i s i o n t o seek a p p r o v a l t o have N o r t h l a n d wound up. T h e r e f o r e , t h e merger o p t i o n was contemplated  i n the  CCB and N o r t h l a n d c a s e s b u t r e j e c t e d because t h e banks' a s s e t s had d e t e r i o r a t e d t o an e x t e n t t h a t made t h e n e c e s s a r y government s u b s i d y p r o h i b i t i v e l y l a r g e . s o l u t i o n had been attempted  earlier,  However,  i f such a  i t may have met  with  t h e s u c c e s s a c h i e v e d i n t h e Bank o f B.C. case and a v o i d e d t h e c o s t l y p a y o f f o f t h e i n s u r e d and u n i n s u r e d d e p o s i t o r s o f b o t h banks.  3.  Rescue Packages A t h i r d c o u r s e o f a c t i o n which t h e government has taken  i n t h e f a c e o f bank f a i l u r e i s t h e arrangement o f a r e s c u e program  ( i . e . t h e i n f u s i o n o f government funds i n t o a  f a i l i n g bank w i t h t h e aim o f r e s t o r i n g i t t o h e a l t h y operation).  There i s no l e g i s l a t i v e framework i n e x i s t e n c e  which p r o v i d e s c r i t e r i a  f o r d e c i d i n g when a Canadian bank  s h o u l d be r e s c u e d by t h e government.  Nor i s t h e r e  l e g i s l a t i o n g i v i n g government a g e n c i e s t h e a u t h o r i t y t o i n s t i t u t e a r e s c u e program o r t h e f l e x i b l e powers needed t o implement i t .  However,  i n t h e s p r i n g and summer o f 1985,  8 I b i d , a t 31:9. 9 E s t e y , s u p r a . c h a p t e r 1, note 1 a t 598-599.  70 when f a c e d w i t h t h e f i n a n c i a l d i f f i c u l t i e s Northland, CCB,  t h e government contemplated  attempted In  a r e s c u e through d i r e c t  o f t h e CCB  and,  and  i n t h e case of  financial assistance.  t h e N o r t h l a n d case, t h e government c o n s i d e r e d a  r e s c u e package as an a l t e r n a t i v e t o t h e l i q u i d a t i o n payoff approach. proposed  1 0  In J u l y ,  1985,  and  t h e bank's management  a major r e s t r u c t u r i n g arrangement t o government  officials the b a n k .  i n t h e hopes o f r e s t o r i n g d e p o s i t o r c o n f i d e n c e i n 1 1  The p r o p o s a l i n v o l v e d t h e purchase  by  the  Government o f Canada o f $250 m i l l i o n worth o f t h e bank's loans.  However, o f f i c i a l s  from t h e Bank o f Canada, t h e  Department o f F i n a n c e and t h e OIGB r e j e c t e d the p r o p o s a l t h e b a s i s t h a t i t was  on  premature:  ...the p r o p o s a l , which would be viewed as a government b a i l - o u t o p e r a t i o n , would h e i g h t e n the p e r c e p t i o n t h a t the t r u e s i t u a t i o n o f t h e N o r t h l a n d , and o f o t h e r s m a l l banks, was much worse than the p u b l i c has been l e d t o b e l i e v e and c o u l d f u r t h e r undermine c o n f i d e n c e i n t h e N o r t h l a n d and p o s s i b l y , i n o t h e r s m a l l banks.12  In  August o f 1985,  a further proposal involving  interest-  f r e e l o a n s from the CDIC o r the f e d e r a l government t o N o r t h l a n d was same r e a s o n s .  r e j e c t e d by government o f f i c i a l s  f o r much the  In September, a f t e r a c u r a t o r was  appointed,  a government-appointed c o n s u l t a n t r e c e i v e d f o u r f u r t h e r p r o p o s a l s t o r e s c u e the bank through  restructuring.  However, t h e s e were r e j e c t e d by the government on 10 P r o c e e d i n g s , supra. c h a p t e r 3, note 37 a t 11 E s t e y , s u p r a . c h a p t e r 1, note 1 a t 578. 12 I b i d , a t 579.  31:9.  two  71 grounds:  1) each i n v o l v e d  " l a r g e and open-ended  subsidies"  from t h e government and 2 ) none would guarantee a " v i a b l e ongoing b a n k i n g o p e r a t i o n continuing  t h a t would n o t be dependent on  government s u p p o r t " .  1 3  Although the p o s s i b i l i t y  o f a r e s c u e program was u l t i m a t e l y r e j e c t e d by t h e government i n t h e c o n t e x t  o f the Northland insolvency, the  s i g n i f i c a n t p o i n t i s t h a t t h e government d i d i n f a c t consider  t h i s approach b e f o r e  resorting t o the statutory  p r o c e d u r e o f l i q u i d a t i o n and p a y o f f uninsured  and t h e compensation o f  depositors.  In t h e CCB case, t h e government a c t u a l l y made attempt  a rescue  ( f o r d e t a i l s o f t h e program see c h a p t e r 3 s u p r a ) .  In making t h e d e c i s i o n t o implement and c o n t r i b u t e funds t o t h e r e s c u e o p e r a t i o n ,  public  government o f f i c i a l s had t o  b a l a n c e t h e d e s i r e t o a v o i d government investment i n a p r i v a t e business against failure.  the p o t e n t i a l negative  These i n c l u d e d :  Western-based f i n a n c i a l  e f f e c t s of  possible repercussions  f o r small,  i n s t i t u t i o n s and t h e Western  Canadian economy; p o s s i b l e i n t e r n a t i o n a l i m p l i c a t i o n s ; d i s r u p t i o n t o t h e b u s i n e s e s o f CCB borrowers; and adverse e f f e c t s on t h e v i a b i l i t y Lacking  o f t h e r e g i o n a l bank c o n c e p t .  1 4  t h e l e g i s l a t i v e a u t h o r i t y t o make d i r e c t  f i n a n c i a l c o n t r i b u t i o n s t o a d i s t r e s s e d bank, t h e f e d e r a l government passed s p e c i a l e n a b l i n g  legislation:  Canadian Commercial Bank A s s i s t a n c e that Act,  $75 m i l l i o n was a u t h o r i z e d  Act.  the  Under t h e terms o f  t o be p a i d from t h e  13 P r o c e e d i n g s , supra, c h a p t e r 3, note 37 a t 31:9. 14 E s t e y , supra, c h a p t e r 1, note 1 a t 478-479.  72  C o n s o l i d a t e d Revenue Fund f o r t h e purposes o f t h e f e d e r a l government's p a r t i c i p a t i o n i n t h e CCB r e s c u e . t h e A c t gave t h e M i n i s t e r o f S t a t e  (Finance)  e n t e r i n t o any agreements n e c e s s a r y support  In a d d i t i o n , t h e power t o  t o provide  financial  t o t h e CCB under t h e terms o f t h e proposed  support  package. The  CDIC a l s o p a r t i c i p a t e d i n t h e r e s c u e program i n t h e  amount o f $75 m i l l i o n .  Presumably, t h e C o r p o r a t i o n ' s  t o make t h i s c o n t r i b u t i o n d e r i v e d from s e c t i o n 11(a) Canada D e p o s i t  Insurance  Corporation Act.  power of the  Under t h e terms  of that s e c t i o n , the Corporation i s e n t i t l e d t o acquire a s s e t s from o r make l o a n s t o a bank f o r t h e purpose o f reducing a r i s k or reducing or averting a threatened the Corporation. support  The c a p i t a l  loss to  i n f u s e d i n t o t h e CCB by t h e  group was d e s c r i b e d i n t h e j o i n t agreement as a  p u r c h a s e o f a package o f nonperforming l o a n s and c o u l d , t h e r e f o r e , be c o n s i d e r e d meaning o f s e c t i o n 11.  a purchase o f a s s e t s w i t h i n t h e A l t e r n a t i v e l y , the transaction could  be d e s c r i b e d as a l o a n by v i r t u e o f i t s repayment p r o v i s i o n (which i s more c h a r a c t e r i s t i c o f a l o a n than and  sale).  o f a purchase  C l e a r l y , t h e CDIC's p a r t i c i p a t i o n —  whether an  a s s e t purchase o r a l o a n — was made i n an attempt t o a v e r t a threatened  loss t o the Corporation,  as r e q u i r e d by s e c t i o n  11. From i t s i n c e p t i o n , t h e support certain to f a i l  package was almost  and w i t h i n s e v e r a l months had done s o . The  73  Estey  Report c i t e d s e v e r a l reasons f o r the  rescue plan,  i n c l u d i n g the  f a i l u r e of  following:  i ) m i s c a l c u l a t i o n o f the amount o f a s s i s t a n c e the type of a s s i s t a n c e r e q u i r e d — i n a d e q u a t e and  the  d i d not p r o v i d e  immediate flow o f income.  The  the  the CCB  and  funds were with  an  r e s c u e funds were  p a i d d i r e c t l y t o the Bank o f Canada t o reduce l i q u i d i t y a d v a n c e s — t h e y became a f u r t h e r debt o b l i g a t i o n o f the CCB insolvency  ii)  o f the  and  d i d not  alleviate  the  CCB;  l a c k o f d i r e c t involvement by t h e one  federal  agency e x p e r i e n c e d i n l i q u i d a t i o n — t h e CDIC;  iii)  inadequate i n s p e c t i o n o f the  the OIGB and  loan p o r t f o l i o  inadequate communication o f the r e s u l t s  o f e x a m i n a t i o n s t o the p a r t i c i p a n t s i n the program.  Due  information an  t o the  l a c k of accurate  regarding  i n s u f f i c i e n t and  and  the bank's f i n a n c i a l  inappropriate  p l a c e t o save a bank which may the p o i n t of  by  p l a n was  support adequate status, put  into  w e l l have been beyond  rescue;  i v ) l a c k o f a method f o r d e a l i n g w i t h the i n t e r e s t s o f CCB  shareholders.  The  w i t h t h e i r i n t e r e s t s was  o n l y method used t o the g r a n t i n g  deal  of warrants t o  74 the b a n k i n g group i n exchange f o r i t s advancement of funds under r i s k y  circumstances.  The  w a r r a n t s would  have v i r t u a l l y e l i m i n a t e d the s h a r h o l d e r s a t some f u t u r e t i m e .  Estey  inappropriate to grant competitor  interests  1  argued t h a t i t was  e q u i t y i n the CCB  to  b a n k s — r e c o v e r y o f t h e i r advances  maintenance o f the s t a b i l i t y o f the  and  financial  system  would have been s u f f i c i e n t c o n s i d e r a t i o n f o r t h e i r financial  v)  assistance;  f a i l u r e t o r e p l a c e the bank's management  thereby help to r e s t o r e confidence  vi)  l a c k o f an a u t h o r i z e d  design  vii) the  The  and  execution  i n the  the  and  l a c k o f a mechanism t o m o n i t o r t h e o p e r a t i o n program.  rescue  program f a i l e d does not  demand the c o n c l u s i o n t h a t such an approach t o i s always i n a p p r o p r i a t e .  Estey's  threatened  retrospective  a n a l y s i s o f t h i s attempt i n d i c a t e s t h a t t h e r e were and  i d e n t i f i a b l e reasons f o r i t s f a i l u r e and  attempt may  of  1 5  f a c t t h a t the CCB  insolvency  bank);  leader to d i r e c t  o f the p l a n ;  (and  a  specific  future  be more s u c c e s s f u l i f t h e s e p i t f a l l s  can  be  15 For a complete d i s c u s s i o n o f t h e s e reasons f o r the f a i l u r e o f the CCB r e s c u e p l a n , see E s t e y , supra, c h a p t e r note 1 a t 114-121.  1,  75  avoided.  On t h e b a s i s o f E s t e y ' s  e v a l u a t i o n of the rescue  attempt, i t i s c o n c l u d e d t h a t a more s t r u c t u r e d framework i s needed t o g u i d e r e g u l a t o r y  legislative  agencies i n the  i n i t i a l d e c i s i o n t o implement a r e s c u e program and i n t h e s t r u c t u r i n g and m o n i t o r i n g o f i t t h e r e a f t e r . a u t h o r i t y should leadership  be v e s t e d  Statutory  i n one agency t o assume  o v e r and c o n t r o l o f t h e p r o c e s s .  In a d d i t i o n , a  s t a t u t o r y mechanism  i s required t o deal with the i n t e r e s t s  of the shareholders  o f an i n s o l v e n t bank i n o r d e r  t h e i r unjust provided  enrichment when d i r e c t government a s s i s t a n c e i s  t o an i n s o l v e n t bank.  h e l p f u l i n that i t provides search  to avoid  The CCB e x p e r i e n c e i s  t h i s type o f i n s i g h t i n t o t h e  f o r reformed l e g i s l a t i o n i n t h e a r e a  o f bank  insolvency.  Conclusion The case s t u d i e s show, t h e r e f o r e , t h a t t h e b a s i c response t o bank i n s o l v e n c y  contemplated by t h e  present  l e g i s l a t i o n — l i q u i d a t i o n and p a y o f f — h a s been c o n s i d e r e d government t o be i n a p p r o p o r i a t e w i t h r e c e n t bank f a i l u r e s . cases,  or undesirable  by  i n dealing  I t i s submitted that,  i n these  t h e government's d e c i s i o n t o r e s o l v e t h e i n s o l v e n c i e s  t h r o u g h methods o t h e r  than l i q u i d a t i o n and p a y o f f ,  explained  by t h e o p e r a t i o n  stability  and/or t h e p o l i t i c a l  of the r a t i o n a l e of f i n a n c i a l benefit rationale.  consumer p r o t e c t i o n had been t h e government's s o l e i n these cases,  can be  l i q u i d a t i o n and p a y o f f  If objective  would have been an  76  a p p r o p r i a t e and  adequate r e s p o n s e —  a f f o r d e d by d e p o s i t i n s u r a n c e .  due  to the p r o t e c t i o n  D e p o s i t i n s u r a n c e i s an  e f f e c t i v e method o f p r o t e c t i n g s m a l l d e p o s i t o r s .  In  addition to providing t h i s protection, l i q u i d a t i o n  and  p a y o f f has t h e added advantage o f m a i n t a i n i n g some measure o f market d i s c i p l i n e through $60,000 (which  the i n s u r a n c e c e i l i n g  of  encourages u n i n s u r e d d e p o s i t o r s t o  i n v e s t i g a t e the r i s k i n e s s of a l t e r n a t i v e investments). also maintains  f i n a n c i a l s t a b i l i t y to the extent  p r e v e n t i n g bank runs on i n s u r e d d e p o s i t s d i s c u s s e d i n c h a p t e r 2, uninsured d e p o s i t s ) .  In c i r c u m s t a n c e s  of  (although,  i t does not p r e v e n t  It  runs  as  on  of r e l a t i v e  financial  s t a b i l i t y where consumer p r o t e c t i o n i s t h e government's major c o n c e r n ,  t h e r e f o r e , d e p o s i t i n s u r a n c e i s an  a p p r o p r i a t e response  t o bank  I t i s i n circumstances  failure.  1 6  where t h e r e e x i s t s ,  government p e r c e i v e s t h e r e t o e x i s t , one  o r the  of the  other  r a t i o n a l e f o r b a i l o u t s , t h a t t h e l i q u i d a t i o n and approach proves  inadequate.  payoff  In t h e case s t u d i e s , t h e  government p e r c e i v e d a r i s k o f a d e s t a b i l i z i n g bank run o r was  motivated  by the r a t i o n a l e o f p o l i t i c a l b e n e f i t t o go  beyond t h e p r o t e c t i o n of s m a l l d e p o s i t o r s — by  implementing  o t h e r forms o f b a i l o u t a s s i s t a n c e .  and  cases,  In the CCB  f o r example, the government was  concerned  Northland  about  16 The whole i s s u e of d e p o s i t i n s u r a n c e i s a complex one. A v a r i e t y o f p r o p o s a l s has been made on r e f o r m of the d e p o s i t i n s u r a n c e system which i n c l u d e s recommendations t o change t h e i n s u r a n c e c e i l i n g , c o - i n s u r a n c e , and r i s k - r e l a t e d premiums. Reform o f the d e p o s i t i n s u r a n c e system i s r e l e v a n t t o t h e t o p i c of t h i s paper, but beyond i t s scope.  77 financial  i n s t a b i l i t y and  d e s t a b i l i z i n g bank r u n . i n t h e s e c a s e s can be  perceived  a r i s k of a  Furthermore, the b a i l o u t  1 7  explained  by the g o v e r n m e n t s i n t e r e s t 1  i n p r o t e c t i n g r e g i o n a l economic development. ° r a t i o n a l e m o t i v a t e d the government's a c t i o n s a r e s c u e program i n the out  CCB  case and,  the u n i n s u r e d d e p o s i t o r s  decision  i n implementing  ultimately,  These  forms o f government i n t e r v e n t i o n were not p r o v i d e d  for in  legislation,  implementation of s p e c i a l enabling submitted, t h e r e f o r e ,  that  and  in bailing  Northland.  the government's a u t h o r i z i n g  of CCB  These  i n the  necessitating  legislation. f a c e o f one  r a t i o n a l e f o r b a i l o u t s which j u s t i f y s a v i n g compensating i t s u n i n s u r e d d e p o s i t o r s  and  It is  o r more o f  creditors,  t o r e s o l v e bank i n s o l v e n c i e s has  i n a d e q u a t e and  i s i n need o f r e f o r m .  aspect of t h i s c o n c l u s i o n  lies  1 9  The  institutuional  structure  f o r c a r r y i n g out  p r o c e s s o f i d e n t i f y i n g the  the been  proven challenging  i n developing broader  more f l e x i b l e powers t o d e a l w i t h i n s o l v e n c y  the  a bank o r  l e g i s l a t i v e s t r u c t u r e under which the government has authorized  the  and  and  an  such powers.  r a t i o n a l e f o r b a i l o u t s and  The the  Canadian government's attempts a t implementing b r o a d e r solutions i n three o f the The  17 18 19 in  recent  case s t u d i e s , has  highlighted  some  c r i t e r i a which reformed l e g i s l a t i o n s h o u l d meet.  following  is a list  of f u n c t i o n s  which, on the b a s i s  of  P r o c e e d i n g s , supra, c h a p t e r 3, note 37 a t 31:46. Ibid, at 31:7. The reforms which the government has a l r e a d y implemented t h i s a r e a are d i s c u s s e d i n c h a p t e r 7 i n f r a .  78  the  preceding  should  a n a l y s i s , r e f o r m e d bank i n s o l v e n c y  legislation  fulfil:  i)  maintain the  ii)  protect  stability  small  of  the  financial  system;  depositors;  i i i ) p r o t e c t t h o s e l o c a l , r e g i o n a l and n a t i o n a l i n t e r e s t s the p r o t e c t i o n of which i s i n the n a t i o n a l interest; iv) m a i n t a i n a degree of market d i s c i p l i n e s u f f i c i e n t t o c o n t r o l e x c e s s i v e r i s k - t a k i n g by b a n k management;20 v) p r o m o t e e c o n o m i c e f f i c i e n c y deposit insurance fund);  (i.e. protect  the  v i ) e s t a b l i s h an a u t h o r i z e d l e a d e r w i t h : c o n t r o l o v e r t h e m a k i n g and i m p l e m e n t a t i o n o f d e c i s i o n s ; a c c e s s t o adequate information f o r the f u l f i l l m e n t of such r e s p o n s i b i l i t i e s ; and b r o a d and f l e x i b l e p o w e r s t o r e s o l v e a c t u a l o r t h r e a t e n e d bank i n s o l v e n c i e s ; v i i ) c r e a t e a mechanism whereby e q u i t y i n t e r e s t s a r e d e a l t w i t h i n c a s e s o f d i r e c t government a s s i s t a n c e t o a v o i d b a i l i n g out s h a r e h o l d e r s ; and v i i i ) p r o v i d e some m e a s u r e o f c e r t a i n t y f o r p e r s o n s i n s t i t u t i o n s a f f e c t e d by b a n k f a i l u r e .  Having  identified  legislation, as  many o f  the  the  next  these c r i t e r i a step  criteria  have been p a r t i c u l a r l y m o d e l and  are  discussed  bank i n s o l v e n c y  and  as  i s to  develop  possible.  significant below:  recent  for  i n the  the  public  Two  reformed a model sources search  American  studies  and  of  embodying of  f o r such  approach the  ideas a  to  Canadian  system.  20 Note t h a t a c o r o l l a r y of t h i s c r i t e r i a i s the need f o r increased disclosure. I f l a r g e d e p o s i t o r s and c r e d i t o r s a r e t o be e x p e c t e d t o e x e r c i s e m a r k e t d i s c i p l i n e , a d e q u a t e f i n a n c i a l i n f o r m a t i o n must be made a v a i l a b l e t o them. The f o r m w h i c h s u c h d i s c l o s u r e s h o u l d t a k e i s an i m p o r t a n t i s s u e , b u t one t h a t i s b e y o n d t h e s c o p e o f t h i s p a p e r .  79  CHAPTER 5.  AMERICAN  APPROACH THE  The every  American banking  s t a t e , two  national and  agencies,  rules  u n d e r them.  investments,  examine t h e i r  i n nature.  For  banks c o - e x i s t :  Comptroller  member o f t h e Federal  Every  1  of the  control  Currency  the  Reserve  Bank i s t h e  of  primary  and  issue  to  ensure  banks legal  and and  creates central  i s governed  a Federal bank  and  f o r such banks,  regulator.  capital  As  requirements  12  by  Reserve  districts apply  the  such, and  a  and  S t a t e - c h a r t e r e d b a n k s may  R e s e r v e membership  inspections  Act  nation's  Federal  reserve  banks  lending practices,  a F e d e r a l R e s e r v e Bank i n e a c h o f States.  the  n a t i o n a l b a n k i s r e q u i r e d t o be  The  The  over  agencies  respect to these  operations  Reserve Act.  United  regulates  the  F e d e r a l Reserve system, which  B o a r d w h i c h a c t s as establishes  example,  requirements,  and  In  state regulatory o f f i c i a l s .  etc. with  records  sound o p e r a t i o n .  the  i s dual  i n addition to t h e i r  regulating capital  powers,  INSOLVENCY:  a p p l i c a t i o n s , have r e g u l a t o r y c o n t r o l o v e r  established  in  the  BANK MODEL  s e t s of commercial  s t a t e b a n k s c h a r t e r e d by  charter  the  FDIC  system  banks c h a r t e r e d by  chartering  TO  for  Federal  i t  carries  out  s t a t e member b a n k s .  1 K e n n e t h E . S c o t t , "The D u a l B a n k i n g S y s t e m : A M o d e l o f C o m p e t i t i o n i n R e g u l a t i o n " (1977) 30 S t a n L. R e v . l a t  3.  30  All Federal  n a t i o n a l a n d s t a t e b a n k s w h i c h a r e members o f t h e R e s e r v e must b e i n s u r e d  Insurance Corporation not  Federal  FDIC.  by t h e F e d e r a l  (the "FDIC").  R e s e r v e members may a p p l y  The f u n c t i o n o f t h e FDIC,  depositors  against  facilitate  i t s insurance  supervisory  losses arising  FDIC does n o t d i r e c t l y state-chartered  reports  supervise  insured  Reserve.  and  conduct  soundness,  grading  on-site  condition.  t h e most  system t o i n d i c a t e loan  2 3 4 5  regulators  and a bank r a t i n g  Estey, supra, chapter I b i d , a t 387. I b i d , a t 390. I b i d , a t 390-391.  1, n o t e  3  laws,  important  safety  e t c . and employ a  quality.  which  a  Secondly, the  4  5  A s a f e t y and  soundness e x a m i n a t i o n p r o d u c e s a bank r e p o r t by  to provide  examinations t o determine  compliance with  by  supervisory  number o f r e g u l a r R e p o r t s o f C o n d i t i o n ,  regulators  of the  liabilities.  banks a r e r e q u i r e d  indicate financial  to the  R e s e r v e a n d t h e FDIC u s e  f o u r b a s i c methods i n e x e r c i s i n g t h e i r  of which  banks  R e s e r v e Bank a n d i s a d v i s e d  the Federal  First,  state  i t has access  as t o any changes i n d e p o s i t  responsibilities.  direct  f e d e r a l l y - c h a r t e r e d banks  member b a n k s ,  Comptroller,  To  Although the  o f i n s p e c t i o n s made t o t h e C o m p t r o l l e r  these agencies  i s to insure  t h e FDIC i s g i v e n  powers o v e r  Currency and t o t h e F e d e r a l  The  t h e CDIC,  from bank i n s o l v e n c y .  function,  and r e g u l a t o r y  banks which a r e  f o r c o v e r a g e by t h e  like  w h i c h a r e n o t members o f t h e F e d e r a l  and  State  2  Deposit  t o be  analyzed  i n d i c a t e s t h e bank's  1 a t 386.  81 l e v e l o f s a f e t y and soundness.  Thirdly,  computer-assisted  s u r v e i l l a n c e systems a r e used t o m o n i t o r f i n a n c i a l o f banks and p r o v i d e Finally,  condition  e a r l y warning o f p o t e n t i a l p r o b l e m s .  7  t h e s e r e g u l a t o r y a g e n c i e s have enforcement powers,  i n c l u d i n g powers t o i s s u e cease and d e s i s t o r d e r s , o r remove d i r e c t o r s and o f f i c e r s ,  terminate  suspend  insurance,  impose c i v i l monetary p e n a l t i e s , and revoke a bank c h a r t e r . The  8  c h a r t e r i n g agency o f a bank has t h e s o l e a u t h o r i t y  t o determine i t s i n s o l v e n c y .  The FDIC can p e t i t i o n t h e  c h a r t e r i n g agency t o d e c l a r e an i n s u r e d bank i n s o l v e n t . When t h e C o m p t r o l l e r  9  becomes s a t i s f i e d o f t h e i n s o l v e n c y o f  a n a t i o n a l bank, i t has t h e power under t h e F e d e r a l  Deposit  I n s u r a n c e A c t (12 U.S.C. s.191), a f t e r due e x a m i n a t i o n o f the bank's a f f a i r s ,  t o appoint  t o c l o s e up t h e bank.  a r e c e i v e r who i s t o p r o c e e d  The s t a t u t e does n o t p r o v i d e a  d e f i n i t i o n of insolvency  and t h e C o m p t r o l l e r  i s given the  s o l e d i s c r e t i o n t o make such a d e t e r m i n a t i o n . determination (except  i s final  This  and n o t s u b j e c t t o j u d i c i a l  i f made a r b i t r a r i l y o r i n bad f a i t h ) .  1 0  review  The  r e c e i v e r f u n c t i o n s under t h e d i r e c t i o n o f and r e p o r t s t o t h e Comptroller.  1 1  I n t h e case o f n a t i o n a l l y - c h a r t e r e d banks,  the FDIC i s a u t o m a t i c a l l y 6 7 8 9  appointed  by t h e C o m p t r o l l e r t o  I b i d , a t 391. I b i d , a t 392. I b i d , a t 392. Edward J . Kane, " C o r r e c t i n g I n c e n t i v e Problems i n D e p o s i t I n s u r a n c e : The Range o f A l t e r n a t i v e S o l u t i o n s " i n Z i e g e l , supra, c h a p t e r 2, note 21 a t 421. 10 Re American C i t y Bank & T r u s t Co., N . A . 1975, D.C.Wisc. 11 89 Pine I n . v. European American Bank, (1976, DC N Y ) 424 F.Supp.908.  82  a c t as r e c e i v e r (12 U.S.C. s . 1 8 2 1 ( c ) ) . r e g u l a t o r s are not o b l i g e d t o appoint  S t a t e bank t h e FDIC as r e c e i v e r  o f i n s o l v e n t s t a t e banks b u t , i n p r a c t i c e , u s u a l l y do s o .  1 2  As r e c e i v e r , t h e FDIC pursues one o f t h r e e b a s i c c o u r s e s of a c t i o n under 12 U.S.C. s.1821 e t . s e q . : payoff; direct  1.  1) l i q u i d a t i o n and  2) a purchase and assumption t r a n s a c t i o n ; o r 3) financial  assistance.  L i q u i d a t i o n and  Payoff  T h i s p r o c e d u r e i n v o l v e s c l o s u r e o f t h e i n s o l v e n t bank, payoff  of insured depositors  ( i . e . d e p o s i t s t o a maximum o f  $100,000) and l i q u i d a t i o n o f t h e bank's a s s e t s by t h e appointed Deposit  receiver.  Under s e c t i o n 1821(f) o f t h e F e d e r a l  Insurance Corporation  A c t , whenever an i n s u r e d bank  i s c l o s e d f o r r e a s o n o f t h e bank's i n a b i l i t y t o meet t h e demands o f i t s d e p o s i t o r s , t h e FDIC i s o b l i g e d t o pay o f f insured depositors  as soon as p o s s i b l e by c a s h o r by making  a transferred deposit depositor. organize  i n a n o t h e r bank a v a i l a b l e t o each  I f determined t o be a d v i s a b l e ,  t h e FDIC may  a new n a t i o n a l bank t o assume t h e i n s u r e d  o f a c l o s e d bank. an amount equal plus operating  deposits  The FDIC makes a v a i l a b l e t o t h e new bank  to the insured deposits expenses.  o f t h e c l o s e d bank  The C o r p o r a t i o n  may d e c i d e t o  o f f e r c a p i t a l s t o c k o f t h e new bank f o r s a l e which shareholders  o f t h e c l o s e d bank w i l l be g i v e n  a first  option  12 W i l l i s R.Buck, "Comments, Bank I n s o l v e n c y and D e p o s i t o r S e t o f f " (1984) 51 U. o f Chicago L.R.188 a t 201 [ h e r e i n a f t e r "Buck"].  83  to  purchase.  I f an adequate amount o f s t o c k i s purchased,  t h e new bank may be conformed i n t o a n a t i o n a l bank (s.1821(g)). Upon payment t o a d e p o s i t o r , t h e FDIC i s s u b r o g a t e d t o all  r i g h t s o f t h e d e p o s i t o r a g a i n s t t h e c l o s e d bank t o t h e  extent  o f such payment.  The FDIC i s then e n t i t l e d t o share  pro r a t a with uninsured liquidation.  d e p o s i t o r s i n t h e bank's a s s e t s upon  I f t h e a s s e t s a r e i n s u f f i c i e n t t o meet  c l a i m s , t h e FDIC and u n i n s u r e d of t h e i r investments. they  creditors will  lose a portion  Even i n t h e event o f f u l l  recovery,  l o s e p o s t - f a i l u r e i n t e r e s t and t h e use o f t h e i r  throughout the l i q u i d a t i o n process.  these  Other l o s s e s  funds  resulting  from t h e c l o s u r e o f t h e bank i n c l u d e d i s r u p t i o n t o i t s c r e d i t o r s , borrowers, employees, t h e community and l o s s o f the bank's g o i n g c o n c e r n  value.  An example o f t h e FDIC's use o f t h e l i q u i d a t i o n and p a y o f f approach i s p r o v i d e d which f a i l e d  i n 1982.  In t h i s case,  i n s u r e d amounts i n f u l l . (i.e.  with  liquidated  by Penn Square N a t i o n a l t h e FDIC p a i d  I t represents  Bank only  t h e o n l y l a r g e bank  a s s e t s i n excess o f $100 m i l l i o n ) t o have been i n American h i s t o r y .  1 3  A r e v i e w o f t h e FDIC's approach t o bank f a i l u r e between 1973 and 1982 shows t h a t out o f 124 f a i l u r e s failures),  (or t h r e a t e n e d  o n l y 25 were r e s o l v e d by l i q u i d a t i o n and p a y o f f  13 Helen A.Garten, "Banking on t h e Market: R e l y i n g on D e p o s i t o r s t o C o n t r o l Bank R i s k s " (1986) 4 Y a l e J.Reg.129 at 146.  84 w h i l e 99 were h a n d l e d by purchase, and assumption.  4  Furthermore, s i n c e 1960, a l l f a i l u r e s o f b i g banks (except Penn S q u a r e ) , have been r e s o l v e d through purchase and assumption.  The FDIC has opted a g a i n s t t h e l i q u i d a t i o n  1 5  and p a y o f f approach i n f a v o u r o f t h e purchase and assumption method i n so many c a s e s i n o r d e r t o a v o i d t h e c o s t t o t h e i n s u r a n c e fund o f p a y i n g t h e c l a i m s o f i n s u r e d to  depositors,  p r e v e n t bank runs and t o m a i n t a i n t h e s t a b i l i t y o f t h e  f i n a n c i a l system,  and due t o t h e p o l i t i c a l  consequences o f  a l l o w i n g l a r g e numbers o f u n i n s u r e d d e p o s i t o r s t o b e a r substantial l o s s e s . its  advantages  The purchase and asumption method and  1 6  and d i s a d v a n t a g e s r e l a t i v e t o l i q u i d a t i o n and  p a y o f f , a r e d i s c u s s e d below.  2.  Purchase and Assumption F r e q u e n t l y employed  Transaction  by t h e FDIC, t h e purchase and  assumption t e c h n i q u e i n v o l v e s t h e purchase o f a f a i l e d bank's a s s e t s and t h e assumption o f i t s l i a b i l i t i e s healthy i n s t i t u t i o n . liquidated. assumption  by a  Upon merger, t h e a c q u i r e d bank i s  Once t h e FDIC d e c i d e s t h a t a purchase and i s feasible,  i t canvasses t h e market  b i d s from p o t e n t i a l p u r c h a s e r s .  by i n v i t i n g  Through t h e b i d d i n g  p r o c e s s , t h e FDIC seeks t h e p u r c h a s e r w i l l i n g t o o f f e r t h e 14 H a r r y Waddell, "FDIC's F i r s t 50 Y e a r s " A.B.A. Banking J o u r n a l , (October, 198 3) a t 52. 15 S t e v e Cocheo, "How Four Large D e p o s i t o r s Rate Market D i s c i p l i n e " A.B.A. Banking J o u r n a l ( J u l y , 1983)at 64. 16 G.J.Benston, P . A . E i s e n b e i s , P.M.Horvitz, E.J.Kane, G.G.Kaufman, ed., P e r s p e c t i v e s on Safe and Sound Banking: P a s t , P r e s e n t and F u t u r e (Cambridge: The MIT P r e s s , 1986) at 101 [ h e r e i n a f t e r "Benston"].  85 h i g h e s t premium f o r t h e f a i l i n g bank's a s s e t s , t h e premium r e p r e s e n t i n g t h e v a l u e o f t h e bank as a g o i n g c o n c e r n .  The  premium i s p a i d by t h e a c q u i r i n g bank a c c e p t i n g a s s e t s worth l e s s than t h e v a l u e o f l i a b i l i t i e s  assumed.  17  I f the value  o f t h e a s s e t s t r a n s f e r r e d i s l e s s than t h e v a l u e o f t h e l i a b i l i t i e s minus t h e premium, t h e FDIC must make up t h e d i f f e r e n c e by way o f s u b s i d y . nonperforming  T y p i c a l l y , there are  a s s e t s which t h e a c q u i r i n g i n s t i t u t i o n i s  u n w i l l i n g t o accept.  These a s s e t s a r e s o l d by t h e FDIC (as  r e c e i v e r ) t o t h e FDIC i n i t s c o r p o r a t e c a p a c i t y . purchase  p r i c e i s t h e amount o f t h e s u b s i d y which t h e FDIC  i s r e q u i r e d t o pay t o t h e a c q u i r o r .  These a s s e t s a r e then  l i q u i d a t e d by t h e FDIC ( i n c o r p o r a t e c a p a c i t y ) , proceeds  The  b e i n g used t o reimburse  t h e FDIC ( r e c e i v e r ) f o r t h e  c o s t s o f l i q u i d a t i o n and t h e remainder f a i l e d bank's r e m a i n i n g  with  creditors.  1 8  d i v i d e d among t h e The FDIC has t h e  a u t h o r i t y t o arrange t h e s a l e o f a d i s t r e s s e d bank's a s s e t s t o t h e a c q u i r i n g i n s t i t u t i o n and t o t h e FDIC ( c o r p o r a t e c a p a c i t y ) on an o v e r n i g h t b a s i s , t o enable t h e bank t o provide uninterrupted s e r v i c e s .  1 9  V a l u a t i o n o f a f a i l i n g bank's a s s e t s by i n t e r e s t e d parties bid),  (which  i s necessary  i n o r d e r f o r them t o t e n d e r a  i s a time-consuming p r o c e s s .  I t i s sometimes a v o i d e d  by t h e FDIC h a v i n g t h e a c q u i r i n g i n s t i t u t i o n assume a l l t h e 17 I b i d , a t 95. 18 M i c h a e l A.Burgee, "Purchase and Assumption T r a n s a c t i o n s Under t h e F e d e r a l D e p o s i t Insurance A c t " (1979) 14 Forum 1146 a t 1155 [ h e r e i n a f t e r "Burgee"]. 19 Rosenberg, s u p r a . c h a p t e r 3, note 1 a t 296.  86 liabilities  o f t h e f a i l e d bank i n exchange f o r a c a s h  s e t t l e m e n t from t h e FDIC e q u a l t o t h e s e l i a b i l i t i e s premium agreed u p o n . the  2 0  A l t h o u g h s i m p l i f y i n g and  l e s s the  shortening  b i d d i n g p r o c e s s , t h i s approach does r e q u i r e a g r e a t e r  c a s h o u t l a y by t h e FDIC and l e a v e s i t w i t h t h e t a s k o f d i s p o s i n g o f t h e f a i l e d bank's a s s e t s . In  some c a s e s , an a c q u i r i n g i n s t i t u t i o n w i l l demand an  i n d e m n i t y from t h e FDIC, due t o c o n c e r n about t h e c o n t i n g e n t l i a b i l i t i e s which i t may  be assuming.  The  indemnity  p r o t e c t s t h e a c q u i r o r from l i a b i l i t i e s unknown a t t h e time of  t h e a c q u i s i t i o n and s h i f t s t h e burden o f t h e s e p o t e n t i a l  liabilities  to the F D I C .  In t h e Penn Square case,  2 1  one  r e a s o n f o r t h e FDIC's d e c i s i o n t o pay o f f t h e c l a i m s o f i n s u r e d d e p o s i t o r s and l i q u i d a t e r a t h e r than, attempt a p u r c h a s e and assumption was of  contingent l i a b i l i t i e s .  assumption,  t h e e x i s t e n c e o f a l a r g e number 2 2  When a r r a n g i n g a purchase  and  i t i s e s s e n t i a l f o r the FDIC t o a c c u r a t e l y  a p p r a i s e e x p e c t e d l o s s e s , but i n Penn Square t h e s i z e o f the c o n t i n g e n t l i a b i l i t i e s made such an a p p r a i s a l  infeasible.  An example o f the FDIC's use o f purchase and to  r e s o l v e a bank i n s o l v e n c y i s p r o v i d e d by  N a t i o n a l Bank. U.S.A., was resulting  assumption  Franklin  F r a n k l i n , the t w e n t i e t h l a r g e s t bank i n the  declared  i n s o l v e n t by the C o m p t r o l l e r i n  i n the appointment  c a n v a s s i n g t h e market, 20 21 22 23  2 3  o f the FDIC as r e c e i v e r .  1974, After  the FDIC determined t h a t s a l e o f a  Benston, s u p r a , note 16 a t 95-96. I b i d , a t 97. Buck, supra, note 12 a t 207. I b i d , a t 207.  87 s u b s t a n t i a l p o r t i o n o f the bank's a s s e t s was of  resolving i t s financial  t r a n s a c t i o n was  difficulties.  2 4  Bank.  e v e n t u a l l y s o l d t o European-American  T r u s t Company. the  While a  b e i n g n e g o t i a t e d , t h e bank's s o l v e n c y was  m a i n t a i n e d by l o a n s from t h e F e d e r a l Reserve F r a n k l i n was  the b e s t method  2 5  Bank and  The a s s e t s were s o l d f o r an amount e q u a l t o  bank's d e p o s i t l i a b i l i t i e s  a t t h e time o f the  r e c e i v e r s h i p l e s s the premium p a i d by  European-American.  The r e m a i n i n g a s s e t s were used by t h e FDIC t o repay t h e Federal Reserve.  2 6  The FDIC's l e g i s l a t i v e financially  assist  a u t h o r i t y t o a r r a n g e and  purchase and assumptions  i s found i n  U.S.C. s . 1 8 2 3 ( c ) ( 2 ) : In o r d e r t o f a c i l i t a t e a merger o r c o n s o l i d a t i o n o f an i n s u r e d bank...with an i n s u r e d i n s t i t u t i o n o r the s a l e o f a s s e t s o f such i n s u r e d bank and t h e assumption o f such i n s u r e d bank's l i a b i l i t i e s by an insured i n s t i t u t i o n , or the a c q u i s i t i o n of the stock o f such i n s u r e d bank, t h e C o r p o r a t i o n i s a u t h o r i z e d , i n i t s s o l e d i s c r e t i o n and upon such terms and c o n d i t i o n s as the Board o f D i r e c t o r s may p r e s c r i b e : i ) t o purchase any such a s s e t s o r assume any such liabilities; i i ) t o make l o a n s o r c o n t r i b u t i o n s t o , o r d e p o s i t s i n , o r purchase the s e c u r i t i e s o f , such i n s u r e d i n s t i t u t i o n o r the company which c o n t r o l s o r w i l l a c q u i r e c o n t r o l o f such i n s u r e d i n s t i t u t i o n ; i i i ) t o guarantee such i n s u r e d i n s t i t u t i o n . . . a g a i n s t l o s s by r e a s o n o f such i n s u r e d i n s t i t u t i o n merging o r c o n s o l i d a t i n g w i t h o r assuming the l i a b i l i t i e s and p u r c h a s i n g the a s s e t s of such i n s u r e d b a n k . . . 27  24 In Re F r a n k l i n N a t i o n a l Bank, 381 F.Supp. 1390 (E.D.N.Y.1974) 25 G a r t e n , s u p r a , note 13 a t 147. 26 In Re F r a n k l i n N a t i o n a l Bank, supra, note 23. 27 Note t h a t s.1823 (c) (2) a u t h o r i z e s the FDIC t o a s s i s t mergers and c o n s o l i d a t i o n s as w e l l as purchase and assumptions. In p r a c t i c e , however, i t has o n l y a s s i s t e d  83  Under s. 1823 (c)(4 (A)) , t h e FDIC i s p r o h i b i t e d  from p r o v i d i n g  such a s s i s t a n c e t o i n s u r e d banks u n l e s s (a) i t i s determined by t h e C o r p o r a t i o n t o be l e s s c o s t l y than t h e l i q u i d a t i o n a l t e r n a t i v e , o r (b) t h e C o r p o r a t i o n determines t h e c o n t i n u e d o p e r a t i o n o f t h e d i s t r e s s e d bank t o be " e s s e n t i a l t o p r o v i d e adequate b a n k i n g s e r v i c e s i n i t s community". Thus, b e f o r e o p t i n g f o r t h e purchase and assumption o p t i o n , t h e FDIC must determine t h a t t h i s approach •minimize c o s t s .  will  The lower t h e q u a l i t y o f t h e f a i l e d bank's  a s s e t s and t h e lower i t s g o i n g c o n c e r n v a l u e , t h e more f e d e r a l a s s i s t a n c e w i l l be r e q u i r e d by t h e a c q u i r i n g i n s t i t u t i o n b e f o r e i t w i l l agree t o assume t h e l i a b i l i t i e s . The r e q u i r e d f e d e r a l a s s i s t a n c e must be l e s s t h a n t h e v a l u e of  t h e f a i l e d bank's i n s u r e d d e p o s i t s , o t h e r w i s e ,  l i q u i d a t i o n and p a y o f f would be t h e cheaper In  alternative.  2 8  d e t e r m i n i n g c o s t , t h e FDIC examines t h e f a i l e d bank's  contingent l i a b i l i t i e s ,  t h e amount o f d e p o s i t s e x c e e d i n g t h e  i n s u r a n c e l i m i t and t h e s i z e o f t h e premium In  offered.  2 9  most c a s e s , t h e purchase and assumption works out t o  be t h e l e a s t c o s t l y approach, due t o t h e premium p a i d by t h e a c q u i r i n g bank and t h e f a c t t h a t t h e FDIC a v o i d s t h e d i r e c t c o s t s a s s o c i a t e d w i t h a p a y o f f , l i q u i d a t i o n expenses and i n t h e l a t t e r t y p e o f t r a n s a c t i o n , perhaps because i n a p u r c h a s e and assumption, t h e a c q u i r o r assumes o n l y s p e c i f i e d l i a b i l i t i e s ; while i n a statutory consolidation or merger, i t i s deemed t o have assumed a l l l i a b i l i t i e s of t h e c l o s e d bank. See: B r a i n s i l v e r , supra, c h a p t e r 2, note 17 a t 331. 28 G a r t e n , s u p r a , note 13 a t 149. 29 Rosenberg, s u p r a . c h a p t e r 3, note 1 a t 297.  89 potential losses.  The purchase and assumption has s e v e r a l  a d d i t i o n a l advantages over t h e p a y o f f approach.  First, i t  p r o v i d e s p r o t e c t i o n f o r u n i n s u r e d d e p o s i t o r s and o t h e r c r e d i t o r s o f t h e f a i l e d bank (they become c r e d i t o r s o f t h e acquiring i n s t i t u t i o n ) .  This i n turn helps t o preserve  s t a b i l i t y and c o n f i d e n c e i n t h e banking market. the bank i n q u e s t i o n s t a y s open, hence, c r e d i t  Secondly, arrangements  remain i n t a c t , customers a r e not inconvenienced, employees' jobs a r e n o t d i s r u p t e d and t h e bank's g o i n g concern v a l u e i s preserved.  3 1  T h i r d l y , t h e FDIC a v o i d s t h e o b l i g a t i o n o f  making a l a r g e and immediate payout t o i n s u r e d d e p o s i t o r s and t h e t y i n g up o f i t s funds f o r l o n g p e r i o d s o f time. These advantages a r e summed up by M i c h a e l B.Burgee,  senior  c o u n s e l t o t h e FDIC i n 1979: The c h i e f advantage o f t h e Purchase and Assumption t r a n s a c t i o n i s t h a t , w i t h FDIC's f i n a n c i a l a s s i s t a n c e , a sound, i n s u r e d bank p r o v i d e s u n i n t e r r u p t e d banking s e r v i c e s t o t h e community p r e v i o u s l y served by t h e f a i l e d bank. FDIC's a b i l i t y t o s t r u c t u r e and t o e f f e c t Purchase and Assumption t r a n s a c t i o n s q u i c k l y and smoothly p r o v i d e s t h e g r e a t e s t p r o t e c t i o n t o our monetary system and t o i n d i v i d u a l d e p o s i t o r s . 3 2  D e s p i t e i t s advantages, t h e purchase and assumption i s open t o t h e c r i t i c i s m t h a t i t does not encourage discipline.  When employed,  market  a purchase and assumption has  the e f f e c t o f p r o v i d i n g 100 p e r c e n t i n s u r a n c e t o a l l d e p o s i t o r s and unsecured c r e d i t o r s . 30 Benston, supra. note 16 a t 95. 31 Buck, supra. note 12 a t 202. 32 Burgee, supra. note 18 a t 1160.  The FDIC i s e n t i t l e d  90  under s e c t i o n 1823(c)(2)  t o a r r a n g e a purchase and  assumption whenever i t i s t h e l e a s t failure.  Extensive years  all  and c r e d i t o r s w i l l  event of  cannot  afford  depositors base  has c r e a t e d  o f bank f a i l u r e .  a large bank—  investment  offer high  This  the public expectation be f u l l y  i s especially  the public perception  t o l e t a l a r g e bank f a i l .  feel  that their  and thereby  attract  higher  risk-taking  the risk  loss users  from which  increases  depositor.  Thus,  services) depositors  recent  years,  force  perceive  that  t h e FDIC  they  will  In order t o  3 4  depositors, I t i s excessive  3 5  o f bank f a i l u r e — t h e (and, t h e r e f o r e , t h e  h a v e no i n c e n t i v e t o d i s c i p l i n e 3 6  i n order  that their  t o make  avoiding  high  decision  t o opt f o r payoff  3 7  large  funds a r e a t r i s k  them t o e x a m i n e b a n k s more c a r e f u l l y risks.  i n t h e case  t h e FDIC h a s b e e n c a l l i n g f o r  i n c r e a s e d market d i s c i p l i n e depositors  i n the  rather than t h e uninsured  banks f o r e x c e s s i v e r i s k - t a k i n g . In  that  I f large  3  large  risk.  i s b o r n e b y t h e FDIC  of financial  true  being  alone.  b a n k management must a c c e p t which  3  protected  funds a r e n o t a t r i s k ,  d e c i s i o n s on y i e l d  yields,  resolution to a  u s e o f p u r c h a s e and assumptions by t h e  FDIC i n r e c e n t depositors  costly  T h i s was one r e a s o n and l i q u i d a t i o n  with  and  thereby  t h e aim o f  f o r t h e FDIC's o f Penn  Square,  33 B e n s t o n , s u p r a . n o t e 16 a t 102. 3 4 R o b e r t W . N o r c r o s s , J r . , " T h e Bank I n s o l v e n c y Game: FDIC S u p e r p o w e r s , T h e D'Oench D o c t r i n e , a n d F e d e r a l Common Law" (1986) 103 T h e B a n k i n g Law J o u r n a l 316 a t 320 [hereinafter "Norcross"]. 3 5 I b i d , a t 3 20. 36 B e n s t o n , s u p r a . n o t e 16 a t 175. 37 R o s e n b e r g , s u p r a , c h a p t e r 3, n o t e 1 a t 299.  91 r a t h e r than  a p u r c h a s e and  Chairman of the everyone out,  assumption.  FDIC a t t h a t t i m e ,  we  banking  system."  Another approach which the p u r c h a s e and  variation 1984  on  involves claims  as  excess  the  o f any  the  holders  the  FDIC a r e  uninsured  value  remaining  by  payout  and  4 2  on  in  technique insured  advances The  4 0  to  payment  FDIC's  recovered are  one  upon  issued to  the  a l l amounts r e a l i z e d  The  pro  4 3  market  rata  The  in  to  funds advanced  some o f t h e  institution.  i s i t s effect  a  the  time  This  distributed  a t r a n s f e r of  bank's a s s e t s t o another modified  3 9  only p a r t i a l  certificates  such c e r t i f i c a t e s .  raised  first  depositors.  are  bailed  payout),  i s based upon t h e  claims  FDIC's e s t i m a t e  of  Bank.  o f a s s e t s t o be  Receivership  4 1  of the  FDIC b u t  depositors  to the  liquidation. holders  f o r the  is  i n s o l v e n t bank, payment o f  c r e d i t o r s and  made t o u n i n s u r e d estimate  by  had  hope o f  adopted  (or m o d i f i e d  Seminole State N a t i o n a l  immediately  Isaac,  3 8  implemented  c l o s u r e o f an  unsecured  i t : " I f we  FDIC h a s  assumption  o f w h i c h was  the  William  w o u l d h a v e b e e n a b a n d o n i n g any  more d i s c i p l i n e d  modified  put  As  by  failed  b e n e f i t of  the  discipline:  By i n t r o d u c i n g an e l e m e n t o f l o s s - s h a r i n g i n t o a b a n k f a i l u r e , t h e m o d i f i e d P & A s h o u l d make l a r g e c r e d i t o r s and i n v e s t o r s more r i s k - s e n s i t i v e and more  38 39 40 41 42 43  P e t e r W. B e r n s t e i n , " T u r n a b o u t a t t h e F D I C " F o r t u n e a t 178 [ h e r e i n a f t e r " B e r n s t e i n " ] . N o r c r o s s , s u p r a , n o t e 34 a t 348. I b i d , a t 349. I b i d , a t 349. I b i d , a t 349. I b i d , a t 349.  (1984)  110  92  s e l e c t i v e i n t h e i r c h o i c e o f banks and, t h e r e f o r e , s h o u l d i n c r e a s e market d i s c i p l i n e s i g n i f i c a n t l y . 4 4  The m o d i f i e d purchase and assumption can be viewed as a compromise between t h e p a y o f f and purchase and assumption approaches.  While i t i n s t i l s a g r e a t e r degree o f market  d i s c i p l i n e t h a n a purchase and assumption,  i t provides  u n i n s u r e d d e p o s i t o r s and unsecured c r e d i t o r s immediate would  payout  (based on t h e FDIC's e s t i m a t e ) which t h e y  n o t have r e c e i v e d i n a l i q u i d a t i o n  situation.  w i t h an  and p a y o f f  4 5  T h e r e f o r e , i n t h e American  e x p e r i e n c e , t h e purchase and  assumption has proven t o be an e x t r e m e l y u s e f u l for resolving  technique  bank i n s o l v e n c y — w i t h many advantages  the  liquidation  the  e f f e c t o f b a i l i n g o u t a l l d e p o s i t o r s and c r e d i t o r s ,  indiscriminate market  and p a y o f f method.  use o f t h i s approach c o u l d s e r i o u s l y  discipline.  discipline,  In an e f f o r t t o r e s t o r e  i t has  impair  market  t h e FDIC has d e v e l o p e d a m o d i f i e d purchase and  assumption which has g r e a t p o t e n t i a l alleviates  However, because  over  as a t o o l  which  some o f t h e d i s a d v a n t a g e s o f t h e p a y o f f and  l i q u i d a t i o n method b u t a t t h e same time imposes  discipline  on t h e market. 44 I b i d , a t 322. 45 There a r e p o t e n t i a l problems w i t h t h e FDIC's use o f t h e m o d i f i e d purchase and assumption, i n t h e c o n t e x t o f U.S. laws. F o r example, i t might p r e v e n t t h e use o f t h e FDIC's "superpowers" as d e b t o r d e f e n c e s . See N o r c r o s s a t 349-350.  93  3.  Direct Financial Assistance A t h i r d a l t e r n a t i v e open t o t h e FDIC i s t h a t o f d i r e c t  f i n a n c i a l a s s i s t a n c e t o banks which remain a g o i n g  concern.  T h i s can be p r o v i d e d by t h e FDIC i n t h e form o f l o a n s t o , d e p o s i t s i n , assumption o f l i a b i l i t i e s o f , p u r c h a s e o f t h e a s s e t s o r s e c u r i t i e s o f , o r c o n t r i b u t i o n s t o any i n s u r e d bank  (s.1823(c)(1)).  that i t i s necessary  T h i s a s s i s t a n c e can be made p r o v i d e d t o : 1) p r e v e n t  t h e c l o s i n g o f an  i n s u r e d bank o r 2) t o r e s t o r e a c l o s e d bank t o normal o p e r a t i o n o r 3) t o p r e v e n t insurance  extraordinary r i s k t o the deposit  fund under a t h r e a t o f i n s t a b i l i t y .  A further  p r e r e q u i s i t e i s t h a t i t be t h e l e a s t e x p e n s i v e a l t e r n a t i v e open t o t h e FDIC u n l e s s the c o n t i n u e d provide  i t i s determined by t h e FDIC t h a t  o p e r a t i o n o f t h e i n s u r e d bank i s " e s s e n t i a l t o  adequate banking s e r v i c e s i n t h e community"  (s.1823(c)(4).  There a r e no c r i t e r i a  s t i p u l a t e d i n the Act  a c c o r d i n g t o which t h e FDIC i s t o make a d e t e r m i n a t i o n o f essentiality. The FDIC used i t s d i r e c t a s s i s t a n c e power i n 1984 i n the c a s e o f C o n t i n e n t a l I l l i n o i s N a t i o n a l Bank and T r u s t Company o f Chicago represents  ("Continental  Illinois").  t h e l a r g e s t bank r e s c u e  This  i n American h i s t o r y .  s i z e o f t h e bank l i m i t e d t h e FDIC's o p t i o n s  The  i n handling i t —  no banks were both l a r g e enough and s u f f i c i e n t l y i n t e r e s t e d in acquiring i t .  4  6  46 Benston, s u p r a .  Thus, t h e FDIC was unable t o arrange a note 16 a t 97.  94 p u r c h a s e and assumption. experiencing to  stop.  Furthermore, t h e bank was  a r u n on d e p o s i t s which t h e government wanted F e e l i n g t h a t use o f a m o d i f i e d p u r c h a s e and  4 7  assumption would f u r t h e r unnerve u n i n s u r e d  d e p o s i t o r s and  i n t e n s i f y t h e run, t h e FDIC t e m p o r a r i l y abandoned technique and  and i n May, 1984, guaranteed t h a t a l l d e p o s i t o r s  c r e d i t o r s would be made whole.  assistance provided $7.5  this  billion  The d i r e c t government  to Continental I l l i n o i s  consisted of a  l o a n t o t h e bank from t h e F e d e r a l Reserve and  the FDIC, t h e assumption by t h e FDIC o f $3.5 b i l l i o n  of the  bank's t r o u b l e d l o a n s and t h e c o n t r i b u t i o n o f $1 b i l l i o n o f c a p i t a l t o the bank.  4 9  The e f f e c t o f t h e a s s i s t a n c e was  t h a t a l l d e p o s i t o r s and c r e d i t o r s o f C o n t i n e n t a l were b a i l e d o u t and i t s s h a r e h o l d e r s but n o t t o t a l l o s s .  5 0  Illinois  suffered a significant,  The FDIC j u s t i f i e d  t h e a s s i s t a n c e on  the b a s i s t h a t C o n t i n e n t a l I l l i n o i s was an " e s s e n t i a l " bank.  5 1  A c r i t i c i s m of the d i r e c t  f i n a n c i a l a s s i s t a n c e method  i s t h a t i t has t h e e f f e c t o f b a i l i n g o u t s h a r e h o l d e r s as w e l l as u n i n s u r e d chapter  2 supra,  d e p o s i t o r s and c r e d i t o r s .  As d i s c u s s e d i n  i t i s c o n c e p t u a l l y d e f e n s i b l e t o b a i l out  s m a l l bank d e p o s i t o r s and, i n some c i r c u m s t a n c e s , d e p o s i t o r s and c r e d i t o r s , b u t never s h a r e h o l d e r s . bank i s r e t u r n e d t o o r kept i n o p e r a t i o n by d i r e c t 47 48 49 50 51  I b i d , a t 98. E s t e y , supra. c h a p t e r 1, note 1 a t 395. I b i d , a t 395-396. Benston, supra, note 16 a t 101. E s t e y , supra, c h a p t e r 1, note 1 a t 395.  large When a  95  assistance,  s h a r e h o l d e r s b e n e f i t as d i r e c t l y as do  depositors.  The FDIC has d e v i s e d ways t o p r e v e n t  enrichment o f s h a r e h o l d e r s assistance. Illinois,  i n cases o f d i r e c t  this  financial  F o r example, i n t h e case o f C o n t i n e n t a l  t h e FDIC r e c e i v e d n o n - v o t i n g  exchange f o r i t s i n v e s t m e n t .  5 2  p r e f e r e n c e shares i n  These p r e f e r e n c e s h a r e s were  c o n v e r t i b l e i n t o v o t i n g s h a r e s which would amount t o 8 0% o f t h e company's o u t s t a n d i n g s h a r e s . was  5 3  I n a d d i t i o n , t h e FDIC  g r a n t e d an o p t i o n t o a c q u i r e t h e r e m a i n i n g  shares a t a  nominal c o s t i n t h e event t h e FDIC s u f f e r e d a l o s s on i t s p u r c h a s e o f C o n t i n e n t a l ' s problem l o a n s .  5 4  In the r e s u l t ,  Continental's shareholders s u f f e r e d a s i g n i f i c a n t not t o t a l )  (albeit  l o s s and t h e FDIC was g i v e n t h e r i g h t t o  p a r t i c i p a t e i n any f u t u r e p r o f i t s made as a r e s u l t o f i t s assistance.  Therefore, d i r e c t t o o l t o prevent  f i n a n c i a l a s s i s t a n c e can be a u s e f u l  l a r g e l o s s e s from b e i n g i n c u r r e d by t h e FDIC  o r t o a v o i d d i s r u p t i o n o f t h e f i n a n c i a l system. circumstances and  where a p u r c h a s e and assumption i s i n f e a s i b l e  i t i s c o n s i d e r e d important  t o reopen a c l o s e d bank, d i r e c t useful.  In  t o keep a bank o p e r a t i n g o r financial assistance i s  However, t h e use o f d i r e c t  f i n a n c i a l a s s i s t a n c e has  t h e e f f e c t o f b a i l i n g o u t a l l d e p o s i t o r s and c r e d i t o r s o f an 52 John D.Hawke, J r . , Commentaries on Banking R e g u l a t i o n (Washington, D.C.: Law & B u s i n e s s I n c . / H a r c o u r t Brace J o v a n o v i c h , 1985) a t 77. 53 I b i d , a t 77. 54 I b i d , a t 77.  96  insolvent devises  bank  (as w e l l  a method  legislative FDIC t h a t subject  as s h a r e h o l d e r s  unless  f o r " p e n a l i z i n g " them).  condition  t h e FDIC  The o n l y  f o ri t s use i s a determination  by t h e  i ti s the least costly alternative or that the  bank i s " e s s e n t i a l " .  approach could  Indiscriminate  s e r i o u s l y impair  have t h e e f f e c t o f u n j u s t l y  u s e o f s u c h an  market d i s c i p l i n e  enriching  a n d may  shareholders.  Conclusion Clearly, more h i g h l y than that against well.  t h e American  structured,  currently  the reform  criteria  protection  i s protected  depositors  place  Deposit  authority failure,  their  thereby  to  implement  4, i t f a i r s  t h e i n t e r e s t o f consumer o f course,  i n insured  that  small  institutions).  The  t h e FDIC w i t h t h e  e l i m i n a t i n g t h e type o f problem  and m o n i t o r t h e r e s c u e program.  d i s c r e t i o n t o take  into consideration  i n t e r e s t s such as t h e s t a b i l i t y  decision  flexibility  encountered  a t t e m p t w h e r e no a g e n c y h a d t h e a u t h o r i t y  system through t h e f l e x i b l e the  approach  t o take c o n t r o l of a s i t u a t i o n of p o t e n t i a l  t h e CCB r e s c u e  important  (provided,  i sa  When m e a s u r e d  s e t out i n chapter  insurance,  funds  and f l e x i b l e  i n Canada.  Insurance A c t provides  in  the  comprehensive  i n force  Through d e p o s i t  Federal  a p p r o a c h t o bank i n s o l v e n c y  i s made t o b a i l  T h e FDIC h a s  and p r o t e c t of the financial  " e s s e n t i a l bank" d o c t r i n e .  When  o u t a bank, t h e FDIC h a s t h e  t o c h o o s e among a number o f a l t e r n a t i v e  97  approaches and has made e f f e c t i v e use o f p u r c h a s e and assumption t r a n s a c t i o n s and d i r e c t  financial  However, t h e r e a r e s e v e r a l a s p e c t s system which f a i l the  supervises  access  t o meet t h e s p e c i f i e d c r i t e r i a .  t o the f i n a n c i a l  Comptroller  First, t h e banks  ( o t h e r t h a n i n s u r e d s t a t e member banks which  d i r e c t l y ) means t h a t i t has o n l y  i t s decisions.  any  o f t h e American  f a c t t h a t t h e FDIC does n o t d i r e c t l y s u p e r v i s e  that i tinsures it  assistance.  indirect  i n f o r m a t i o n upon which i t must base  The FDIC i s e n t i t l e d t o be a d v i s e d  by t h e  o f t h e C u r r e n c y and t h e F e d e r a l Reserve as t o  changes made i n r e s p e c t o f d e p o s i t l i a b i l i t i e s ,  but i t  i s a r g u a b l e t h a t t h e FDIC would be b e t t e r a b l e t o make informed and t i m e l y d e c i s i o n s i f d i r e c t l y r e s p o n s i b l e f o r supervision.  Combination o f t h e two f u n c t i o n s w i t h i n one  agency would a l s o g i v e t h e r e g u l a t o r g r e a t e r  incentive to  t a k e more immediate a c t i o n v i s a v i s a d i s t r e s s e d bank, s i n c e f a s t e r a c t i o n would m i n i m i z e l o s s e s s u f f e r e d by t h e agency i n i t s c a p a c i t y as i n s u r e r . A second a s p e c t  o f U.S. bank i n s o l v e n c y  which has proven p r o b l e m a t i c direct  financial assistance.  legislation  i s the b a i l o u t technique of The l a c k o f a s t a t u t o r y  mechanism f o r d e a l i n g w i t h t h e i n t e r e s t s o f e q u i t y has  c r e a t e d u n c e r t a i n t y and c r i t i c i s m w i t h  FDIC's h a n d l i n g  of shareholders  i n direct  holders  respect to the financial  EC  a s s i s t a n c e cases.  J  55 See, f o r example, John D. Hawke's c r i t i c i s m o f t h e way the FDIC h a n d l e d t h e C o n t i n e n t a l c r i s i s , supra, note 52 at 77-81.  98 A t h i r d c r i t i c i s m o f t h e American  system a r i s e s  t h e FDIC's p r e d i l i c t i o n f o r the purchase and transaction.  from  assumption  The f r e q u e n t use o f t h i s t e c h n i q u e f o r  r e s o l v i n g bank i n s o l v e n c i e s has c r e a t e d an e x p e c t a t i o n i n depositors  ( e s p e c i a l l y o f l a r g e banks) t h a t t h e y w i l l  bailed o u t .  The l e g i s l a t i o n a u t h o r i z e s t h e FDIC t o  5 6  a r r a n g e a p u r c h a s e and assumption p u r c h a s e and assumption and l i q u i d a t i o n  i n any s i t u a t i o n where a  i s more c o s t - e f f i c i e n t t h a n p a y o f f  (or i f a bank i s deemed " e s s e n t i a l " ) .  e f f e c t o f t h i s p r o v i s i o n i s t o encourage p u r c h a s e assumptions—  be  a t t h e expense  o f market  The  and  discipline.  A f i n a l comment w i t h r e s p e c t t o t h e American  system  i n v o l v e s t h e broad d i s c r e t i o n g r a n t e d t o t h e FDIC i n the bank i n s o l v e n c y p r o c e s s — not o n l y i s the C o r p o r a t i o n r e s p o n s i b l e f o r d e v i s i n g and implementing r e s o l u t i o n s t o bank f a i l u r e ,  but i t i s g i v e n the s o l e a u t h o r i t y t o make the  u n d e r l y i n g d e c i s i o n t o r e s c u e a bank o r t o l e t i t f a i l . make t h i s  fundamental d e c i s i o n r e q u i r e s t h a t a number o f  conflicting  i n t e r e s t s be b a l a n c e d .  g o a l o f c o s t - m i n i m i z a t i o n , which  On the one hand, i s t h e  i s often  b e s t s e r v e d by a purchase and assumption.  (but not  always)  On the o t h e r  hand, i s t h e importance o f m a i n t a i n i n g market which  To  discipline,  i s b e s t a c h i e v e d through l i q u i d a t i o n and p a y o f f .  An  o v e r r i d i n g f a c t o r t h a t must be c o n s i d e r e d by the FDIC i s essentiality—  a vague term which a l l o w s the FDIC t o take  i n t o account a v a r i e t y o f i n t e r e s t s , 56 N o r c r o s s , s u p r a . note 34 a t  319.  i n c l u d i n g consumer  99  p r o t e c t i o n , f i n a n c i a l s t a b i l i t y and t h e dependence o f a community on a bank.  These c o n c e r n s would be b e s t  served,  i n many c i r c u m s t a n c e s , by d i r e c t f i n a n c i a l a s s i s t a n c e o r a p u r c h a s e and assumption. provides  little  guidance f o r t h e FDIC's d e c i s i o n which  r e s u l t s i n unpredictable uncertainty.  The broad language o f t h e A c t  d e c i s i o n s and, t h e r e f o r e ,  In a d d i t i o n , the l e g i s l a t i v e s t r u c t u r e  a s i t u a t i o n where an e s s e n t i a l l y p o l i t i c a l  decision (i.e.  whether o r n o t t o b a i l o u t a bank) i s b e i n g a d m i n i s t r a t i v e body. political  creates  made by an  I t i s s u b m i t t e d t h a t i n t h e Canadian  environment, i t would be more a p p r o p r i a t e  p o l i t i c a l l y - a c c o u n t a b l e body t o make t h i s  for a  fundamental  decision.  Out  o f t h i s d i s c u s s i o n on t h e American approach t o bank  insolvency,  several conclusions  can be made w i t h r e s p e c t t o  t h e model f o r r e f o r m o f t h e Canadian system: i ) The c r e a t i o n o f a s t r o n g , c e n t r a l i z e d agency l i k e t h e FDIC, w i t h t h e a u t h o r i t y and t h e broad powers t o a r r a n g e and o v e r s e e r e s o l u t i o n s t o bank i n s o l v e n c i e s i s desirable. However, t h e f a c t t h a t t h e FDIC l a c k s d i r e c t and on-going a c c e s s t o t h e i n f o r m a t i o n on which i t must a c t i s i n e f f i c i e n t . i i ) I n t h e Canadian c o n t e x t , i t would be i n a p p r o p r i a t e f o r an a d m i n s t r a t i v e agency such as t h e FDIC t o possess the power t o d e c i d e whether o r n o t t o b a i l out a b a n k — t h i s d e c i s i o n s h o u l d be t h e r e s p o n s i b i l i t y o f an e l e c t e d o f f i c i a l who i s a c c o u n t a b l e t o t h e p u b l i c . However, t h e e x p e r t i s e o f t h e a d m i n i s t r a t i v e agency s h o u l d be r e c o g n i z e d by g i v i n g i t t h e r e s p o n s i b i l i t y o f recommending a c o u r s e o f a c t i o n t o an e l e c t e d body. i i i ) The FDIC has made s i g n i f i c a n t use o f t h r e e t e c h n i q u e s f o r r e s o l v i n g bank f a i l u r e s which would be u s e f u l i n t h e Canadian c o n t e x t : t h e purchase and  100 assumption t r a n s a c t i o n , t h e m o d i f i e d p u r c h a s e and assumption and d i r e c t f i n a n c i a l a s s i s t a n c e . However, due t o t h e d e l e t e r i o u s e f f e c t o f purchase and assumptions and d i r e c t f i n a n c i a l a s s i s t a n c e on market d i s c i p l i n e , t h e i r use s h o u l d be l e g i s l a t i v e l y controlled. i v ) A s t a t u t o r y mechanism f o r d e a l i n g w i t h e q u i t y i n t e r e s t s i n d i r e c t f i n a n c i a l a s s i s t a n c e cases i s required.  T h i s model f o r r e f o r m i s f u r t h e r d e v e l o p e d by examining recent proposals  f o r r e f o r m made i n t h e Canadian  context.  101  CHAPTER 6.  CANADIAN  PROPOSALS  FOR  REFORM  Two r e c e n t p u b l i c s t u d i e s have recommended reforms  t o t h e bank i n s o l v e n c y p r o c e s s  i n Canada and, i n  p a r t i c u l a r , t h e CDIC's r o l e i n t h i s p r o c e s s : Report  and t h e F i n a l Report  Canada D e p o s i t Insurance Minister of State Report").  on A p r i l  Both r e p o r t s recommended  f u n c t i o n a l reforms  the Estey  o f t h e Working Committee on t h e  Corporation submitted  (Finance)  significant  t o the  24, 1985 (the "Wyman s t r u c t u r a l as w e l l as  t o bank i n s o l v e n c y l e g i s l a t i o n .  Their  p r o p o s a l s w i l l be d i s c u s s e d and e v a l u a t e d below i n l i g h t o f the reform c r i t e r i a  1.  Wyman  s e t o u t i n c h a p t e r 4.  Report  The Wyman Committee examined t h e o p e r a t i o n and s t r u c t u r e o f t h e CDIC and made recommendations r e g a r d i n g t h e o b j e c t s o f t h e C o r p o r a t i o n ; t h e s u p e r v i s o r y , enforcement and examination and  powers i t s h o u l d p o s s e s s ;  funding, o r g a n i z a t i o n  s t a f f i n g o f t h e C o r p o r a t i o n ; and p o s s i b l e methods t o  improve market d i s c i p l i n e .  Of s i g n i f i c a n c e here a r e t h e  Committee's p r o p o s a l s r e g a r d i n g t h e CDIC's r o l e i n t h e bank insolvency  a)  process.  P r o p o s a l s r e : S t r u c t u r a l Reform The Wyman Report  accepted  the current structure of the  bank r e g u l a t o r y system, i n c l u d i n g t h e b a s i c d i v i s i o n between t h e OIGB as t h e primary  r e g u l a t o r and t h e CDIC as i n s u r e r .  102  However, i t d i d recommend an enhanced s u p e r v i s o r y and r e g u l a t o r y r o l e f o r t h e CDIC.  I n t h e event  of failure,  Wyman recommended t h a t t h e CDIC be g r a n t e d broad  powers t o  cope w i t h t h e i n s o l v e n c y i n a c o s t - e f f i c i e n t manner. f a c i l i t a t e t h e f u l f i l l m e n t o f i t s broader  To  responsibilities,  t h e Committee r e c o g n i z e d t h e CDIC's need f o r g r e a t e r  access  t o i n f o r m a t i o n , t o be p r o v i d e d by: i ) t h e CDIC m a i n t a i n i n g i t s own d a t a base o f c u r r e n t i n f o r m a t i o n about i n s u r e d banks and  i i ) t h e CDIC r e c e i v i n g c o p i e s o f a l l r e p o r t s and  c o r r e s p o n d e n c e made f o r o r by t h e OIGB w i t h r e s p e c t t o problem banks.  Furthermore, i t proposed t h a t t h e CDIC  conduct i t s own i n s p e c t i o n o f problem banks. Wyman s p r o p o s a l 1  f o r s t r u c u t u r a l reform  represents a  p a r t i a l s t e p toward t h e c r e a t i o n o f a p o w e r f u l cope w i t h bank f a i l u r e .  agency t o  However, i t has t h e drawback o f  i n v o l v i n g a d u p l i c a t i o n o f i n f o r m a t i o n - g a t h e r i n g e f f o r t s (by t h e OIGB and t h e CDIC), an i n e f f i c i e n c y which c o u l d be e l i m i n a t e d by t h e combination f u n c t i o n s i n one agency.  o f r e g u l a t o r y and i n s u r a n c e  T h i s i s s u e i s addressed  E s t e y R e p o r t and i s d i s c u s s e d i n g r e a t e r d e t a i l  b)  Proposals  below.  r e : F u n c t i o n a l Reform  Wyman's p r o p o s a l insolvency process CDIC.  i n the  f o r f u n c t i o n a l reform  o f t h e bank  i s based on an expanded r o l e f o r t h e  F o r example, t h e Report recommends t h a t t h e C D I C be  g i v e n t h e power t o i n i t i a t e  liquidation  C u r r e n t l y , t h e CDIC i s g r a n t e d  proceedings.  t h i s power by v i r t u e o f  103 s e c t i o n 2 9 o f t h e Canada D e p o s i t Insurance C o r p o r a t i o n  Act:  where t h e CDIC i s o f the view t h a t a bank i s o r i s about t o become i n s o l v e n t ,  i t c a n t a k e any p r o c e e d i n g which a  c r e d i t o r c a n t a k e , i n c l u d i n g h a v i n g t h e bank wound up. The problem w i t h t h e CDIC h a v i n g t h e a u t h o r i t y  to initiate  winding-up p r o c e e d i n g s i s t h a t t h i s d e c i s i o n one  i s a complex  which i s c l o s e l y l i n k e d t o t h e b a i l o u t d e c i s i o n .  bank i s n o t wound up, w i l l funds?  i t be r e s c u e d t h r o u g h government  I f i t i s wound up, w i l l  that uninsured depositors  i t be wound up i n such a way  a r e compensated?  the American c o n t e x t , t h e s e d e c i s i o n s  discipline,  regional  As d i s c u s s e d i n  involve the balancing  o f a number o f i n t e r e s t s such as consumer financial stability,  I f the  protection,  economic development, market  cost-efficiency, etc.  The Wyman R e p o r t  r e c o g n i z e d t h a t broad p o l i c y f a c t o r s must be c o n s i d e r e d when an  insured  i n s t i t u t i o n i s facing insolvency.  such f a c t o r s t h e Report c i t e d : system and t h e  confidence i n the f i n a n c i a l  e f f e c t o f f a i l u r e on t h e  national or regional  economy o r on t h e i n t e r n a t i o n a l p e r c e p t i o n financial  institutions.  1  As examples o f  o f Canada's  A l t h o u g h t h e Report recommended  that the consideration  o f t h e s e f a c t o r s remain o u t s i d e t h e  mandate o f t h e CDIC,  i t d i d n o t suggest how t h e s e  s h o u l d come t o p l a y  2  a role i n the regulatory  would seem, however, t h a t are t o i n f l u e n c e  i f political  factors  process.  It  and s o c i a l f a c t o r s  t h e d e c i s i o n t o wind up o r b a i l  1 Wyman, supra, c h a p t e r 2, note 48 a t 14. 2 I b i d , a t 15.  o u t a bank,  104 then an e l e c t e d o f f i c i a l  s h o u l d have t h e u l t i m a t e a u t h o r i t y  t o make t h i s d e c i s i o n , r a t h e r than an a d m i n i s t r a t i v e body such as t h e CDIC.  On t h e b a s i s o f t h i s r e a s o n i n g , s e c t i o n  29 o f t h e Canada D e p o s i t Insurance  C o r p o r a t i o n A c t s h o u l d be  amended t o g i v e t h e M i n i s t e r o f F i n a n c e t h e u l t i m a t e decision-making  power t o wind up a bank.  3  Similarly, the  power t o d e c i d e whether a bank s h o u l d be b a i l e d o u t s h o u l d be v e s t e d i n t h e M i n i s t e r o f F i n a n c e . and  The CDIC's i n t e r e s t  e x p e r t i s e i n t h i s a r e a s h o u l d be r e c o g n i z e d by g i v i n g i t  t h e power t o recommend a c o u r s e o f a c t i o n t o t h e M i n i s t e r when f a c e d w i t h an i n s o l v e n t o r p o t e n t i a l l y  i n s o l v e n t bank.  4  Wyman a l s o recommended t h a t t h e CDIC be g i v e n t h e r i g h t t o become, i f i t so e l e c t s , t h e l i q u i d a t o r o f an i n s o l v e n t bank.  P r e s e n t l y , t h e l i q u i d a t o r i s c o u r t - a p p o i n t e d and i s  s u b j e c t t o t h e a p p r o v a l o f t h e bank's s h a r e h o l d e r s and creditors.  However, t h e CDIC i s a u t h o r i z e d t o a c t as t h e  curator o r l i q u i d a t o r i f i t i s duly appointed such.  t o a c t as  I n t h e USA, t h e C o m p t r o l l e r o f t h e Currency i s  o b l i g e d t o a p p o i n t t h e FDIC t o a c t as t h e r e c e i v e r o f n a t i o n a l l y - c h a r t e r e d banks.  I t i s arguable  that a c o n f l i c t  o f i n t e r e s t c o u l d a r i s e when t h e d e p o s i t i n s u r a n c e agency a c t s as i n s u r e r (and, t h e r e f o r e , c r e d i t o r ) and l i q u i d a t o r 3 The E s t e y Report makes t h i s argument a t 32 6. 4 Wyman d e a l t i n some d e t a i l w i t h a r e l a t e d i s s u e — t h e need t o c l a r i f y t h e t e s t o f i n s o l v e n c y and t o s p e c i f y which a u t h o r i t i e s have t h e power t o determine i n s o l v e n c y . T h i s i s s u e has important r a m i f i c a t i o n s f o r a bank (upon a d e c l a r a t i o n o f insolvency, the M i n i s t e r s h a l l appoint a c u r a t o r ) and f o r t h e CDIC ( i n s o l v e n c y i s t h e p o i n t a t which u l t i m a t e i n s u r a n c e c l a i m s a g a i n s t t h e C o r p o r a t i o n a r e measured). While important, t h e i s s u e o f a r e v i s e d i n s o l v e n c y t e s t i s beyond t h e scope o f t h i s paper.  simultaneously.  However, i t i s s u b m i t t e d  that this  i s o v e r r i d d e n by t h e advantages t o such an approach. example, i t i s d e s i r a b l e t o develop  concern For  t h e e x p e r t i s e t o conduct  bank l i q u i d a t i o n s w i t h i n one agency.  Furthermore, as argued  by Wyman, t h e d e p o s i t i n s u r a n c e c o r p o r a t i o n has a s p e c i a l and  substantial financial  interest i n the insolvency  p r o c e e d i n g which s h o u l d be r e c o g n i z e d .  Also, there are  c o s t l y delays associated with the court-appointed which c o u l d be a v o i d e d by automatic For these reasons,  process  appointment o f t h e CDIC.  Wyman's p r o p o s a l t o g r a n t t h e CDIC t h e  r i g h t t o become l i q u i d a t o r o f an i n s o l v e n t bank would be a d e s i r a b l e f e a t u r e i n r e v i s e d bank i n s o l v e n c y  legislation.  As a f u r t h e r component o f i t s p r o p o s a l t o c r e a t e a s t r o n g e r r o l e f o r t h e CDIC, t h e Wyman Committee examined t h e p u r c h a s e and assumption t r a n s a c t i o n .  I t recognized the  c o n s i d e r a b l e advantages t o t h i s t e c h n i q u e , which i n c l u d e avoiding the costs of l i q u i d a t i o n , preventing the d i s r u p t i o n o f on-going c r e d i t r e l a t i o n s h i p s and m a i n t a i n i n g t h e g o i n g c o n c e r n v a l u e o f t h e bank.  The Wyman Report  recognized the  CDIC's p r e s e n t l a c k o f l e g i s l a t i v e a u t h o r i t y t o arrange a p u r c h a s e and assumption t r a n s a c t i o n and recommended t h a t t h e Canada D e p o s i t Insurance remedy t h i s The and  C o r p o r a t i o n A c t be amended t o  omission.  American e x p e r i e n c e has i l l u s t r a t e d t h e u t i l i t y o f  t h e b e n e f i t s t o be d e r i v e d from t h e purchase and  assumption t r a n s a c t i o n .  I t was c o n c l u d e d  5  1, note  E s t e y , supra,  chapter  1 a t 3 39.  i n that context  106 that  the  arrange  CDIC s h o u l d h a v e t h e such  technique bailing the  s h o u l d be  out  effect  i t should not  rationale  This  for this  i s especially  effect  which  legislation  uninsured be  important  available  as  an  alternative  exists  an  interest  c o n d i t i o n s f o r i t s use.  In chapter  such  a bailout  risk  of a d e s t a b i l i z i n g  controlled of  an  by  and  assumption  less  expensive  interest expensive  6  An  two  way  1)  the  alone  criterion  supra.  the  clearly  and  of  and  p a y o f f when  note  which  2)  the  f o r the use  at  justified  existence national  of a  then  t h a t the  160.  clear  be  i f there  same r e s u l t ,  29  depositors  i s i n the  would d i c t a t e  2,  be  market  taken.  chapter  purchase  existence of a  cost-efficiency—  to achieve  a p p r o a c h be  of a  uninsured  interest  may  Therefore,  bank r u n w h i c h c o u l d n o t  of c o s t - e f f i c i e n c y  Goodman,  out  of  assumption  I t should  the p r o t e c t i o n of which  s h o u l d be  and  circumstances  deposit insurance  additional  6  to liquidation  were i d e n t i f i e d :  interest,  interest.  2,  unsecured  potential  CDIC s h o u l d  in bailing  i t has  intervention.  implementation  c r e d i t o r s which o v e r r i d e s the  discipline.  because  of the  down m a r k e t d i s c i p l i n e .  the  for  a b s e n c e o f one  of the purchase  stipulate  and  2:  i n the  the  this  d e p o s i t o r s and  in light  t r a n s a c t i o n by  of  rationale  o f government  p r o v i d i n g f o r the  assumption  there  used  type  f r e q u e n t use  have i n b r e a k i n g  and  the  banks d i s c u s s e d in. c h a p t e r out  authority to  However, t h e u s e  consistent with  of b a i l i n g  creditors, the  a transaction.  legislative  purchase is a the less  107  I t i s s u b m i t t e d , t h e r e f o r e , t h a t t h e CDIC be g r a n t e d t h e l e g i s l a t i v e a u t h o r i t y t o implement a purchase and assumption.  . However, t h e agency's power t o implement such a  c o u r s e o f a c t i o n t o t h e M i n i s t e r and t h e M i n i s t e r ' s d i s c r e t i o n t o d e c i d e upon such an approach, l i m i t e d by e x p r e s s l e g i s l a t i v e c r i t e r i a  s h o u l d be  i n order t o provide  some measure o f c e r t a i n t y t o t h o s e a f f e c t e d by t h e d e c i s i o n , t o m a i n t a i n market d i s c i p l i n e and t o ensure  cost-efficiency.  The Wyman Committee summarized i t s p r o p o s a l s aimed a t s t r e n t h e n i n g t h e CDIC's power t o a c t i n a s i t u a t i o n o f bank i n s o l v e n c y , w i t h a broad recommendation t h a t t h e C o r p o r a t i o n be g i v e n broad and f l e x i b l e powers t o p r o t e c t s m a l l d e p o s i t o r s and a d m i n i s t e r t h e i n s u r a n c e fund i n t h e most e c o n o m i c a l l y - e f f i c i e n t way.  The powers t o be g r a n t e d t h e  CDIC would i n c l u d e t h e power t o make d i r e c t assistance to a distressed  financial  insititution:  C o n t r i b u t i o n s t o t h e r e h a b i l i t a t i o n o f an i n s t i t u t i o n i n d i f f i c u l t y , designed t o avoid a g r e a t e r l o s s a t a l a t e r d a t e , a r e o n l y one example o f t h e t y p e s o f a c t i o n t h a t s h o u l d be p e r m i s s i b l e , i f CDIC's Board c o n c l u d e s t h e y w i l l c o n t r i b u t e t o i t s object.7  As c o n c l u d e d  i n t h e d i s c u s s i o n on t h e U.S.  system,  direct  f i n a n c i a l a s s i s t a n c e i s an important t o o l t o be p o s s e s s e d b y t h e CDIC.  However, because i t has t h e e f f e c t o f r e s c u i n g a  bank (and b a i l i n g o u t i t s c a p i t a l  7  suppliers),  Wyman, supra, c h a p t e r 2, note 48 a t 23.  i t s use s h o u l d  108 be s t r u c t u r e d and c o n t r o l l e d .  T h i s i s s u e i s examined i n  d e t a i l by t h e E s t e y Report  i s d i s c u s s e d below.  2.  Estey  Report  a) S t r u c t u r a l The reforms  and  Recommendations  E s t e y Commission recommended b r o a d e r than t h o s e proposed  structural  i n the Wyman Report.  Estey  c o n c l u d e d t h a t t h e most l o g i c a l approach would be  a  c o n s o l i d a t i o n o f t h e OIGB and t h e CDIC i n t o a new  body, t o  be named t h e Canadian D e p o s i t Insurance "Commission").  The  Commission would be  d i r e c t e d by t h r e e f u l l - t i m e a p p o i n t e e s :  Commission managed one  a u d i t i n g ; one w i t h s e n i o r banking  and  from  a u d i t i n g p r o f e s s i o n with f i v e years' experience  (the  the  i n bank  e x p e r i e n c e ; and t h e  third  w i t h s e n i o r management e x p e r i e n c e i n the i n s u r a n c e i n d u s t r y with general business, p r o f e s s i o n a l or s e n i o r p u b l i c experience.  service  I t i s s u b m i t t e d t h a t the c r e a t i o n o f a s m a l l ,  highly-experienced,  f u l l - t i m e group t o c a r r y out  the  e s s e n t i a l l y a d m i n i s t r a t i v e t a s k s o f the Commission would  be  much more e f f e c t i v e than the p r e s e n t approach o f a Crown c o r p o r a t i o n a d m i n i s t e r e d by a p a r t - t i m e board. sector composition understanding  The  private  o f such a Commission would b r i n g t o i t an  o f t h e banking  and  insurance i n d u s t r i e s ,  and  t h e e x p e r i e n c e n e c e s s a r y t o i d e n t i f y and s o l v e p o t e n t i a l problems.  109 The  Commission would have d e p o s i t  insurance  r e s p o n s i b i i t i e s s i m i l a r t o t h o s e p o s s e s s e d by the CDIC as w e l l as r e g u l a t o r y and  s u p e r v i s o r y powers b r o a d e r t h a n t h o s e  c u r r e n t l y p o s s e s s e d by the OIGB.  The  Estey Report  t h e advantages o f t h i s approach t o reform bank r e g u l a t o r y s t r u c t u r e , as  o f the  discussed  present  follows:  ...by p u t t i n g the i n s u r e r i n a p o s i t i o n t o p r o t e c t i t s e l f e f f e c t i v e l y through c o n f i d e n t i a l s u p e r v i s i o n o f the i n s u r e d banks, t h i s a l t e r n a t i v e r e c o g n i z e s and a p p e a l s t o n a t u r a l human i n s t i n c t s . It r e c o g n i z e s t h a t the i n s u r e r has the i n c e n t i v e t o a c t on i n f o r m a t i o n r e c e i v e d t o reduce t o a minimum the r i s k s i t f a c e s i n any f a i l u r e . It is precisely this i n c e n t i v e o r w i l l t o a c t which was so g r a p h i c a l l y i l l u s t r a t e d t o be l a c k i n g i n the i n s t i t u t i o n a l forms o f t h e e x i s t i n g r e g u l a t o r y scheme.8  Furthermore, c o n s o l i d a t i o n o f the r e g u l a t o r y and f u n c t i o n s i n one  body would overcome the  insurance  informational  b a r r i e r c u r r e n t l y f a c e d by the CDIC when a t t e m p t i n g perform i t s insurance  function.  As  Commission would have f i r s t - h a n d and information and  regulator,  the  on-going a c c e s s  to  the  needed t o make recommendations t o the M i n i s t e r  implement s o l u t i o n s e x p e d i t i o u s l y and  Combining the two  and  efficiently.  f u n c t i o n s would have the a d d i t i o n a l  advantage o f a v o i d i n g the d u p l i c a t i o n o f gathering  to  information-  r e g u l a t o r y e f f o r t s which would be  a result  of  the Wyman Committee's s t r u c t u r a l p r o p o s a l . For t h e s e r e a s o n s , the c r e a t i o n o f a c e n t r a l i z e d agency possessing 8 Estey,  both s u p e r v i s o r y  supra.  chapter  and  insurance  1, note 1 a t 2 77.  responsibilities  110 would  a p p e a r t o be  carry  out  possess  b)  a logical  the broader  and  powers w h i c h such  agency  must  F u n c t i o n a l Recommendations Estey Report  given the  recommended t h a t t h e  o f a c t i o n when f a c e d w i t h  bank:  liquidation,  implementation  merger w i t h  these The  k e e p an with  are  a  examined  a healthy  institution  and  bank i n o p e r a t i o n w h i l e  example,  through  Commission).  The  monitored  provided through  Extensive  private  Report  management o f t h e b a n k be confidence-restoring significant  proposal  by  the  Commission.  the  capital.  As  F D I C ' s ad h o c  Funding  sources  at least  partially  would  (for  l o a n s by  recommended t h a t d i r e c t o r s  Estey  of e x i s t i n g  r e p l a c e d , as  discussed i n chapter  Commission's  i s i t s mechanism  i n v e s t o r s i n the 5,  system of d e a l i n g w i t h  to  bank's  the problem with shareholders  the  and  measure.  feature of the  problem  merging  designed,  of unsatisfactory  f o r bank a s s i s t a n c e programs  deal with  ownership or  and/or p u b l i c  to  reorganizing i t  p r o g r a m w o u l d be  the purchase  The  the  below.  a v i a b l e bank.  implemented  or  r e s p e c t t o bank a s s i s t a n c e p l a n s  a view t o r e t u r n i n g i t to p r i v a t e  A  three  o b j e c t o f a b a n k a s s i s t a n c e p r o g r a m w o u l d be insolvent  with  of  be  financially-troubled  o f a bank a s s i s t a n c e p l a n .  p r o p o s a l s w e r e made w i t h and  Commission  p o w e r t o recommend t o t h e M i n i s t e r one  course  be  an  structure to  i n o r d e r t o cope w i t h bank i n s o l v e n c y .  The  it  efficient  the  i s the  a  Ill  potential for criticism perceived  from the p u b l i c  that shareholders  the government aid)  and  are b e i n g  (when i t i s  u n j u s t l y enriched  from the bank's s h a r e h o l d e r s  t h e FDIC attempts t o " p e n a l i z e " them).  The  Estey  p r o p o s e d a s t a t u t o r y mechanism which would a l l o w i s s u e s t o be  j u d i c i a l l y determined.  by  (when  Commission these  I t recommended t h a t i n  c a s e s where a bank i s i n s o l v e n t o r where i n s o l v e n c y  is  imminent o r i n e v i t a b l e , the bank a s s i s t a n c e program  contain  a term c a n c e l l i n g the  i n t e r e s t s o f the c a p i t a l  (which would i n c l u d e debt and capital).  9  share components o f the  T h i s i s j u s t i f i e d on the b a s i s t h a t ,  i n s o l v e n t , a bank's c a p i t a l has t h e r e f o r e , the any  been exhausted  once  and,  To p r e s e r v e the bank's  a nominal number o f T r e a s u r y s h a r e s would  i s s u e d t o the Commission, which would be p u b l i c once t h e bank had  recovered.  p o s s i b i l i t y o f a c l a i m by  Estey  been e x t i n g u i s h e d ) .  the not  in  was  i n v e s t o r s ' i n t e r e s t had  In t h a t event, E s t e y  the  anticipated  i n v e s t o r s t h a t the bank was  (meaning t h a t the  be  s o l d back t o  f a c t i n s o l v e n t a t the time the a s s i s t a n c e program instituted  bank's  i n v e s t o r s i n t h a t c a p i t a l have ceased t o have  i n t e r e s t i n the bank.  continuity,  investors  not  proposed a  s t a t u t o r y mechanism whereby i n v e s t o r s whose i n t e r e s t s had been c a n c e l l e d c o u l d a p p l y  t o a c o u r t t o determine whether  9 Note t h a t E s t e y uses the term " c a p i t a l " as i t i s d e f i n e d i n the Bank A c t , i . e . , t o i n c l u d e common shares, p r e f e r e n c e s h a r e s and long-term, s u b o r d i n a t e d , unsecured debt i n the n a t u r e of a s i m p l e bond. E s t e y ' s c o n c e r n i n t r e a t i n g a l l c a p i t a l a l i k e i s t o p r e v e n t one c l a s s from b l o c k i n g the r e s c u e of a bank, and t h e r e b y f o r c i n g i t s liquidation. See E s t e y a t 329.  112 o r n o t t h e bank was  insolvent at the c r i t i c a l  i s determined t h a t i t was not, t h e v a l u e  time.  Ifi t  of t h e i r i n t e r e s t s  i n t h e c a p i t a l would be e s t i m a t e d and t h e Commission o r d e r e d t o compensate them f o r t h e i r l o s s . insolvency should  I f , on t h e o t h e r  hand,  i s e s t a b l i s h e d , t h e i n v e s t o r s would n o t and  n o t be compensated.  T h i s j u d i c i a l mechanism  They took a r i s k and t h e y  represents  an e f f e c t i v e and j u s t way  to deal with the i n t e r e s t s of c a p i t a l o f bank f a i l u r e .  lost.  i n v e s t o r s i n t h e event  I t i s s u b m i t t e d t h a t i t i s an e s s e n t i a l  f e a t u r e o f t h e r e g u l a t o r ' s power t o implement a bank a s s i s t a n c e program. Estey's  proposal  a l s o d e a l t with the p o t e n t i a l  o f a bank a s s i s t a n c e program. recommended t h a t a l l d e p o s i t o r s  failure  I n t h i s s i t u a t i o n , t h e Report and d e b t - h o l d e r s  c a p i t a l - i n v e s t o r s ) be f u l l y compensated.  (other  than  The p o l i c y r e a s o n  b e h i n d t h i s recommendation i s t h a t t h e s u c c e s s o f a r e s c u e p l a n depends on t h e maintenance o f d e p o s i t o r the d i s t r e s s e d bank.  In o r d e r  confidence  t o induce d e p o s i t o r s  in  and  p r i v a t e s o u r c e s t o l e n d funds t o t h e bank, t h e government must s t a n d b e h i n d t h e a s s i s t a n c e program and v i r t u a l l y guarantee i t s s u c c e s s . f a i l u r e and a l l o w  To t u r n around i n t h e f a c e o f  t h o s e who have r e l i e d on government  a s s u r a n c e s t o l o s e t h e i r funds would be  politically  inconceivable. The E s t e y  Commission recommended t h a t t h e u l t i m a t e  d e c i s i o n t o implement a bank a s s i s t a n c e program be t h e r e s p o n s i b i l i t y of the M i n i s t e r of Finance.  However,  the  113 d e c i s i o n would be based on t h e CDIC's recommendation. R e p o r t c o n c l u d e d t h a t i n making i t s recommendation, should  The  t h e CDIC  consider:  "a wide range o f f a c t o r s , i n c l u d i n g t h e n a t i o n a l i n t e r e s t i n t h e s t a b i l i t y o f t h e b a n k i n g system as w e l l as t h e l i k e l i h o o d o f l o s s t o i t s e l f . T h i s would f o r m a l l y r e c o g n i z e i n t h e system t h e s o - c a l l e d • e s s e n t i a l bank c o n c e p t ' as a c o n s c i o u s s t e p i n t h e a d m i n i s t r a t i v e p r o c e s s o f s e r i o u s l i q u i d i t y and s o l v e n c y problems i n a bank.  The E s t e y Report d i d not propose any more s p e c i f i c f o r t h e CDIC's recommendation, t o implement  or the M i n i s t e r ' s  a bank a s s i s t a n c e program.  criteria  decision,  I t i s submitted that  i n t h e i n t e r e s t o f c e r t a i n t y and i n o r d e r t o ensure t h a t the conflicting  i n t e r e s t s which o p e r a t e i n a s i t u a t i o n o f bank  f a i l u r e a r e e x p r e s s l y c o n s i d e r e d , t h e power t o implement bank a s s i s t a n c e program criteria.  a  be l i m i t e d by e x p r e s s l e g i s l a t i v e  Because a bank a s s i s t a n c e p l a n  (as proposed by  E s t e y ) and a p u r c h a s e and assumption have e s s e n t i a l l y t h e same b a i l o u t e f f e c t s  ( i . e . t h e compensation o f u n i n s u r e d  d e p o s i t o r s and c r e d i t o r s ) , t h e y s h o u l d be based on legislative criteria  similar  (see c r i t e r i a proposed i n t h e  d i s c u s s i o n on t h e purchase and assumption, s u p r a ) .  In most  s i t u a t i o n s , t h e purchase and assumption would be t h e more cost-efficient solution acquiring institution). implement  (due t o t h e premium p a i d by the However, the CDIC's power t o  a bank a s s i s t a n c e program  should r e f l e c t the f a c t  t h a t i n some c i r c u m s t a n c e s , a purchase and assumption be u n a v a i l a b l e o r i n a p p r o p r i a t e  ( f o r example,  i f the  will  114  Minister bank  deems i t t o b e  i n the national  interest  i n o r d e r t o p r o t e c t t h e r e g i o n a l bank  o n l y merger  candidates  Minister  concept,  f o r t h e bank a r e l a r g e ,  banks o r f o r e i g n banks).  In these  to rescue but the  national  circumstances,  s h o u l d have t h e a u t h o r i t y t o d i r e c t  a  the  t h e CDIC t o  implement a bank a s s i s t a n c e p r o g r a m —  regardless of the cost  s a v i n g which c o u l d have been a c h i e v e d  by a p u r c h a s e and  assumption. Therefore, recommendations particular reform.  with its  aspects  first  t o t h e development o f a model f o r  access  i n the event  i s the detailed  experienced  by b o t h  proposal  o f bank  failure.  The  f o r bank a s s i s t a n c e  t h e problems which have  t h e C a n a d i a n government  been  ( i n the  CCB  a t t e m p t ) and by t h e FDIC.  Conclusion: On  A Model  i n chapter  chapter  4,  i t i s now  C a n a d i a n bank  f o r bank  2, t h e c r i t e r i a  and u s i n g a s p e c t s  as t h e p r o p o s a l s  Reports,  f o r Reform  the basis of the rationale  discussed  well  agency  t o t h e i n f o r m a t i o n needed t o c a r r y out  programs, which d e a l s w i t h  in  regualation are of  i s t h e Commission's recommendation t o  responsibilities  rescue  Commission's  t h e OIGB a n d t h e CDIC t o c r e a t e a c e n t r a l i z e d  direct  second  of the Estey  on C a n a d i a n b a n k  significance  The  combine  two  contained  bailouts  f o r reform e s t a b l i s h e d  o f t h e A m e r i c a n a p p r o a c h as i n t h e Wyman a n d  possible to outline  insolvency legislation.  a model  Estey  f o r reform  I t i s proposed:  of  115 i ) t h a t a new a d m i n i s t r a t i v e agency (the "Agency") be c r e a t e d which would a c t as d e p o s i t i n s u r e r and as the p r i m a r y r e g u l a t o r o f banks. The Agency would be managed by a Committee o f f u l l - t i m e a p p o i n t e e s , with e x p e r i e n c e i n o r r e l a t e d t o the f i e l d s o f banking, a u d i t i n g and i n s u r a n c e . i i ) t h a t i n a s i t u a t i o n of a c t u a l or p o t e n t i a l i n s o l v e n c y , the M i n i s t e r o f F i n a n c e p o s s e s s the u l t i m a t e d e c i s i o n - m a k i n g a u t h o r i t y as t o an a p p r o p r i a t e c o u r s e o f a c t i o n . The Agency would be r e s p o n s i b l e f o r canvassing the a v a i l a b l e options, conducting c o s t a n a l y s e s and recommending a c o u r s e o f a c t i o n t o the Minister. i i i ) t h a t the M i n i s t e r ' s d i s c r e t i o n i n d e c i d i n g the f a t e o f a bank and the CDIC's power t o recommend a c o u r s e o f a c t i o n be l i m i t e d by l e g i s l a t i v e c r i t e r i a ( s e t out i n paragraphs i v , v and v i below) which w i l l r e f l e c t t h e i n t e r e s t s o f consumer p r o t e c t i o n , f i n a n c i a l s t a b i l i t y , market d i s c i p l i n e , c o s t - e f f i c i e n c y and l o c a l , r e g i o n a l and n a t i o n a l i n t e r e s t s o f n a t i o n a l concern. i v ) t h a t l i q u i d a t i o n and p a y o f f be the g e n e r a l r u l e i n t h e event o f i n s o l v e n c y . Deposit insurance would be r e t a i n e d i n o r d e r t h a t s m a l l consumers are p r o t e c t e d and some measure o f f i n a n c i a l s t a b i l i t y i s e n s u r e d . A m o d i f i e d purchase and assumption (which has the same e f f e c t as l i q u i d a t i o n and p a y o f f , i . e . , o f b a i l i n g out i n s u r e d d e p o s i t o r s only) would be an a c c e p t a b l e a l t e r n a t i v e , p r o v i d i n g i t i s f e a s i b l e and l e s s c o s t l y t h a n l i q u i d a t i o n and p a y o f f . v) t h a t a second o p t i o n be a v a i l a b l e i n an i n s o l v e n c y s i t u a t i o n : purchase and assumption. The use o f t h i s t e c h n i q u e would be l i m i t e d by the f o l l o w i n g l e g i s l a t i v e c r i t e r i a : a) the e x i s t e n c e o f a c l e a r r i s k o f a d e s t a b i l i z i n g bank run which c o u l d not be c o n t r o l l e d by d e p o s i t i n s u r a n c e a l o n e ; o r b) the e x i s t e n c e o f an i n t e r e s t , the p r o t e c t i o n o f which i s i n the n a t i o n a l i n t e r e s t and which would be b e s t s e r v e d by a p u r c h a s e an assumption. v i ) t h a t a t h i r d o p t i o n be a v a i l a b l e i n an insolvency s i t u a t i o n : d i r e c t f i n a n c i a l assistance i n the form of a bank a s s i s t a n c e program. The l e g i s l a t i v e c o n d i t i o n s f o r i t s use would be as f o l l o w s : a) the e x i s t e n c e o f a c l e a r r i s k of a d e s t a b i l i z i n g bank run which c o u l d not be c o n t r o l l e d by d e p o s i t i n s u r a n c e a l o n e ; or b) the e x i s t e n c e o f an i n t e r e s t , the p r o t e c t i o n of which i s i n the n a t i o n a l i n t e r e s t and which would be b e s t s e r v e d by a bank a s s i s t a n c e program. The l e g i s l a t i o n would p r o v i d e a s t a t u t o r y  116 mechanism f o r the r e s o l u t i o n o f the i n t e r e s t s o f the bank's c a p i t a l i n v e s t o r s i n the event a bank a s s i s t a n c e program i s implemented.  T h i s model f o r r e f o r m i s not aimed a t p r e v e n t i n g bank i n s o l v e n c i e s , but  future  r a t h e r , a t p r o v i d i n g a more  comprehensive s t a t u t o r y mechanism f o r d e a l i n g w i t h such f a i l u r e s when t h e y o c c u r . creates  Based on the American model, i t  an agency w i t h d i r e c t and  information  that only  the  needed t o recommend a c o u r s e o f a c t i o n t o  M i n i s t e r and decision.  on-going a c c e s s t o  the broad powers t o implement the  The  s t a t u t o r y scheme p r o v i d e s  insured depositors  o f f a i l u r e but  allows  Minister's  as a g e n e r a l  w i l l be b a i l e d out  the  i n the  rule event  f o r w i d e r compensation i n  c i r c u m s t a n c e s which j u s t i f y g r e a t e r government i n t e r v e n t i o n . The  model i s a l s o d e s i g n e d t o promote t h e  e f f i c i e n c y and As  a final  insolvency  market  i n t e r e s t s of  cost-  discipline.  s t e p , the reforms t o the Canadian bank  l e g i s l a t i v e framework which the  government r e c e n t l y enacted, w i l l be t h e model f o r r e f o r m which has  federal  examined i n l i g h t  been proposed  herein.  of  117 CHAPTER 7.  RECENT  FEDERAL  FINANCIAL  On  July  proclaimed  2 and  the  3,  a  to  number o f  of  evaluated chapter  1.  government  and  An  Act  Deposit  and  to  of  the  the  this  system of  deposit  and  of  the  are  model  Acts  Acts  introduced financial  system with  stability  following  legislation  two  insurance  competition In the  Insurance  t o Amend C e r t a i n  supervising  in light  in  discussion,  the the  e x a m i n e d and  the  relevant  then  f o r reform proposed  in  6.  L e g i s l a t i v e Framework The  e f f e c t of  Insurance of  federal  changes t o  sector.  provisions  the  REGULATION  The  increasing  financial  1987,  CANADIAN  Financial Institutions.  institutions goals  MARKET  OF  F i n a n c i a l I n s t i t u t i o n s and  S y s t e m Amendment A c t Relating  REFORM  change the  that  Acts  provisions  was  to  e s t a b l i s h a new operations  Relating  to  to  own  of  repeal  the  regulatory the  Financial  which allow  institutions  c e r t a i n share  Minister  to  p o w e r s and  Amend C e r t a i n  financial  F i n a n c i a l I n s t i t u t i o n s and  S y s t e m Amendment A c t  Insurance Act,  contains  the  CDIC.  Department b o d y and  An  Act  to  to  Institutions  federally-regulated  securities dealers,  transactions  Deposit  requires  have t h e a p p r o v a l o f t h e  o f F i n a n c e , s p e c i f i e s c i r c u m s t a n c e s under w h i c h t h e  Superintendent independent  of F i n a n c i a l  appraisal  I n s t i t u t i o n s can o b t a i n an  o f r e a l e s t a t e a s s e t s h e l d by any  113 trust,  l o a n o r i n s u r a n c e company, and g r a n t s t h e  S u p e r i n t e n d e n t o f F i n a n c i a l I n s t i t u t i o n s t h e power t o make cease and d e s i s t o r d e r s . Three a s p e c t s o f t h i s new have p a r t i c u l a r impact a r e examined below:  financial  sector legislation  on t h e i s s u e o f bank i n s o l v e n c y and  a) t h e c r e a t i o n o f t h e S u p e r i n t e n d e n t  o f F i n a n c i a l I n s t i t u t i o n s ; b) t h e p r o v i s i o n s which amend t h e Canada D e p o s i t Insurance C o r p o r a t i o n A c t and c r e a t e new o b j e c t s and powers f o r t h e CDIC; and c) t h e p r o v i s i o n s which amend t h e Bank A c t .  a) The O f f i c e o f t h e S u p e r i n t e n d e n t o f F i n a n c i a l Institutions P a r t I o f The F i n a n c i a l I n s t i t u t i o n s and D e p o s i t I n s u r a n c e System Amendment A c t c r e a t e s t h e O f f i c e o f t h e Superintendent of F i n a n c i a l I n s t i t u t i o n s , a c o n s o l i d a t i o n of t h e p r e - e x i s t i n g S u p e r i n t e n d e n t o f Insurance  (which  r e g u l a t e d i n s u r a n c e , t r u s t and l o a n companies) and t h e OIGB. A Superintendent of F i n a n c i a l ("Superintendent")  Institutions  i s a p p o i n t e d by c a b i n e t t o a d m i n i s t e r the  A c t and r e p o r t t o t h e M i n i s t e r on m a t t e r s such a d m i n i s t r a t i o n .  connected  with  In a d d i t i o n , t h e A c t c r e a t e s a  Committee d e s i g n e d t o f a c i l i t a t e c o n s u l t a t i o n s and exchanges o f i n f o r m a t i o n between government r e g u l a t o r y a g e n c i e s . Committee  c o n s i s t s o f the S u p e r i n t e n d e n t ,  The  t h e Deputy  M i n i s t e r o f F i n a n c e , t h e Governor o f t h e Bank o f Canada and the Chairman o f the CDIC.  Each member o f t h e Committee  has  119 the  right  financial any  t o any  information r e s p e c t i n g the  institutions  o t h e r member.  regulatory the  and  OIGB a n d  Acts  b)  Superintendent  the  which remains responsible  Corporation  alter  independent  As  continues  deposit  somewhat e x p a n d e d . p r e s c r i b e s broader  increased specific  financial  system.  Act  Corporation  and  Deposit  Act.  The  new  b a s i c s t r u c t u r e of the  from the  agency  of F i n a n c i a l  t o be  limited  example,  (now  the  Institutions).  to that of  deposit  i t s powers  i n s e c t i o n 57,  objects f o r the  CDIC  primarily  s u p e r v i s i o n o f banks  i n s u r e r , however, For  by  c o n t a i n s p r o v i s i o n s amending  the  Superintendent  CDIC's r o l e  possessed  These  Institutions  f o r r e g u l a t i o n and  of the  insurer.  s e c t o r s of the  Insurance  does not  those  of  greater  o f amendments t o t h e  Financial  Deposit  or control  i s given  Insurance.  S y s t e m Amendment A c t  legislation  The  way  of  Insurance  I I o f The  Canada  Office  by  individual  Canada D e p o s i t  Insurance  Superintendent  enforcement powers t h a n  governing  Part  w i t h i n the possession  The  powers a r e p r o v i d e d  s u p e r v i s i o n of  are  the  CDIC w h i c h r e a d  Act as  follows:  "a)  to provide  insurance... against the  loss  of  part  or a l l of d e p o s i t s ; b)  t o be  instrumental  of  sound b u s i n e s s  institutions  and  and  i n the  promotion  financial  t o p r o m o t e and  of  practice otherwise  standards f o r member contribute  120 t o t h e s t a b i l i t y and c o m p e t i t i v e n e s s  of the  f i n a n c i a l system i n Canada; and c) t o pursue t h e o b j e c t s s e t out i n paragraphs (a) and  (b) above f o r t h e b e n e f i t o f persons  having  d e p o s i t s w i t h member i n s t i t u t i o n s and i n such manner as w i l l minimize t h e exposure o f t h e C o r p o r a t i o n t o loss.  T h i s amendment has broadened t h e CDIC's o b j e c t s which were previously r e s t r i c t e d to providing deposit The  new A c t goes on t o add s e v e r a l s p e c i f i c powers t o  the i l l u s t r a t i v e l i s t i n s e c t i o n 11. any  insurance.  of the Corporation's  powers p r o v i d e d  These i n c l u d e t h e power t o manage and i n v e s t  funds accumulated as a r e s u l t o f i t s o p e r a t i o n s ; t h e  power t o i n c o r p o r a t e o r a c q u i r e a company f o r t h e purpose o f f a c i l i t a t i n g the a c q u i s i t i o n ,  management  or d i s p o s a l of the  a s s e t s o f a member i n s t i t u t i o n t h a t t h e C o r p o r a t i o n  may  a c q u i r e ; and t h e power t o a c t as i n s p e c t o r o f a member i n s t i t u t i o n when d u l y a p p o i n t e d The  t o a c t as such.  CDIC's powers i n t h e a r e a o f s u p e r v i s i o n a r e  expanded by t h e new l e g i s l a t i o n . member i n s t i t u t i o n s w i l l  Although  i n s p e c t i o n s of  c o n t i n u e t o be performed on b e h a l f  of t h e CDIC by t h e S u p e r i n t e n d e n t , a new power t o make p r e p a r a t o r y  t h e CDIC i s p r o v i d e d  with  examinations where t h e  C o r p o r a t i o n b e l i e v e s t h a t t h e o b l i g a t i o n t o pay an i n s u r e d c l a i m i s imminent.  With t h e a p p r o v a l  of the  Superintendent,  t h e CDIC may examine books, r e c o r d s and accounts  o f a member  121 i n s t i t u t i o n r e l a t i n g t o i t s d e p o s i t l i a b i l i t i e s and i s e n t i t l e d t o r e q u i r e any o f f i c i a l to  f u r n i s h such  of the insured  institution  i n f o r m a t i o n as r e q u i r e d ( s e c t i o n 60). I n  a d d i t i o n , t h e CDIC i s g i v e n t h e power t o make d i s c r e t i o n a r y payments t o i n s u r e d d e p o s i t o r s p r i o r t o w i n d i n g i n s t i t u t i o n where such  i n s t i t u t i o n i s unable  up a member  by r e a s o n o f  c o u r t o r d e r o r an a c t i o n taken by a r e g u l a t o r y body t o make any payment i n r e s p e c t o f t h e d e p o s i t , o r t h e p o l i c y o f deposit insurance i s c a n c e l l e d or terminated. A n o t h e r a s p e c t o f t h e Canada D e p o s i t  Insurance  C o r p o r a t i o n A c t which i s amended by t h e F i n a n c i a l I n s t i t u t i o n s and D e p o s i t Insurance enforcement. and  System Amendment A c t i s  The C o r p o r a t i o n i s now a u t h o r i z e d t o a s s e s s  c o l l e c t a premium s u r c h a r g e  from any member  which i s v i o l a t i n g t h e C o r p o r a t i o n ' s by-laws  institution  ( s e c t i o n 65).  Furthermore, t h e CDIC's power t o t e r m i n a t e t h e i n s u r a n c e o f provincial  institutions  institutions.  i s extended t o i n c l u d e f e d e r a l  Thus, when a bank o r o t h e r member  institution  i s n o t f o l l o w i n g s a f e and sound p r a c t i c e s as p r e s c r i b e d by t h e C o r p o r a t i o n ' s by-laws, t h e CDIC may send a r e p o r t o f such v i o l a t i o n t o t h e member i n s t i t u t i o n . remedy t h e c o m p l a i n t  I f i t f a i l s to  to the Corporation's s a t i s f a c t i o n , i t  may t e r m i n a t e t h e i n s t i t u t i o n ' s  i n s u r a n c e , upon t h e l a p s e o f  a p r e s c r i b e d time p e r i o d and s u b j e c t t o m i n i s t e r i a l approval. The  CDIC's power t o i n i t i a t e t h e winding-up o f a bank  i s r e t a i n e d by t h e new l e g i s l a t i o n ,  b u t amended t o p r o v i d e  122 t h a t such a measure r e q u i r e s the p r i o r a p p r o v a l o f the Minister.  c)  Bank A c t The  F i n a n c i a l I n s t i t u t i o n s and D e p o s i t Insurance  System  Amendment A c t and An A c t t o Amend C e r t a i n A c t s R e l a t i n g t o F i n a n c i a l I n s t i t u t u i o n s amend t h e Bank A c t t o g i v e s t r o n g e r s u p e r v i s o r y and enforcement powers t o t h e S u p e r i n t e n d e n t v i s a v i s banks.  F o r example, t h e l a t t e r A c t e n t i t l e s  S u p e r i n t e n d e n t t o i s s u e d i r e c t i o n s o f compliance d e s i s t o r d e r s ) t o banks c o n d u c t i n g o r about t o u n s a f e o r unsound p r a c t i c e s . D e p o s i t Insurance  The  the  (cease  and  conduct  Financial Institutions  System Amendment A c t o u t l i n e s  and  two  p r o c e s s e s which can be used by t h e S u p e r i n t e n d e n t t o assume c o n t r o l o f a bank i n s p e c i f i e d c i r c u m s t a n c e s . i n t e n d e d f o r emergency s i t u a t i o n s , where the  The  first is  Superintendent  b e l i e v e s t h a t t h e a s s e t s a p p e a r i n g on a bank's books are not s a t i s f a c t o r i l y accounted liabilities  f o r , a bank has  t h a t have come due  f a i l e d t o pay  or there e x i s t s a s i t u a t i o n  that i s p r e j u d i c i a l to c r e d i t o r s or d e p o s i t o r s . case, the Superintendent  all  In such a  i s e n t i t l e d t o t a k e c o n t r o l of the  bank's a s s e t s f o r seven days While  any  (or l o n g e r i f n e c e s s a r y ) .  i n c o n t r o l , the S u p e r i n t e n d e n t  i s a u t h o r i z e d t o take  s t e p s n e c e s s a r y t o p r o t e c t the bank's d e p o s i t o r s and  c r e d i t o r s and has a v e t o power over the bank's a c t i o n s i n order to preserve i t s assets. office  I f the  Superintendent's  i s not c o n v i n c e d t h a t a bank i s s o l v e n t o r w i l l  123 remain leads  s o , i t h a s t h e power t o i n v o k e t o more e x t e n s i v e c o n t r o l  procedure  i n any c a s e where:  insufficient;  Act;  t h e bank.  i s commenced b y t h e S u p e r i n t e n d e n t  the M i n i s t e r  directors  over  a procedure  reporting to  a r e p o r t has been sent t o a bank's board  or there exists  a state  Insurance  of a f f a i r s  w h i c h may  to the interests  of  Upon h o l d i n g a h e a r i n g , t h e M i n i s t e r  number o f o p t i o n s :  restrict  practices  and/or d i r e c t  o f t h e bank.  bank's d i r e c t o r s becomes  has a prescribe a  t o take  takes  or  control  control  of a  t h e powers and d u t i e s o f t h e  a r e suspended  and t h e  Superintendent  r e s p o n s i b l e f o r t h e management o f t h e b a n k ' s  satisfactorily, General  creditors  i t sdeficiency  the Superintendent  order,  b u s i n e s s and a f f a i r s .  if  t h e bank's l i c e n c e ,  When t h e S u p e r i n t e n d e n t  bank by M i n i s t e r i a l  be  of the depositors or  w i t h i n w h i c h t h e b a n k must remedy  I f the i n s t i t u t i o n  t h e M i n i s t e r may  to apply  control  relinquish  control.  Superintendent  to  respond  On t h e o t h e r h a n d ,  a bank under t h e  h a s met  Bank A c t , t h e M i n i s t e r may  fails  request the Attorney-  f o r a winding-up order.  the Minister believes that  Superintendent's  direct  a l l the requirements the Superintendent  of the to  Through t h e s e mechanisms, t h e  i s given legal  rights  of control  over  banks  w h i c h go b e y o n d t h e p r e v i o u s p o w e r s o f t h e OIGB o r t h e  2.  of  Corporation  prejudicial  time  The  a bank's a s s e t s a r e  u n d e r t h e Canada D e p o s i t  a bank.  which  E v a l u a t i o n o f F e d e r a l Reforms  CDIC.  124  The  f e d e r a l government's amendments t o the  f o r r e g u l a t i o n o f the  f i n a n c i a l s e c t o r t a k e some s i g n i f i c a n t  steps i n the d i r e c t i o n of i n c r e a s i n g s t a b i l i t y competition  i n the  f i n a n c i a l market and  r e g u l a t i o n o f f e d e r a l and respect  framework  and  harmonizing  provincial institutions.  the With  t o t h e more s p e c i f i c i s s u e of the power o f  government i n s t i t u t i o n s t o d e a l w i t h i n s o l v e n t banks,  the  amendments r e f l e c t a b r o a d e r approach than t h a t which e x i s t e d under p r e v i o u s l e g i s l a t i o n ,  but  one  which i s  significantly limited.  a)  S t r u c t u r a l A s p e c t s o f Reform The  c r e a t i o n o f a new  I n s t i t u t i o n s and  regulatory  body by  the  Financial  D e p o s i t I n s u r a n c e System Amendment  which i s a c o n s o l i d a t i o n o f t h e OIGB and I n s u r a n c e , i s c o n s i s t e n t w i t h the  the  Act,  Department of  f e d e r a l government's  o b j e c t i v e o f removing the d i s t i n c t i o n s between  the  traditional  perspective  four f i n a n c i a l p i l l a r s .  1  o f t h e b a n k i n g s e c t o r , however, i t can supra-regulatory problematic. statement by  From the be  approach t a k e n by the new  T h i s c o n c e r n was  argued t h a t Act  expressed i n a  the Canadian Bankers'  the  is recent  Association:  I t has been and c o n t i n u e s t o be the CBA's b e l i e f t h a t an i n d i v i d u a l charged w i t h e x c l u s i v e r e s p o n s i b i l i t y f o r one p a r t i c u l a r s e c t o r would be 1 An a n a l y s i s of the methods by which the government proposes t o a c h i e v e t h i s o b j e c t i v e i s beyond the scope of t h i s paper.  125  more l i k e l y t o d e v e l o p the k i n d o f e x p e r t i s e and d e t a i l e d knowledge n e c e s s a r y f o r d e a l i n g w i t h the i s s u e s and problems unique t o t h a t s e c t o r t h a n would a " s u p e r - r e g u l a t o r " charged w i t h the much b r o a d e r mandate o f o v e r s e e i n g the r e g u l a t i o n o f a l l financial institutions.2  T h i s c o n c e r n i s a l l e v i a t e d t o some e x t e n t p r o v i s i o n i n the A c t S u p e r i n t e n d e n t who  would have e x p e r t i s e  in  and  Whether o r not  approach w i l l prove adequate o r a p p r o p r i a t e until  the government has  i n t e g r a t i n g the  four  by the  cannot be  aspect  o f the  order  to i n s t i l  provide the  Deposit  i n v o l v e s the r e t e n t i o n of  insurer.  I t has  of insurance  combined i n one  agency.  and  about i n s u r e d  the CDIC the power t o make p r e p a r a t o r y s i t u a t i o n s o f imminent i n s o l v e n c y ,  information  of  to banks,  r e g u l a t i o n o f banks s h o u l d  A l t h o u g h the new  would be more c o s t - e f f i c i e n t  the  been argued t h a t i n  a w i l l t o a c t i n the r e g u l a t o r and  d i r e c t access to information  functions  of  s t r u c t u r a l reforms  f u n c t i o n a l d i s t i n c t i o n between the p r i m a r y r e g u l a t o r the d e p o s i t  fully  completed the p r o c e s s  F i n a n c i a l I n s t i t u t i o n s and  I n s u r a n c e System Amendment A c t  banks and  this  pillars.  A second p r o b l e m a t i c introduced  the  f o r the appointment o f a Deputy  r e s p o n s i b i l i t y over the banking s e c t o r .  assessed  by  and  legislation  be  gives  examinations i n  i t i s argued t h a t i t  effective i f this  were a v a i l a b l e t o the d e p o s i t  i n s u r e r on an  on-  going b a s i s . 2 Canadian Bankers' A s s o c i a t i o n , Response t o B i l l C - 4 2 : An A c t R e s p e c t i n g F i n a n c i a l I n s t i t u t i o n s and the D e p o s i t I n s u r a n c e System (Toronto: A p r i l , 1987) a t 2 .  126  A by  final  the  the  new  aspect  legislation  comprised Canada,  of the  the  Finance,  The  previous  this  form  I t i s submitted financial  The  federal  legislation  Corporation Act.  the  powers proposed  i s an  financial  of  improvement  which  lacked  i n t h e model  the  CDIC a n d  actual  compliance  of the  powers  or p o t e n t i a l  when c o m p a r e d  f o r reform  the  Insurance  expansion  especially  sector  to enforce  Canada D e p o s i t  to deal with  is minimal—  Bank  c o - o r d i n a t i n g mechanism.  powers t o b o t h  However, t h e  institutions  which i s  Deputy M i n i s t e r o f  that this  t o s u p e r v i s e banks and and  federal  c o n s u l t a t i o n and  g o v e r n m e n t ' s new  Bank A c t  insolvency  the  of  Reform  grants broader  Superintendent the  of  creation  the Governor of the  sector legislation,  of i n s t i t u t i o n a l i z e d  introduced  i s the  Committee,  Superintendent,  F u n c t i o n a l Aspects  amendments  of the v a r i o u s  object of this  i s to p r o v i d e on-going  over  these  officials  C h a i r m a n o f t h e CDIC and  communication.  with  structural  t h a t i s noteworthy  Committee l i n k i n g  authorities.  b)  of the  s e t out  bank  to in  of  the chapter  6. The  amendments t o t h e  Corporation Act  expand t h e  Canada D e p o s i t  CDIC's o b j e c t s b e y o n d  provision  of deposit insurance.  objective  of the  financial  practices,  concern  Insurance  By  specifying  the  that  CDIC i s t o p r o m o t e s o u n d b u s i n e s s the Act  reflects  in protecting financial  the  stability  an and  government's and  the  interests  127 o f d e p o s i t o r s and  of the CDIC and  recognizes  Corporation's r o l e i n t h i s process.  the  Furthermore,  i n t e r e s t o f c o s t - e f f i c i e n c y i s r e c o g n i z e d by t h e t h a t t h e CDIC minimize i t s exposure t o l o s s .  the requirement  Although  expanded o b j e c t s p r o v i d e t h e CDIC w i t h a b r o a d e r  frame o f  r e f e r e n c e , t h e y w i l l not have a s i g n i f i c a n t e f f e c t on CDIC's a b i l i t y t o r e s o l v e bank f a i l u r e ,  amendments t o t h e Canada D e p o s i t Insurance  by  The  Corporation Act  s u p e r v i s i o n and  enforcement powers aimed a t p r e v e n t i n g i n s o l v e n c y . they f a l l  the  u n l e s s backed up  w i d e r powers t o a c t i n an i n s o l v e n c y s i t u a t i o n .  do p r o v i d e t h e CDIC w i t h s t r e n g t h e n e d  these  s h o r t i n s o f a r as p r o v i d i n g f o r new  and  However,  flexible  powers t o r e s o l v e bank i n s o l v e n c y . One  s i g n i f i c a n t new  power which i s i n t r o d u c e d by  F i n a n c i a l I n s t i t u t i o n s and  D e p o s i t Insurance  the  System  Amendment A c t i s t h e S u p e r i n t e n d e n t * s l e g a l r i g h t t o c o n t r o l o f a bank o r i t s a s s e t s i n c e r t a i n T h i s i s an important Superintendent  take  circumstances.  p r o v i s i o n i n that i t grants  the  t h e power t o t a k e temporary c o n t r o l o f a  t r o u b l e d bank and,  t h e r e f o r e , the o p p o r t u n i t y t o i n v e s t i g a t e  t h e s o u r c e o f t h e t r o u b l e and t o p r e v e n t  further prejudice  t o t h e i n t e r e s t s o f d e p o s i t o r s or c r e d i t o r s .  The  result  of  t h i s temporary r i g h t o f c o n t r o l i s e i t h e r a c o r r e c t i o n of t h e s i t u a t i o n and  the r e t u r n o f c o n t r o l over the bank's  a s s e t s t o bank management or a more complete t a k i n g of c o n t r o l over the bank's a f f a i r s u n t i l the unsound p r a c t i c e or s t a t e of a f f a i r s  i s remedied o r the bank i s wound  up.  128 The new A c t s e t s o u t s p e c i f i c c r i t e r i a  f o r the taking of  such a c t i o n by t h e S u p e r i n t e n d e n t and g i v e s t h e u l t i m a t e a u t h o r i t y t o i n v o k e such a p r o c e d u r e t o t h e M i n i s t e r . T h i s p r o c e d u r e w i l l be u s e f u l i n c i r c u m s t a n c e s where the r e g u l a t o r  i s concerned about a member i n s t i t u t i o n ' s  s o l v e n c y and wants t o p r e v e n t f u r t h e r l o s s t o t h e bank's depositors,  c r e d i t o r s and t o t h e CDIC b e f o r e t h e bank i s  wound up o r i n c i r c u m s t a n c e s where t h e i n t e r e s t s o f depositors  and c r e d i t o r s a r e t h r e a t e n e d by an unsound  p r a c t i c e o r s t a t e o f a f f a i r s which c a n be remedied.  The  p r o c e d u r e does n o t contemplate n o r i n any way p r o v i d e a mechanism whereby an i n s o l v e n t bank can be b a i l e d o u t .  Conclusion When measured a g a i n s t  the c r i t e r i a  f o r reform s e t out  i n c h a p t e r 6 , t h e f e d e r a l government's  legislative  initiative  insolvency  f a l l s short.  L i k e t h e bank  l e g i s l a t i o n p r e c e d i n g i t , t h e new l e g i s l a t i o n one u l t i m a t e  c o u r s e o f a c t i o n i n t h e event o f bank  l i q u i d a t i o n and p a y o f f .  failure:  I t does n o t a d d r e s s t h e i s s u e o f  government b a i l o u t s o f i n s o l v e n t banks deposit  contemplates  insurance f o r small  (other t h a n  depositors).  providing  Therefore, the  p r e s e n t s i t u a t i o n w i l l c o n t i n u e — w i t h t h e government continuing  to bail  o u t i n s o l v e n t banks w i t h o u t t h e b e n e f i t  o f t h e s t r u c t u r e , c o n t r o l and p r e d i c t a b i l i t y p r o v i d e d legislative  framework.  by a  129  CONCLUSION  The  e x p e r i e n c e of the Canadian government i n attempting  t o r e s o l v e r e c e n t bank i n s o l v e n c i e s has inadequacy of the authorized  illustrated  the  l e g i s l a t i v e framework under which i t  to act.  That l e g i s l a t i o n d i d not  recognize  was nor  p r o v i d e a mechanism f o r the b a i l i n g out of d i s t r e s s e d banks. Because bank b a i l o u t s can be j u s t i f i e d i n s p e c i f i c c i r c u m s t a n c e s , bank i n s o l v e n c y  l e g i s l a t i o n should  t h i s form of government i n t e r v e n t i o n and and  appropriate  recognize  p r o v i d e an  adequate  framework f o r t h i s p r o c e s s .  American bank i n s o l v e n c y  legislation reflects a highly-  s t r u c t u r e d approach t o the problem of a c t u a l or p o t e n t i a l insolvency  and  p r o v i d e s the d e p o s i t  i n s u r e r w i t h broad  powers t o d e c i d e whether a bank should be b a i l e d out allowed t o f a i l . deposit  or  I f the d e c i s i o n i s made t o b a i l out,  the  i n s u r e r possesses the a u t h o r i t y t o choose among a  number o f a l t e r n a t i v e approaches, i n p a r t i c u l a r , the purchase and  assumption t r a n s a c t i o n and  direct financial  assistance. The  model f o r reform of Canadian bank  insolvency  l e g i s l a t i o n which i s proposed i n t h i s t h e s i s i s based on  the  American approach.  I t creates  on-  going access t o the  information  an agency w i t h d i r e c t and  needed to recommend a course  of a c t i o n t o the M i n i s t e r w i t h r e s p e c t and  to a d i s t r e s s e d bank,  the broad powers t o implement the M i n i s t e r ' s  decision.  130 The model proposes a l e g i s l a t i v e scheme which would as a g e n e r a l  r u l e t h a t o n l y i n s u r e d d e p o s i t o r s would be  b a i l e d out i n the event o f f a i l u r e but would a l l o w compensation i n circumstances which j u s t i f y government i n t e r v e n t i o n . the  provide  wider  greater  The model i s designed t o promote  i n t e r e s t s o f c o s t - e f f i c i e n c y and market d i s c i p l i n e . When t h i s model f o r reform i s a p p l i e d t o r e c e n t  federal  i n i t i a t i v e s t o amend f i n a n c i a l s e c t o r l e g i s l a t i o n , the conclusion  i s reached t h a t the new l e g i s l a t i o n , w h i l e a step  i n the r i g h t d i r e c t i o n , does not go f a r enough.  Further  and  more meaningful l e g i s l a t i v e reforms are needed i f government a g e n c i e s a r e t o r e s o l v e f u t u r e bank i n s o l v e n c i e s i n a more c o n s i s t e n t and e f f e c t i v e way than r e c e n t resolved.  f a i l u r e s have been  131 BIBLIOGRAPHY Balamut, George B., "A M o r a l i t y T a l e : E v e r y t h i n g ' s Got a Moral I f Only You Can F i n d I t " , (1975) 27 Ad.L.Rev.343. 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