The Bank of Canada has issued its own version of a cost-benefit analysis of tougher capital and liquidity requirements for banks, concluding that the effects would be similar for Canada as in other jurisdictions — the cost of tougher rules are far outweighed by the reduced risk of financial crisis.

Earlier Wednesday, the Financial Stability Board and the Basel Committee on Banking Supervision issued reports examining the effects of new bank capital and liquidity standards, essentially concluding that benefits of less frequent, and less costly, financial crises more than justify the short-term drag on GDP growth imposed by tougher regulations.


In its report, the Bank of Canada finds that the new rules would generate “significant net benefit for Canada… from the decreased likelihood of future financial crises.
As well, the macroeconomic costs of implementing the new standards would be “small and broadly similar” to other jurisdictions.

The BoC report estimates the net economic benefits to be gained over time from improving the safety and robustness of the Canadian and international financial systems would amount to about $200 billion for Canada, about 13% of GDP.

At the same time, it estimates that higher capital requirements would reduce economic output at about the same level as in other jurisdictions: for each percentage- point increase in the bank capital ratio, lending spreads would increase by about 14 basis points, and new liquidity requirements are also estimated to add about another 14 basis points, in total, to lending spreads, it says. Therefore, a two-percentage-point increase in capital requirements, along with new liquidity standards, is expected to increase lending spreads by about 42 bps. This would reduce the level of GDP by about 0.3% relative to a baseline trend over the long run, the report says.

Assuming a four-year transition period, a one point increase in capital ratios would result in the level of GDP declining by roughly 0.3% at the outset, and then converging to a longer-run decline of 0.1% of GDP within 10 years. For a two-year implementation period, the initial decline is forecast at 0.5% of GDP.

“The recent global financial crisis left a legacy of damaged economies, failed financial institutions, lost jobs, and higher fiscal deficits. Canada was not immune. It too was buffeted by financial shocks from abroad, and could not escape the spillover effects of the ensuing global economic downturn,” says Mark Carney, governor of the Bank of Canada.

“It is thus clearly in Canada’s interest to work with other countries to develop stronger international capital and liquidity standards. This will improve the robustness of our own banking system, and contribute to the promotion of global financial stability.”

IE