Canada: Canadian Commercial Bank Emergency Liquidity Program

In the years leading up to the CCB collapse, large losses among Canadian banks stemming from lending to developing countries^FThese countries included Brazil, Argentina, Mexico, and Nigeria, oil shocks, and the mass failure of trust companies^FCanadian trust companies were lightly regulated entities permitted to engage in certain banking activities. By the time of the CCB rescue, risky lending practices and an unfavorable interest rate environment had led to the failure of 10 notable trust companies requiring CDIC payouts totalling more than CAD 3 billion (Macintosh 1991). had weakened the domestic financial system (Kobrak and Martin 2018). Since its founding in 1976, the CCB had embarked on a rapid expansion in Western Canada and then into California and Eastern Canada (Estey 1986).

After some initial success, problems began to emerge for CCB owing to the generally poor performance of its loan book and the onset in 1982 of a deep and prolonged recession in Western Canada (Estey 1986). In 1983, CCB first requested liquidity support from the BoC because of its associations with failing trust companies. The BoC agreed in late January 1983 to provide extraordinary advances to CCB if needed and took security collateral for that purpose. The BoC also convened a meeting with the six largest Canadian chartered banks—the Royal Bank of Canada, the Toronto-Dominion Bank, the Bank of Montreal, the Bank of Nova Scotia, the Canadian Imperial Bank of Commerce, and the National Bank of Canada—to arrange a special line of credit for CCB, which CCB drew upon to survive the episode without need of the BoC facility (Bank of Canada 1986). CCB repaid all borrowings to the banks by June 1983. CCB survived that episode. By the end of 1984, it had a loan portfolio of CAD 2.3 billion (Estey 1986).

By early 1985, CCB was no longer earning a positive net interest margin owing to its high proportion of nonperforming loans. Further, its cash income had dried up, leaving the bank without a viable future. On March 14, 1985, CCB CEO Gerry McLaughlan flew to Ottawa to make unannounced presentations to officials at the BoC and the OIGB, in which he said the bank would not survive unless the government provided it “massive assistance” (Estey 1986, 105).

The CCB CEO presented the government with three options: recapitalization, merger, or liquidation (Estey 1986).  The Canadian authorities did consider liquidating the bank and a prospective merger with an acquiring institution, recognizing the latter option would also likely require government support. In particular, National Bank, Canada’s sixth-largest bank, was considered as a potential acquirer, but this possibility was dismissed for political reasons (Johnson 1986).

The CDIC, which participated in the consortium package, also decided it was important to support the intervention, noting that participating in the rescue attempt would limit risk or “avert the loss which it would face if the CCB failed” (CDIC 1986, 8).

Canadian officials feared that the failure of CCB could spark a broader liquidity crisis for two main reasons. Most significantly, there were a number of similarly vulnerable regional banks in Western Canada.^FThe institutions of concern did indeed encounter problems after CCB’s collapse and either failed or merged with other banks despite a government bailout of uninsured CCB depositors (Macintosh 1991). They also had concerns about the potential impact on interbank funding markets and the risk of international depositors and investors losing confidence in Canadian banks (Estey 1986). BoC Governor Gerald Bouey was a particularly strong advocate for the CCB rescue, despite skepticism expressed by some other government officials. Ultimately, concerns about potential negative impacts on the already struggling economy in Western Canada tipped the balance in favor of proceeding with the rescue of CCB (Johnson 1986). According to the BoC,

it was crucial that the Bank of Canada be in a position to provide advances promptly to the Canadian Commercial Bank to prevent its failure due to lack of liquidity and to help maintain market confidence in similar institutions that might have been susceptible to contagion problems (Bank of Canada 1986, 9).

In the BoC’s submission to the Estey Commission, the BoC clearly explained its thinking on its role as lender of last resort:

Extraordinary advances are intended to prevent the failure of the particular institution that is illiquid but still solvent and to preserve confidence in that institution and in other deposit-taking institutions and the financial system. This latter concern is sometimes referred to as the “contagion” problem, where the difficulties of one deposit-taking financial institution may lead to a general market concern that other deposit-taking financial institutions could be subject to the same problems, thus putting the stability of the financial system as a whole at risk. Depositors have a considerable incentive to withdraw their funds from an institution when they believe, whether justified or not, that the institution is experiencing difficulties. . . . When depositors see that there are no problems in obtaining their funds, that their initial concerns are unfounded and that the institution is continuing to operate without difficulty, confidence should return. Losses of confidence can develop and spread with great speed and, for extraordinary advances to be effective, the central bank must be prepared to lend quickly and without hesitation (Bank of Canada 1986, 2–3).

The consortium loan and the BoC’s liquidity support to CCB were announced as part of a single support package. The first component of this package was an injection of cash into CCB from a consortium that included the Canadian federal government, Alberta provincial government, the CDIC, and the six largest Canadian banks. This action involved purchasing the losses on a CAD 530 million pool of nonperforming loans by buying a junior claim at a par value of CAD 255 million; the intended purpose of this was to allow the CCB to write off large losses while remaining solvent. This loan was contingent upon the agreement of the debenture holders to subordinate their claims to the advances made by the parties involved in the rescue program, and it required the CCB to pay back 50% of its pretax profits to the consortium members until the capital on the refinancing deal was repaid in full (Estey 1986; LA Times 1985).

However, there was some disagreement over the nature of the CAD 255 million participation by the consortium. Estey contended that the CAD 255 million was “simply a liquidity advance, “since the final participation agreement would still require CCB to repay the consortium members in the event of its own liquidation (Estey 1986, 125).^FEstey (1986) also wrote, “It is surprising that the ‘rescue’ moneys of $255M were simply paid through the CCB to the Bank of Canada in reduction of liquidity advances” (115). Estey wrote, “The Inspector General, therefore, was in error in finding the bank to be solvent upon receipt of the $255M” (Estey 1986, 115). The day after CCB failed, Alberta’s provincial treasurer called its CAD 70 million participation in the consortium a deposit, for which he expected full recovery (Legislative Assembly of Alberta 1985). In 1992, the Supreme Court ruled that the consortium’s participation ranked pari passu with other unsecured creditors (Supreme Court of Canada 1992).

In addition to the CAD 255 million cash injection, the governments of Canada, Alberta, and British Columbia also purchased CAD 39 million subordinated debentures at par value from the investors who held them, in three equal tranches (Estey 1986). These debentures had little value, since they were subordinated to the claims held by the consortium members.

Beyond these measures, the BoC sought to bolster confidence by exercising  moral suasion when the largest Canadian chartered banks began to withdraw lines of credit to CCB. On April 10, Governor Bouey met with representatives from the six largest Canadian banks—the same banks that had participated in CCB’s recapitalization—to express concerns that their reluctance to conduct regular business with CCB was undermining market confidence. In late May, with the minister of finance’s support, Governor Bouey personally wrote to each of the six major chartered banks imploring them to resume normal relations with CCB. Despite Governor Bouey’s appeals, it is not apparent that banks resumed regular business with CCB, with the president of the Royal Bank of Canada stating that confidence could not be restored as CCB continued to draw from the BoC (Estey 1986).

According to the Bank of Canada Act, the BoC could “make loans or advances for periods of not more than six months to any member of the Canadian Payments Association” upon receipt of eligible security including mortgages (Parliament of Canada 1985b, sec. 18). These loans or advances were eligible to be renewed (Estey 1986).

In its submission to the Estey Commission, the BoC described two types of liquidity support allowed under the Bank of Canada Act: ordinary, one-day advances to banks encountering temporary reserve shortfalls, and  extraordinary advances to “banks which are experiencing difficult liquidity problems because of a loss of depositor confidence and are unable to meet deposit withdrawals from their own resources (that is, selling liquid assets) or from additional deposits raised in the market at or near their usual rates of interest” (Bank of Canada 1986, 2).

While the BoC stated that solvency of an institution was a precondition for such advances, they asserted they lacked the legislative authority and capacity to “assess the financial soundness and solvency of chartered banks” and hence relied upon the OIGB by necessity for such assessments (Bank of Canada 1986, 4).

The CDIC Act gave the CDIC the authority to provide emergency liquidity funding to deposit-taking institutions and to assist in improving the regulation of such institutions, but it did not invoke these authorities in the CCB case (Estey 1986).

Following the announcement of liquidity support, the BoC made logistical arrangements pertaining to CCB’s liquidity needs (Bank of Canada 1986). The BoC maintained communication with the OIGB during various inspections of CCB’s loans and continued to lend when the report written in August 1985 by George Hitchman, a retired deputy chairman of the board of the Bank of Nova Scotia, described the condition of CCB as very serious. By mid-August, the BoC believed that CCB was heading toward insolvency; however, it continued providing liquidity advances until September 1, 1985, when it received a letter from Inspector General Kennett stating that CCB was no longer viable (Bank of Canada 1986).

To provide oversight, the BoC has a board of directors, which includes the deputy minister of finance as a nonvoting member, and the BoC is ultimately accountable to the Canadian minister of finance (Parliament of Canada 1985a, sec. 5). The BoC needs to consult with the minister of finance, who has the right to issue overriding directives in the case of disagreements on issues of monetary policy (Parliament of Canada 1985a, sec. 14).

Within a month of the collapse of CCB and Northland Bank, the government commissioned a special inquiry report into the circumstances of these failures led by Supreme Court Judge Willard Estey (Estey 1986; Kobrak and Martin 2018, 265). Shortly thereafter, in December 1985, the Canadian parliament passed the Financial Institutions Depositors Compensation Act to provide compensation to all uninsured depositors at an initially estimated cost of CAD 875 million (Estey 1986). The circumstances surrounding the CCB collapse led to sweeping regulatory changes, including the creation of the OSFI, which subsumed the OIGB and Department of Insurance, and was given a strengthened mandate to provide effective supervision of banks and insurance companies (Kobrak and Martin 2018, 265).

During CCB’s problems in January 1983 resulting from associations with failing trust companies, the BoC issued a press release stating: “Canadian Commercial Bank is a solvent and profitable bank and if it requires any liquidity support, the Bank of Canada will provide it” (Estey 1986, 165–66). When problems re-emerged in March 1985, Governor Bouey advocated for a rescue of CCB and led negotiations during the crucial days of March 22–24, despite the BoC not being a contributor to those funds (Estey 1986; Johnson 1986).

Coming out of the weekend, on March 25, 1985, the Department of Finance issued a press release announcing the consortium’s support package for CCB, clearly stating the imperative to protect the bank, the Western Canadian economy, and the domestic financial system. The Department of Finance described the support package as “an infusion of capital with repayment provisions,” contributed by the Province of Alberta, six Canadian banks, the CDIC, and the federal government to restore the CCB’s solvency (Estey 1986, 499). It also announced the availability of liquidity support for CCB and an overall accommodative stance for emergency lending: “the Bank of Canada stands ready to provide liquidity for Canadian Commercial Bank, if requested, as well as for any other Canadian bank” (Estey 1986, 499). This emergency liquidity assistance began almost immediately for CCB and reached CAD 492 million, or 40% of their Canadian dollar loan portfolio, by mid-April 1985 (Bank of Canada 1986).

As the CCB continued to experience a loss of depositors and wholesale funding after the announcement of the support package, on April 18 the BoC issued the following press release to bolster confidence:

. . . with the agreement of the Canadian Commercial Bank, the Governor, Mr. Gerald K. Bouey, confirmed that the Bank of Canada has been providing liquidity support to that chartered bank. The Governor noted that it is the role of the central bank to act as an ultimate source of liquidity for Canadian banks, and he reiterated that the Bank of Canada stands ready to provide the Canadian Commercial Bank with whatever amount of liquidity support it may require (Estey 1986, 500).

While the BoC identified CCB by name, at the time, the BoC published recipients of liquidity advances in weekly and monthly reports, so information about its support to CCB would have been publicly available regardless of press releases (Estey 1986).

The BoC’s April 18, 1985, press release indicated that liquidity advances to the CCB would be provided at whatever level the CCB required (Estey 1986). The BoC stated that it accepts loans as security at book value and that as “the composition of a loan portfolio changes over time and the valuation of individual loans is subject to considerable fluctuation, the Bank of Canada’s approach has been to take as security a floating charge against the total loan portfolio” (Bank of Canada 1986, 5–6). The BoC was providing approximately 65% of CCB’s funding at the time the bank collapsed at over CAD 1.3 billion as shown in Figure 2 (Estey 1986). In its submission to the Estey Commission, the BoC indicated that if funding reached 75% to 80% of the book value of supporting collateral it would have triggered further action to assess the quality of the pledged loan portfolios (Bank of Canada 1986).

Figure 2: BoC 1985 Liquidity Advances to CCB

Source: Estey 1986. 

The Estey report describes the rate charged on liquidity advances to CCB as “favourable” and conducive toward earning positive net interest margins on new loans. Northland Bank, a similar bank also borrowing from the BoC at the same time, paid a lower rate of interest on its BoC advances relative to comparable lines of credit at the large Canadian banks (Estey 1986, 115).

The Bank of Canada Act permits the BoC to issue loans or advances for durations up to six months, with the option for renewal (Parliament of Canada 1985a, sec. 18). Our research did not uncover the term for the loans that were made, but all BoC lending was subject to a renewable six-month maximum. As indicated in Figure 2, although total advances to CCB increased over time on average, during certain periods it declined. In its submission to the Estey Commission, the BoC stated that with extraordinary advances it “stands prepared to provide any liquidity support required although it naturally expects the borrowing bank to take action, as soon as possible, to reduce its reliance on Bank of Canada advances” (Bank of Canada 1986).

The BoC said that it required liquidity advances to be fully secured. Its normal practice was to secure short-term advances to chartered banks with government securities; however, for larger, longer-term advances in exceptional circumstances, it could secure advances against a bank’s loan portfolio if marketable securities were insufficient (Bank of Canada 1986). Shortly following the announcement of the support package in late March 1985, the CCB signed a legal agreement with the BoC for the assignment of its Canadian loan book as collateral. By early April, it became clear that the bank’s liquidity needs would increase significantly, and, in mid-April, the CCB signed another agreement to pledge its US loan portfolio as additional collateral. Internally, the BoC had established a benchmark of “75 to 80% of the book value of collateral” as a “reasonable checkpoint” for demarcating when the sufficiency of collateral for further lending might need to be re-evaluated (Bank of Canada 1986).

In the BoC’s submission to the judicial inquiry into the failure of CCB and Northland Bank, the BoC gave no indication that its actions had any impact on the transmission of monetary policy (Bank of Canada 1986). The failure of CCB in September 1985 led to significant strain in the financial system, with three of the 10 largest remaining banks (Mercantile Bank, the Bank of British Columbia, and the Continental Bank) being taken over by other Canadian banks (Kobrak and Martin 2018). Accordingly, BoC advances to troubled institutions continued to increase after the failure of CCB and peaked at approximately CAD 5.2 billion in March 1986 (BoC data; author’s analysis). For the duration of this stressed period in the mid-1980s, there were no unusual changes in the growth of the BoC’s balance sheet or in the quantum of reserve liabilities. The BoC appeared to sterilize liquidity advances to banks by offsetting reductions in holdings of government of Canada securities (see Figure 3).

Figure 3: Changes to the Size and Composition of Assets on the BoC Balance Sheet, 1980–1989

Source: BoC balance sheet data; authors’ analysis.

According to the Estey Commission, in July 1985 “[t]he Bank of Canada objected to Northland’s use of liquidity advances to finance new loans” (Estey 1986, 578). As the BoC discouraged new lending activity at Northland Bank during the same timeframe at which CCB was receiving large advances, it is possible that similar discouragement was directed at CCB, but there was no explicit mention of this in the literature. The Estey Report also noted that the BoC did not require a change in the CCB management team, a stipulation that was common practice in other jurisdictions (Estey 1986).