Canadian Bank Derivatives Exposures – 2016 Q1 update

In light of the government of Canada’s latest move to introduce bank bail-in legislation (link), following the footsteps of the EU whose union-wide bank bail-in regime takes effect in 2016, here’s an update on derivatives exposure of various major Canadian banks.

The following table summarizes the total notional derivatives exposures of the big 5 Canadian banks based on the 2016 Q1 report from the Office of the Superintendent of Financial Institutions (OSFI).

BankAssets (billions)Derivatives notional total (billions)
Royal Bank1,18012,425
TD Bank1,1387,630

For those who are just recently dialing in and/or are otherwise not familiar with the causes of the global financial crisis of 2008, the reason we keep harping on the topic of derivatives exposures is that derivatives (see the primer on derivatives) were certainly a key if not THE contributing factor to the 2008 financial meltdown. How governments all over the world ended up incurring trillions of public debt to bail out private banks and how the world plunged into global recession and seven years of economy non-recovery should be quite familiar to most. As articulated in The derivatives time bomb, not only is the problem of bank derivatives exposure not addressed since the meltdown, it has gotten even bigger.

Now that the bank bail-in regime has either been or will soon be introduced to every banking system in the industrialized world, it is all the more important that depositors understand who owns what when it comes to your bank deposits, what happens when a bank blows up and what safeguards are put in place to ensure these banks don’t blow up.

For the defenders of the status quo practice of allowing toxic derivatives mixed in with bank depositors money in a bank’s assets, the standard argument is the usual “Don’t worry, the numbers involved are notional amounts, the net amounts are tiny and often zero”.

At face value the argument is not incorrect, and, under normal circumstances, derivatives are designed to transact and transpire as intended. Problem is, when a banking crisis flares up, the circumstances are anything but normal. In the world of derivatives where participants are exposed to long, convoluted chains of counter-parties, one’s notional exposure immediately becomes one’s net exposure when one counter-party along the entire chain fails, as amply demonstrated in 2008. Rather than regurgitating the entire failure mechanism here, readers are encouraged to check out the full explanation here.

In terms of what it means to you as a depositor, here’s a recap:

  • When you deposit money in the bank, your money becomes the asset of the bank. You become an unsecured creditor of said bank.
  • When a bank fails and their liabilities need to be settled and creditors paid, it is done according to creditor seniority. As a depositor (unsecured creditor), you are the bottom of the pile. To add insult to injury, derivative bets between financial institutions are considered super senior and they all get settled first. That’s right. Read this one more time: those institutions which are derivatives counter-party to the failed bank get to pick at the carcass first.
  • The bail-in regime would ensure that shareholders of a failed bank get wiped out first (right thing to do), bondholders get a haircut and depositor’s money gets bailed in. The if, how-much and exact order of ‘sacrifice in order to save the bank’ for each group of creditors involved would vary depending on the circumstances at the time.
  • If you think CDIC/FDIC and other deposit insurance schemes would be your savior, think again. The amounts in these insurance systems amount to a few drops in the bucket when something big blows up. As made abundantly clear in the 2008 fiasco, the entire FDIC would have vaporized in a matter of days if the government did not step in to bail out the banks. Remember, ALL of the big banks, including non-banks such as Goldman Sachs which got turned into a ‘bank’ in order to get bail-out money, would have failed in 2008.
  • If you think bank failures won’t happen in Canada because it did not in 2008, think again. Just because it did not last time does not mean that it won’t next time. Besides, until details get declassified decades down the road, us common folks will never find out what was done behind the scene between the government and the banks at the height of the last crisis. By the way, the people in Cyprus did not think a bail-in would happen to them either. Nor did the Italians. Or Austrians (check out the latest bail-in actions in Europe here).
  • The most fundamental requirement for a functioning fractional reserve banking system is the confidence that depositors feel their money is safe in the banks. The minute that confidence disappears, depositors would pull their money out and a bank-run would ensue. For that simple reason, no bank or banking regulator would ever warn the public that a bank might be in danger of failing. In other words, take it as a given that you as a depositor would be the last one to find out.

With bail-in legislation introduced and depositors now explicitly on the hook in the name of saving a failing bank, what extra measures are being put in place to reduce the risk of banks blowing up? What argument is left for not separating commercial banking activities where depositors’ money resides and is protected by deposit insurance and investment banking where the banks are engaged in high risk derivatives and other casino activities?

Bank bail-in

This article is part of the Bank bail-in in-depth topic. Get a crash course and read the latest developments on this topic.


3 thoughts on “Canadian Bank Derivatives Exposures – 2016 Q1 update

  1. tom coghill

    The amounts are missing 000, extra. The accounting in the thousands if you look at the document on the link you provided.
    SHIT —- the banks are QUADRILLIONS OF DOLLARS in exposure to derivative.
    This cannot be a mistake on a report at the highest level of government as all the accounting would be wrong.

    Tom Coghill

    • Editor Post author

      Hi Tom, thanks for the note. Yes, I realize the numbers in the documents in the link are in ‘000, and the numbers in the table take that into account. So the total notional at the bottom of the table is 32,204 billion which is 32 trillion plus change.

  2. Bob

    When paper money is eliminated and we only have electronic money then we will not be able to withdraw our money from the banks.

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