The federal government’s recent proposal to increase the insurance coverage for bank deposits in Canada to $150,000 aims to protect depositors in case of a bank failure. But would the new amount be enough? Financial Post explains who is protected, why the amount is changing and how likely a bank failure might be in Canada.

What is the government proposing?

Ottawa released a consultation paper on Tuesday aiming to get feedback from “interested Canadians and stakeholders” on a range of proposals to do with deposit insurance.

Currently, the amount of money that Canadians can get back if a bank shuts down is limited to $100,000 per category of deposit, such as a chequing account, a joint deposit or a registered retirement savings plan (RRSP), per member firm. This is guaranteed by the

Canada Deposit Insurance Corp.

(CDIC), a Crown corporation established in 1967.

All large Canadian banks and many other financial institutions such as federal credit unions are insured by the CDIC, though deposit categories such as mutual funds, stocks, bonds or cryptocurrencies are not included.

The government is now considering increasing the insured limit to $150,000 and providing even higher coverage for businesses and other non-retail investors.

Why does Ottawa want to change the limit?

The paper, released by the Department of Finance, mentions a number of reasons behind the proposed increases.

For one, the last time the limit was increased was in 2005 and Ottawa wants to adjust the amount for inflation.

It also noted that Canadians’ saving patterns and changing demographics have increased the number of deposits that exceed the $100,000 limit, with fewer fully protected depositors.

Uninsured eligible deposits, or deposits that are in excess of $100,000, grew by 594 per cent from 2005 to 2024 in Canada, while insured deposits grew by 183 per cent over the same time, the paper said. The proportion of deposits that are insured as a percentage of total eligible deposits has declined from 58 per cent in 2005, to 36 per cent in 2024.

Increasing the deposits could boost confidence and potentially lower the risk of bank runs, the paper noted. It referred to the

2023 crisis

in the United States when three banks had to be shut down.

While Canada’s financial sector was not affected by the fall of the

Silicon Valley Bank

and the other lenders in the U.S. in 2023, it was a reminder that large banks could experience runs that could quickly lead to their end and highlighted the important role of the federal deposit insurance, the Department of Finance said in the paper.

What are the details?

The paper mentions five proposals. Aside from increasing the insurance limit to $150,000, it also wants to explore whether non-retail depositors such as corporations, municipalities, universities, schools or hospitals should receive a higher deposit insurance of about $500,000 per category.

The current insurance framework does not differentiate between individual depositors and non-retail depositors, but the needs of the latter group are different, the paper stated.

“Many non-retail depositors hold deposit accounts specifically for operational purposes, to fund their ongoing operations (e.g. transactional accounts to cover payroll, pay suppliers, etc.),” the paper said. “Any delay or cessation in access to the funds in these accounts could be highly disruptive.”

Mark Zelmer, a former deputy superintendent at Canada’s top banking regulatory agency,

 the Office of the Superintendent of Financial Institutions,

and currently a Fellow-In-Residence at the C.D. Howe Institute, said he is not a fan of introducing different coverages for different groups of people. It further complicates the system and makes it easier for people to “game” it.

“Let’s say somebody manages their personal savings through a Trust, as opposed to themselves. Is that trust suddenly going to be a non-retail deposit versus a retail deposit,” he said.

The paper is also proposes an insurance limit of $1 million for “temporary high balances,” for a brief period of time. The payments that fall in this category include large sums that depositors hold for a limited amount of time, such as an inheritance, an insurance payout, a divorce settlement, or the proceeds from the sale of a home. Canada’s aging population may increase the circumstances leading to temporary high balances, it said.

Ottawa has also proposed asking banks to provide its customers with “tailored information explaining the amount of insured deposits that are held” in order to strengthen depositor confidence.

“Recent financial market turbulence in the United States highlighted the impact that social media can have during a financial crisis,” the paper said. “The speed with which negative information (whether true or false) about a financial institution and deposit insurance can reach depositors is faster than ever before.”

CDIC members are currently required to provide depositors with general information about the insurance framework and about the CDIC itself. But they are not required to inform them about the actual deposit insurance coverage applicable to the funds they hold at the institution, the paper said.

The additional disclosure could “support financial stability,” the paper said.

Can increasing the deposit insurance prevent bank runs?

While the paper suggests a higher insurance coverage could mean that depositors are less likely to withdraw funds in times of stress and reduce the risk of bank runs, Zelmer “doesn’t buy it,” he said. “If somebody reads in the newspaper or on social media that there are some questions about the strength of their institution, they’re going to run,” he said. “You run first and ask questions later. We saw that with Silicon Valley Bank. They lost most of their deposit base within a day. The insured depositors ran too.”

Cristian Bravo Roman, a professor at Western University who is also the Canada Research Chair in Banking and Insurance Analytics, said funds today are more fluid and easy to to take out of a bank.

As such, increasing the deposit insurance may not prevent a bank run in a single institution, but what it can do is potentially prevent the fear from spreading to other banks, he said. If the banking system of a country is perceived safe as a result of the protections, this would avoid an “overall run” in the system.

“If a small retailer bank is having issues, people won’t run to one of the

Big Six

to get their money out thinking that the entire system is crumbling,” he said.

Increasing the coverage could help boost competitiveness in the banking sector, which is overly reliant on a few lenders, Zelmer said. If it increased the public’s confidence in smaller financial players, it may provide them with more options. The bigger players are already considered safe, he said.

But the benefit would depend upon how much premium CDIC members would have to pay.

The government would consider the fact that any increase in the scope and level of coverage could lead to additional premiums paid by CDIC members and affect the cost of financial services to consumers, the paper said.

This could decrease competitiveness, Roman said, if smaller institutions had to pay higher premiums and either charge customers more or earn less profit.

The proposal did not discuss how increasing coverage would affect the premiums banks are paying, he said.

How likely is a bank failure in Canada?

Canadian big banks follow guidelines that are stricter than their global peers when it comes to ensuring they have sufficient capital on hand, so a major bank failure is generally deemed an unlikely event. There has not been a deposit insurance payout in almost 30 years.

However, questions were raised about the deposit insurance in Canada in 2023 after the collapse of a few U.S. banks and whether a limit of up to $100,000 was enough. Some analysts urged the need to increase it back then, saying that the U.S. limit of US$250,000 was much higher.

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Amir Barnea, an associate professor of finance at HEC Montreal, for instance, said at the time that the number needed a “serious update.” He said that the number in 2023 should be 42 per cent higher just to keep up with inflation.

In 2023, the finance minister temporarily received the authority, upon the Governor in Council’s approval, to increase the deposit insurance limit, but it wasn’t used and the limit remained unchanged.

• Email: bcousins@postmedia.com