Following the financial crisis of 2008, harsher regulations governing financial institutions were implemented to mitigate future economic recessions. As discussed in an article by the Canadian Bankers Association, new financial regulations, such as Basel III, have targeted capital and liquidity because both affect a bank’s ability to “cushion the blow” of any losses and maintain its ability to meet its financial responsibilities. The international regulation, Basel III, is comprised of capital and liquidity rules, which were implemented in Canada in 2013 and 2015 respectively.
Basel III capital rules
The Basel III capital rules were introduced in Canada by national regulators as the Capital Adequacy Requirements (CAR) Guideline. This Guideline requires banks to have an amount of capital that is at least 10.5% of their “risk-weighted assets” before 2019. Also, since January 1, 2016, greater requirements have been placed on the six largest Canadian banks in Canada. These banks now must retain one extra percent of capital, will be monitored more regularly than other banks and have even more reporting obligations.
Another guideline is the Leverage Requirements Guideline, which requires banks to have a leverage ratio that is equal to or greater than 3 %.
Basel III liquidity rules
Stemming from the Basel III liquidity rules, banks are required to comply with the following:
- the Liquidity Coverage Ratio, which has a 30-day time horizon and will be introduced from 2015 to 2018; and
- the Net Stable Funding Ratio, which has a one-year time horizon and will be in effect sometime before 2018.
Effects of rules on the escrow landscape
Now that banks need to report more regularly on their progress in complying with these rules and are required to retain more of their capital, certain effects on the escrow landscape have been noted by SRS Acquiom:
- Greater transparency of financial institutions’ abilities to weather adverse economic conditions, which allows M&A parties to consider different options more carefully.
- Some financial institutions are shifting the extra costs associated with keeping short-term deposits onto consumers through lower yields.
- Banks are eliminating or modifying certain deposit products as the costs of offering them have increased. This means that there will be fewer escrow products out there for customers, making it more difficult to arrange escrows if the existing products do not align with their needs.
- Certain banks in the United States have already begun to warn their biggest customers that depositing large amounts of money will now come with an extra cost. Financial institutions are even recommending that these customers go elsewhere to avoid the new expense of making these types of deposits.
As a result of these effects, M&A parties will likely have to be much more cautious when considering escrow management and the different escrow options available.
The author would like to thank Monica Wong, summer student, for her assistance in preparing this legal update.
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