The regulatory limit on banks’ issuance of covered bonds should be boosted, argues a new report from the Toronto-based C.D. Howe Institute.

In the wake of the financial crisis, covered bonds, which are fully backed by the issuing bank and covered by mortgage assets, have emerged as an efficient funding source for the Canadian banks, the report from the not-for-profit research institute notes. However, banks are limited to issuing covered bonds that amount to just 4% of their assets.

At this point, most of the banks are well below their limits, according to the report. So far, it calculates that banks have collectively issued approximately $101.6 billion in covered bonds, compared with a total regulatory limit of $173 billion. “While only one bank is practically constrained by that limit, it will begin to bind, particularly if Canada’s policy goal remains aimed at restraining government or taxpayer support for home lending,” the report says.

Moreover, the covered bond issuance limit in Canada is “extremely low compared to other developed nations,” that have active covered bond markets, the report says, and it maintains that the rationale for the 4% limit has never been established.

Raising the limit to 6% of bank assets would result in a total $158 billion in issuance capacity, the report says, and boosting the limit to 8% would supply $244.5 billion in capacity.

The report allows that there is a downside to boosting the limit. If a bank fails, the mortgage assets that are pledged to the covered bonds would be excluded from the bankruptcy. This would raise the risks to the Canada Deposit Insurance Corp. (CDIC), which would likely have to raise premiums in response. Moreover, the bonds would be excluded from the “bail in” regime that is currently in the process of being adopted.

Ultimately, raising the limit would impose costs on depositors that don’t necessarily benefit from the gains in lending and borrowing activity that would be gained by raising the limit. To address that concern, the report recommends shifting the basis for CDIC’s assessments from deposits to consolidated assets less tangible equity.

“A shift to assets as opposed to deposits, as the deposit insurance assessment base, would favour those institutions that are less leveraged, or otherwise have a lower asset-to-deposit ratio, rather than larger and more complex institutions, whose borrowing and lending activities are large relative to their deposit-taking activities. The mechanism would make deposit insurance less a tax on consumers who make deposits, and more a tax on size, leverage, or bank complexity,” the report says.