Toronto: Canadian banks, facing higher capital requirements to meet new global standards, may soon be allowed to tap investments from global sovereign wealth funds under a proposal in this year's budget.

Public-sector investment pools, in Canada and abroad, would be allowed to buy shares in Canadian banks for the first time if the plan is approved.

"Permitting these pools of capital to invest in Canadian financial institutions provides these institutions access to new sources of stable long-term investment, which promotes financial stability," according to the budget document released in Ottawa.

The funds would have to meet certain criteria, including pursuing commercial objectives, to invest directly in shares of lenders such as Royal Bank of Canada. Some Canadian investment pools, including the Ontario Teachers' Pension Plan, already have exemptions that allow them to buy bank shares.

Canadian banks need to boost their capital base to meet requirements under the Basel III capital rules for global lenders.

International context

The change "looks at Canada in an international context," said Craig Wright, chief economist at Royal Bank, the country's biggest lender. "It's not going to be in large numbers but moving forward it's about competitive access to capital."

Banks in Canada face potentially higher costs of capital under planned changes to rules governing the sale of covered bonds, which are debt backed by mortgages.

Most covered bonds issued in Canada are secured by mortgages insured by Canada Mortgage & Housing Corp, a federal agency. A government consultation paper in May 2011 sought input on whether the law should encourage banks to secure covered bonds with uninsured mortgages.

The government is "moving forward" with a legislative framework for covered bonds, according to Thursday's budget. The document made no reference to uninsured mortgages.

"I expected to see more detail," said Avery Shenfeld, chief economist at CIBC World Markets. "Obviously it's still a work in progress. It doesn't have to be in the budget. It's a bit of a surprise because I was looking for a whole addendum on it."

CMHC will administer the covered bond programme once the rules are in place, according to the budget, which also said the programme will be available to any federally or provincially regulated mortgage lender.

"A legislative framework will support financial stability by helping lenders find new sources of funding and by making the market for Canadian covered bonds more robust," the budget said.

The government also reiterated it plans to strengthen the oversight and governance of CMHC.

Covered bonds are rising on speculation the government would stifle issuance by making it more expensive to raise mortgage-backed bonds, helping to keep an overheated housing market from threatening the economy.

Covered bonds issued in US dollars by Canadian banks have returned 1.8 per cent this year, compared with a 0.7 per cent gain for securitised debt overall, according to Bank of America Merrill Lynch index data.

Consumers are taking on record debt as condominiums proliferate in Toronto and Vancouver, pressuring lawmakers to prevent a potential housing bubble. By barring banks from securing covered bonds with government-insured loans, the government would raise costs to covered bonds because issuers would need to pledge more collateral to gain AAA ratings.

Canadian banks increased issuance of covered bonds this year before Thursday's fiscal plan. The lenders sold $12.6 billion (Dh46.2 billion) in covered bonds since December, compared with $6.6 billion in the same period a year earlier, according to data compiled by Bloomberg.