Canadian banks have been considered mostly risk-free for a long time, but every streak ends. A former Canadian banking regulator urges the country’s policymakers to prepare for that day while it still can. In a new report from CD Howe, a former OSFI manager urges the country to modernize its banking crisis response and adopt more prudent measures. Failing to do so can result in a major hit to the country’s financial stability, resulting in a wide range of issues from bank runs to an outright collapse of financial institutions. As unlikely as this sounds, it comes after the recent wave of global financial institutions that were believed to be invincible, collapsed over a few months. Policymakers were left claiming no one saw it coming, but were they even looking?
Canadian Banks Have A Strong Track Record, But Risk Happens Fast
The Canadian banking system has a well-deserved reputation of one of the most resilient in the world. Unfortunately, in the past few years, a number of storied global financial institutions have suddenly collapsed in a matter of weeks. One example cited in the report is last year’s wave of medium-sized regional financial institutions across the US collapsing, such as Silicon Valley Bank. Another is the more shocking failure of Credit Suisse last year, resulting in the Swiss government brokering a merger of the firm (and its CHF 1.3 trillion in assets under management) with UBS. It can never happen until it does. As they say in finance, risk happens fast.
“While Canada has not had any serious failures in many years, it would be best to prepare for possible problems now when things are quiet, rather than in the heat of the moment,” writes Mark Zelmer, a senior fellow at C.D. Howe who formerly served as the deputy superintendent at OSFI, Canada’s bank regulator.
Canadian banks may not present any blaring issues, but that doesn’t mean they’re non-existent. As the global banking trade becomes more interconnected, an issue need not even originate within the country to have an impact. The risk vulnerability stemming from a lack of prudence in another country has never been higher. Make hay when the sun shines, right?
“There are some emerging trends that suggest our current prudential regulatory framework’s focus on preventing bank failures may not be sustainable going forward,” explains Zelmer.
Adding, “If indeed our prudential regulatory framework cannot be sustained in the future, one must ask what preventative steps can be taken to manage the systemic risks posed by bank runs, and facilitate an orderly resolution or exit of a deposit-taking institution that is no longer viable before it fails– all without calling on the public purse.”
Canadian Banks Need to Modernize Consumer Protections & Lower Taxpayer Risks While They Can
The best and worst aspect of a strong regulatory framework is there are no gaping holes. The report notes there’s no perfect solution and all need to be balanced with a proper risk-reward assessment for the institutions and the public. Overly burdensome reporting requirements can consume excessive resources, resulting in a narrow focus and more noise. That can leave consumers with higher banking costs, and little to no improvements. Failing to hit the right balance can ultimately result in a higher cost to taxpayers, either through a direct or indirect bailout.
The report has four key suggestions that range from the mundane to complete monetary reform. At one extreme, they even suggest separating money creation from credit extension at financial institutions. As unlikely as the last suggestion is, it’s still made since it would lead to a more resilient financial system.
Regardless of whether the appetite exists for any of those solutions, that’s not the whole focus. Instead, Zelmer focuses on a handful of solutions that can be adopted now, but with a relatively low level of resistance.
Canadians Need Stronger Protections From Bank Runs
The highest impact change suggested involves modernizing the federal deposit insurance scheme. The member-funded CDIC ensures prompt reimbursement of insured deposits in case of a bank failure. Since it was formed in the late 60s, it has only overseen 43 failures, and the last was in 1996. No insured funds have ever been lost. Most take that as a positive sign, but it also means the system hasn’t been tested in nearly a quarter of a century.
Zelmer suggests this has resulted in the CDIC failing to evolve compared to its global peers. An example would be the current limit is just CA$100k per account. The US equivalent (the FDIC) has an insured cap of US$250k (CA$344k) per account. At a straight conversion, that’s 150% larger than the CDIC limits and 240% larger using today’s exchange rate.
Reimbursement acceleration is also of concern. The CDIC currently aims for reimbursement within 3 business days, but once again, they haven’t been tested recently. This also factors into another one of their suggestions—regulators need to plan for the potential failure of multiple institutions simultaneously.
Like most countries with robust financial systems, Canada first attempts market solutions. More bluntly, they try to merge the failing institution into a stronger, larger one—often with incentives for that institution. Zelmer warns this is a less-than-ideal solution if more than one bank failure occurs simultaneously. The relatively concentrated size of Canada’s banking industry makes it much harder not to see a spillover effect.
The report also notes that the Bank of Canada (BoC) could play an earlier role in crisis intervention. Zelmer believes banks hesitate to use the BoC’s emergency liquidity facilities since they signal stress to the market. He would like to see modifications to the liquidity facilities and reclassify some of the instruments. That would encourage banks to seek use earlier, reducing the sudden use of emergency liquidity.
Is Canada Early Or Too Late For Stronger Bank Regulations?
Beyond the global banking issues, there are some early signs of financial stress in the system. The BoC recently made a significant increase to its short-term liquidity facilities. It also reclassified certain types of debts, increasing the available leverage. The central bank claims this is routine, but the sudden change over just a few days suggests otherwise. Plus at least one bank went on record to explain there were liquidity issues.
The regulatory side has also experienced a substantial change in direction. OSFI’s new leadership came in roaring, suggesting aggressive risk reduction while lenders were strong. After industry and policy consultations, that tone recently changed. They even recently delayed Canada’s adoption of global risk standards. One of the impacts of those standards would have been the reclassification of investor mortgages as higher-risk assets. That conflicts with the current policy agenda of the state absorbing more investor risk to help preserve home prices.
Just those two moves are substantial shifts. Especially considering everything is fine.
English (US) · 