Although Canada weathered the recent financial crisis relatively well compared with other countries such as the United States, another similar crisis could seriously damage the country’s financial institutions and economy as a whole.
A University of Calgary School of Public Policy study published March 13 found that regulators have not addressed key issues that affect banks, credit unions, trust and mortgage companies and money mutual funds, leaving them vulnerable should another global crisis hit.
So far, the study argues, many policies in that are in place are reactive rather than preventative, and this needs to change.
“Canadian regulators are part of a class of international regulators who jointly develop initiatives to maintain stability of financial systems,” said study author John E. Chant, retired professor in the department of economics at Simon Fraser University.
“The class, as a whole, has spent too much attention on how to pick up the pieces of financial failures and not enough on how to prevent this breakage in the first place.”
The problem, said the study, is that the financial sector in Canada has a few large banks that could be argued to be “too big to fail.” But because of the size of these institutions, some of which have assets worth up to 50% of gross domestic product, if they did fail it could devastate the economy.
Chant said there are two ways of mitigating these risks.
The first way is to find a way to allow financial institutions to “fail safely,” which would involve developing procedures that would wind them up without costs to the government or taxpayer.
“Part of the procedure for winding them up is to make large financial institutions develop so-called “living wills;’ in other words they go and examine their business and suggest ways in which they could be would out,” Chant told Business in Vancouver, explaining that there are problems inherent in this alternative.
“If it does go bad, are you really sure that you want to adopt the plans of that management that managed to make it go bad?”
The second way would be to make sure the financial institutions are too safe to fail in the first place.
“That would require the bank’s capital as sort of a buffer between the size of its liabilities and the size of its assets,” Chant said. “If the buffer is too thin, when the bank fails there is not enough there to satisfy all the creditors, and that may lead to the problem of a bailout.
“The alternative then is to make sure that buffer is big enough so that it would take really extraordinary circumstances for the bank to fail.”
Chant said there are currently regulations for this in place, but they need to be tightened.
“To be fair to Canadian regulators, they have moved to make their requirements higher than the international standards and in addition to capital requirements, they also were among the few regulatory authorities to set leverage ratios,” he said.
A copy of the study can be found here.
