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The Bank Act Review is Coming… No Hard Questions, Please

One nice thing about Canada’s financial regulatory architecture is the provision that the bank act must be reviewed every 5 years.  This gives us all a time to take stock of the direction that bank regulation is heading.

 

This is the year we are due for the Bank Act review. After a couple of years of financial crisis, it might seem a propitious time to check in with Canadian banking regulation.  The spectre of what is going on for European banks, not to mention the fancy footwork of Canada and other jurisdictions during the fall of 2008, might create the impression that a little regulatory soul-searching is a good thing.  

 

It seems that this time around, the Bank Act review will be anything BUT a critical exercise.  The Harper government seems so persuaded of the merits of Canadian banking system – and its smarts at handling the financial crisis – that it deems a vigorous Bank Act review process is unnecessary.

 

Indeed, Ottawa whispers that the government is not willing to entertain any debate about policy issues during this review of the Bank Act. Scuttlebutt is that only “narrow technical” issues are being considered.

 

Today in Rabble I discussed the moral hazard issue that looms following the 2008 manoeuvres that supported banking systems – here and elsewhere- to prevent contagion.  The G20 has mostly punted on the question of Systemically Important Financial Institutions (SIFIs), so it really is up to domestic authorities to handle the moral hazard issues emanating from the too big to fail problem. 

 

Domestic authorities have shown themselves quite willing to rush to the support of the banking sector during a crisis, in many cases regardless of the letter of the law.  Canada’s use of CMHC to purchase up to $125 billion in CMHC-insured mortgage pools illustrates this policy innovation on the fly to support banks in wholesale funding markets.  The moral hazard implied by these precedents from both here and abroad will not be handled by new Basel standards.  Even though Canada was not obliged to intervene as forcefully as government’s elsewhere, little mystery remains about the government’s probable course of action during a future financial crisis.

 

Rather that crowing about performance of Canada’s banking sector over the last couple of years, perhaps the government might want to consider why Canada was spared some of the hocus pocus that went on elsewhere. Are Canadian regulators that much smarter than their counterparts abroad?  Are Canadian banks just inherently more prudent?

 

I argue that there were some very peculiar circumstance prior to 2008– especially the prohibition of bank mergers – that contributed a situation in which Canadian banking overseers were in a better position to credibly threaten Canadian banks with unattractive consequences should they misbehave.  This situation both emboldened regulators, and subdued the more adventurous tendencies of banks.  

 

Today, the precedent set by the obvious willingness of the government to do whatever is necessary to support banks in a crisis is a game changer.  “Constructive ambiguity” (the uncertainty concerning how  the central bank will respond to a potential bank failure) is deeply undermined by recent events.  

 

The Harper government should contemplate how this new banking landscape may both contribute to incentives for banks to behave less prudently, and how the government might enhance the so-called “constructive ambiguity” which serves to keep banks cautious.  A Banking Act review might be the forum in which this sort of critical debate could occur.  It is ironic, and potentially tragic, that Harper’s complacency about the stability of Canada’s banks only masks the possibility that the Canadian regulatory landscape is losing the very qualities that made it resilient in the past.

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Comment from Numeru
Time: July 3, 2011, 12:37 pm

Financial news and learning

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