Superintendent of Financial Institutions Julie Dickson defended OSFI’s role in the credit crisis, and suggests that the episode gives rise to several big picture issues for regulators to ponder.

In a speech to the Financial Services Institute in Toronto today, Dickson said that the authorities need to look at the key factors that lead to financial stability, and whether regulators, accounting standard setters or central banks do anything that contributes to instability.

“For example, we need to determine whether capital rules are pro-cyclical — amplifying distortions by fuelling aggressive lending on the way up and generating severe pullbacks from credit granting on the way down. We also need to know whether pro-cyclicality is related more to badly managed banks with insufficient capital cushions than to the capital rules themselves — as there is nothing more pro-cyclical than a badly managed bank,” she says.

Regulators also need to work with accounting standard setters to determine whether fair value accounting rules are pro-cyclical, she says. It must also be determined whether accounting rules for loan loss provisions are pro-cyclical by preventing banks from building up reserves in good times, or whether they are neutral, she notes.

She also asked whether the public expects regulators or central bankers to be better at predicting the future than other market participants. “Up to this point, regulators have understood the limitations associated with predicting the future direction of the financial markets, so they have focused on cushions for the unexpected – and the more focused regulators were on cushions, the better off their banking systems were,” she says.

“I think we can never take our eyes off the cushions, but we can always try to do a better job of anticipating the future direction of the financial markets. However, I do not think we can kid ourselves about the difficulty in doing the latter ─ each time there is a bubble, there are always fascinating debates and questions about whether the exuberance reflects a new paradigm based on changed fundamentals, or irrational behaviour,” she says.

Other issues that must be addressed include oversight of the financial system, such as the infrastructure that underpins the decentralized over-the-counter markets; whether private pools of capital such as hedge funds should be regulated, and if so, who should do it and how.

None of these questions have complete answers, Dickson says, “but they are being asked by OSFI and by everyone who is closely involved in the regulation of banks in particular. One positive outcome of financial market turmoil has been the move to debate some very large issues and to reflect on what we do and why. Such dialogue moves everyone forward and I continue to encourage it.”