Canada’s chief federal banking and insurance regulator suggests that Canadian banks shouldn’t be considered systemically important to the global financial system.

Speaking to the Montreal Chapter of Chartered Financial Analysts on Wednesday, Julie Dickson, Superintendent of Financial Institutions, said that, notwithstanding recent agreements to boost bank capital levels, among other changes, the regulatory reform process is not over.

For example, the Financial Stability Board is planning to recommend a policy framework for addressing systemically important financial institutions, which would likely require such banks to have a greater ability to absorb losses.

It’s not entirely clear what higher loss absorbency means, Dickson said, “but they do make clear that the primary target are those institutions that are of such importance to global financial intermediation that their failure can create shock waves that could disrupt the entire global financial system. It is not apparent that Canadian banks currently fit the bill.”

However, she cautioned that it remains to be seen whether the FSB recommends similar treatment for institutions that are considered systemically important to a national financial system. “My position has been that it is not wise to publicly declare certain institutions as systemically important. It is beneficial to focus on ways to give governments options for dealing with failing institutions, beyond bailing them out at taxpayer expense,” she said; adding that Canadian authorities have been focusing on living wills, bridge banks, contingent capital, and risk-proofed central clearing systems and central counterparties for derivatives markets.

To prevent failures in the first place, Dickson stressed that disclosure and market discipline are extremely important, and she said efforts must be made to strengthen these areas. Market discipline also requires proper incentives, she noted.

To that end, regulators are looking at contingent capital as a vehicle for increasing market discipline, and more disclosure by banks may be needed for contingent capital to be widely accepted, she said. Also, the FSB has begun a peer review of risk disclosures by banks. “These initiatives to increase market discipline and disclosure make sense, and in my view deserve more profile,” she said.

So far, much of the world’s attention has been focused on the effort to boost capital levels. While capital is extremely important, Dickson cautioned that “it is not a panacea”.

“An institution will never have enough capital if there are material flaws in its risk management processes,” she said. “We cannot be lulled into a false sense of security because of some of the significant changes we are making to capital under the recently announced Basel III capital rules. Capital is an important building block, but it is only one of many.”

Moreover, the problem with many reform efforts, Dickson said, is a lack of follow through. “While we have devoted a lot of time and energy to finding solutions to the crisis, many of the proposals that are being discussed really amount to doing what we said we would do many years ago. The material we are writing today about the importance of things like risk management, governance, and quality supervision is really no different than what was written many years ago,” she said.

“Sometimes we think we have broken new ground when we describe these things and what we feel needs to be done, but then we see that it has all been written before. We all know these issues are important, but for some reason, the follow-through is weak; we do not get around to implementing what we know to be important,” she added.

This tendency to fail to implement reforms can be addressed by close oversight and peer reviews, she suggested, “These initiatives make it more difficult for various players to not implement the things we say are important.”

She also suggested that regulators should focus on compensation, as it can drive behaviour; that industry and regulators employ financial historians to help avoid firms from repeating history; and that they undertake anything that sharpens incentives and the ability for the market to monitor financial institutions.

“There is no silver bullet to achieving a safe and sound financial sector. Rather, it is multi-dimensional – all parties that touch the sector have a role – bank management and boards, regulators and supervisors, governments, central banks, markets (investors, analyst and rating agencies), and auditors. Emphasis cannot be placed on one area to the exclusion of others,” she concluded. “In an effort to save us all from ourselves, policies aimed at our own weaknesses and biases may be the most important of all.”

IE