Source: The Canadian Press

Bank of Canada governor Mark Carney is backing proposed new international rules that would make banks and their shareholders and creditors — not governments — pay the cost of any future financial crisis like the Wall Street money crunch that triggered the recent recession.

Carney said Tuesday the bailout of many big banks around the world created a moral hazard, that if left unchecked will distort behaviour and inflate costs.

Speaking to the International Centre for Monetary and Banking Studies in Geneva, the central bank governor called for steps to be taken to build the infrastructure needed to help it from happening again.

“A series of concerted measures will be required to build resilient, continuously open funding and derivatives markets and to restore market discipline to financial institutions,” Carney said.

“There is a firm conviction among policy-makers that losses incurred in future crises must be borne by the institutions themselves,” he said in his speech, which was released in advance in Ottawa.

“That means management, shareholders and creditors, rather than taxpayers.”

The United States, Britain, Germany and other governments poured hundreds of billions of dollars into their banks to save them from collapse after they suffered huge losses because of risky loans, and investing in high-risk derivatives, a financial product tied to the U.S. housing market.

He said Canada’s central bank was working with its partners to establish the mechanisms to help maintain liquidity in the financial markets in times of crisis.

“Current G20 efforts to transfer standardized OTC derivatives to clearing houses have great potential to reduce contagion from counterparty risk and to improve the transparency, pricing and management of risk,” Carney said.

The central bank governor also pointed to a plan that would see financial institutions embed “contingent capital” into unsecured debt and preferred shares that could convert into shares if the institution was in trouble as a promising market-based mechanism to prevent excessive risk taking.

“Its presence would also disciple management, since common shareholders would be incented to act prudently to avoid having their stakes diluted by conversion.”

Canada and its banks fared better than many of its G7 counterparts through a combination of a well-regulated mortgage market, less leverage and a bit of good fortune.

But Carney said Canadians shouldn’t be complacent.

He said the first line of defence will be investors, management and boards of directors.

“We would all be advised to remember that pride goes before the fall.”