Superintendent of Financial Institutions Julie Dickson says that bringing market discipline back should be the top priority for financial sector policymakers.

Speaking to a C.D. Howe Institute lunch in Toronto Wednesday, the head of OSFI said that “the highest priority should be given to policies aimed at re-asserting market discipline in the financial services sector.”

She stressed that policymakers must dispel expectations of government support for financial institutions. “Markets need to understand there are consequences for poor decisions, and conduct themselves accordingly,” she said.

To get to that point, she suggested that reforms are needed to: provide more certainty about what will happen if there is a failure at a financial institution, particularly with respect to penalties; explore the use of contingent capital, which is lower quality capital that could convert into high quality capital before an institution could receive government support; risk proof the system by establishing central counterparties for derivatives, and increasing the monitoring of bespoke transactions; increase control of counterparty risk via capital rules; and, focus on wind-down arrangements.

Dickson also reiterated her caution about the prospect of developing effective countercyclical capital requirements. Some aspects of macro-prudential regulation are very realistic, she said, but “more challenging, and possibly less realistic at this point based on the work which has been done, is the notion of moving capital targets up and down based on macro indicators.”

She suggested that such a system “may be extremely difficult to operationalize given expected market behaviours. However, we will continue to work hard on this.”

Finally, she argued that while regulators should try to assess systemic risk, they should not try to define systemically important financial institutions. “Identifying financial institutions as systemic would increase moral hazard,” she said.

IE