Canadian banks have been considered mostly risk-free for a long time, but every streak ends. A former Canadian banking regulator urges the country’s policymakers to prepare for that day while it still can. In a new report from CD Howe, a former OSFI manager urges the country to modernize its banking crisis response and adopt more prudent measures. Failing to do so can result in a major hit to the country’s financial stability, resulting in a wide range of issues from bank runs to an outright collapse of financial institutions. As unlikely as this sounds, it comes after the recent wave of global financial institutions that were believed to be invincible, collapsed over a few months. Policymakers were left claiming no one saw it coming, but were they even looking?
Canadian Banks Have A Strong Track Record, But Risk Happens Fast
The Canadian banking system has a well-deserved reputation of one of the most resilient in the world. Unfortunately, in the past few years, a number of storied global financial institutions have suddenly collapsed in a matter of weeks. One example cited in the report is last year’s wave of medium-sized regional financial institutions across the US collapsing, such as Silicon Valley Bank. Another is the more shocking failure of Credit Suisse last year, resulting in the Swiss government brokering a merger of the firm (and its CHF 1.3 trillion in assets under management) with UBS. It can never happen until it does. As they say in finance, risk happens fast.
“While Canada has not had any serious failures in many years, it would be best to prepare for possible problems now when things are quiet, rather than in the heat of the moment,” writes Mark Zelmer, a senior fellow at C.D. Howe who formerly served as the deputy superintendent at OSFI, Canada’s bank regulator.
Canadian banks may not present any blaring issues, but that doesn’t mean they’re non-existent. As the global banking trade becomes more interconnected, an issue need not even originate within the country to have an impact. The risk vulnerability stemming from a lack of prudence in another country has never been higher. Make hay when the sun shines, right?
“There are some emerging trends that suggest our current prudential regulatory framework’s focus on preventing bank failures may not be sustainable going forward,” explains Zelmer.
Adding, “If indeed our prudential regulatory framework cannot be sustained in the future, one must ask what preventative steps can be taken to manage the systemic risks posed by bank runs, and facilitate an orderly resolution or exit of a deposit-taking institution that is no longer viable before it fails– all without calling on the public purse.”
Canadian Banks Need to Modernize Consumer Protections & Lower Taxpayer Risks While They Can
The best and worst aspect of a strong regulatory framework is there are no gaping holes. The report notes there’s no perfect solution and all need to be balanced with a proper risk-reward assessment for the institutions and the public. Overly burdensome reporting requirements can consume excessive resources, resulting in a narrow focus and more noise. That can leave consumers with higher banking costs, and little to no improvements. Failing to hit the right balance can ultimately result in a higher cost to taxpayers, either through a direct or indirect bailout.
The report has four key suggestions that range from the mundane to complete monetary reform. At one extreme, they even suggest separating money creation from credit extension at financial institutions. As unlikely as the last suggestion is, it’s still made since it would lead to a more resilient financial system.
Regardless of whether the appetite exists for any of those solutions, that’s not the whole focus. Instead, Zelmer focuses on a handful of solutions that can be adopted now, but with a relatively low level of resistance.
Canadians Need Stronger Protections From Bank Runs
The highest impact change suggested involves modernizing the federal deposit insurance scheme. The member-funded CDIC ensures prompt reimbursement of insured deposits in case of a bank failure. Since it was formed in the late 60s, it has only overseen 43 failures, and the last was in 1996. No insured funds have ever been lost. Most take that as a positive sign, but it also means the system hasn’t been tested in nearly a quarter of a century.
Zelmer suggests this has resulted in the CDIC failing to evolve compared to its global peers. An example would be the current limit is just CA$100k per account. The US equivalent (the FDIC) has an insured cap of US$250k (CA$344k) per account. At a straight conversion, that’s 150% larger than the CDIC limits and 240% larger using today’s exchange rate.
Reimbursement acceleration is also of concern. The CDIC currently aims for reimbursement within 3 business days, but once again, they haven’t been tested recently. This also factors into another one of their suggestions—regulators need to plan for the potential failure of multiple institutions simultaneously.
Like most countries with robust financial systems, Canada first attempts market solutions. More bluntly, they try to merge the failing institution into a stronger, larger one—often with incentives for that institution. Zelmer warns this is a less-than-ideal solution if more than one bank failure occurs simultaneously. The relatively concentrated size of Canada’s banking industry makes it much harder not to see a spillover effect.
The report also notes that the Bank of Canada (BoC) could play an earlier role in crisis intervention. Zelmer believes banks hesitate to use the BoC’s emergency liquidity facilities since they signal stress to the market. He would like to see modifications to the liquidity facilities and reclassify some of the instruments. That would encourage banks to seek use earlier, reducing the sudden use of emergency liquidity.
Is Canada Early Or Too Late For Stronger Bank Regulations?
Beyond the global banking issues, there are some early signs of financial stress in the system. The BoC recently made a significant increase to its short-term liquidity facilities. It also reclassified certain types of debts, increasing the available leverage. The central bank claims this is routine, but the sudden change over just a few days suggests otherwise. Plus at least one bank went on record to explain there were liquidity issues.
The regulatory side has also experienced a substantial change in direction. OSFI’s new leadership came in roaring, suggesting aggressive risk reduction while lenders were strong. After industry and policy consultations, that tone recently changed. They even recently delayed Canada’s adoption of global risk standards. One of the impacts of those standards would have been the reclassification of investor mortgages as higher-risk assets. That conflicts with the current policy agenda of the state absorbing more investor risk to help preserve home prices.
Just those two moves are substantial shifts. Especially considering everything is fine.
Canada will redefine bailout. It’ll be “investments in the prosperity of middle class banks”
You just, but a few years ago TD scrapped an ad campaign intended to show average Canadians that its story and struggles were somehow similar to ours. It got embarrassingly far before the tone deaf nature of the ad was called out.
Banks can fail just as any household can fail, as Banks depend and do business with households. The only difference is they have the government, the people,. bailing them out. The financial crisis in the states is a perfect example.
If we look at the Canadian population and their debt, income, inflation, interest rate, net equity , housing crisis,
unemployment and employment rate, population inequality, population increase, etc. The bottom 40% of the population is going to fail. It is just a matter of time. So much is against them, they are just fighting to survive. And it will affect all of us, and in turn the banks. No one is exemp from this. The costs will be spread to all of us. The government will save but we will all pay.
A bank can fail. Wake up and smell the coffee.
Surely you’re not dumb enough to believe that a bank can actually crash?
Did we read the same article? Not at all what he said and they’re covering the former OSFI deputy super.
Not that Stephen needs someone to defend him, but he’s said something to the effect of “they’ll grind you up and sell you for liquidity funding before we let a bank fail.”
When a bank fails, it doesn’t fail. You get a bill.
Or they could get off the DEI bandwagon and start being banks again…
Did I just read a subtle hint about HSBC or did I read too much into that line?
Anyway, great piece as usual.
Now we talk about what can be done aboit policies for banks ,CIDC and so on, but nothing is talk about what the account holders can do to protect their money???
Do Banks follow any rules? TD Bank isn’t the only financial institution that has been caught laundering money.
TD Bank Pleads Guilty in Money-Laundering Case Will Pay $3B Settlement Oct 10, 2024
https://www.newsweek.com/td-bank-pleads-guilty-money-laundering-settlement-1967328
I would surmise that clients and depositors at the Bank are paying the money-laundering fine over time.
Then there is the Criminal Code: The offence of money laundering is defined in section 462.31 of the Criminal Code.
The current wording of the offence states that EVERYONE who commits an offence who:
Uses, transfers, sends, delivers, transports, transmits, alters, disposes of or otherwise deals with any property or proceeds
With intent to conceal or convert that property or proceeds
Knowing, believing, or being reckless as to whether the property/proceeds were obtained from a designated offence in Canada or an equivalent act abroad
The offense was amended in 2019 to add “being reckless” as an alternative mental element, expanding the scope of the offense.
Penalties:
If prosecuted by indictment: Up to 10 years imprisonment
If prosecuted by summary conviction: Up to 2 years less a day imprisonment and/or $5,000 fine
There is an increased penalty of up to 14 years imprisonment if the offence is committed for the benefit of, at the direction of, or in association with a criminal organization.
Peace officers acting in the course of their duties are exempt from the offence.
The offence is part of Part XII.2 of the Criminal Code dealing with “Proceeds of Crime”.
It is a hybrid offence, allowing the Crown to elect to proceed by indictment or summary conviction.
There are no mandatory minimum penalties for this offence.
IT DOES NOT TAKE MUCH FOR PEOPLE AND BANKS TO LOSE IT ALL.
MORTGAGE DEBTS, CREDIT CARD DEBTS LINE OF CREDIT CARD DEBTS MULTIPLIED BY TENS OF MILLIONS OF PEOPLE WILL DEFINITELY HAPPEN. STAND BACK AND WATCH THEM ALL GO UNDER.
I am heavily invested in Canadian banks. With all the restrictions on their behaviour, stress-tests on loans, etc it is unlikely that any of these banks will crash, even if they engage in stupid behaviour as TD has, very recently. Life insurance companies in Canada may do better than banks, but the five big ones are truly too big to fail. Recent bank failures in the US and Switzerland are due to management stupidity at a major scale, impossible here.
Our banking system is solid and liquidity has been built in and maintained through CETI ratio standards. ALL canadian banks exceed government requirements and some to a significant degree. I for one sleep well at night except when I think of TD bank being fined $3 billion u.s. for their money laundering practices which they have admitted. To me, this is absolutely criminal and all staff involved should be disciplined / incarcerated AND increased liquidity requirements should be imposed
So I should take it all out and keep in a sock. Cannot bury it as cannot afford a house with backyard. Probably should just get my pre paid cremation done ..Don’t want to leave it to kids as they never visit..
The key problem, as noted above, is there are no signs of a bank failure, until there is one. The other key problem is that extension of credit = money creation in Canada. Basically our monetary system is a for profit Ponzi scheme where private banks create all of our money based on gdp or fictitious valuations of properties. Now this would be sort of Ok (not really, since banks effectively fund all credit by creating new money backed by the bank of Canada and you and me. However, when we see housing prices rise by 100% during a period where gdp and gdp per capita were decreasing, that means effectively our banks created 2.4 to,es as much money based on the same or less income to pay the interest on it?
This is a picture of a central bank and federal govt who are at best, asleep at the wheel, and at worst, complicit in this fraud. If you had any doubts, Canada’s only bank with major us operations was caught as the usa’s biggest money laundering bank, nation a $3B fine, and restrictions on credit expansion in the USA? So if td is the worst money laundering bank in the USA with 2% market share, how is it that we think that isn’t happening here?
The reality is that in Canada the big banks dictate policies like mortgage and credit regulation, immigration, etc. it’s very unlikely that any such action in Canada. So if our banks are involved in money laundering, how safe are they?
Secondly, the current mess in housing, cost of living is a direct result of govt prioritizing bank profits over wages and financial stability for the country.