Canada's Carney urges system-wide view on reform

Date: Tuesday, March 31, 2009
Author: Scott Haggett, Reuters.com

The G20 meeting in London this week should take an approach to financial regulation reform that looks at the system as a whole and the interaction between banks and markets, Bank of Canada Governor Mark Carney said on Monday.

In a speech in Edmonton, Carney said global policymakers seeking to prevent financial crises should extend regulation to all financial activities that can pose a systemic risk.

"We are stressing the need for a macroprudential (i.e., comprehensive and system-wide) approach that takes into account the importance of banks, markets, and the interactions between them," Carney said.

"This will include pools of capital of material size, leverage and maturity mismatches," he said.

The speech disappointed markets looking for clues about the central bank's next monetary policy move, whether it be another interest rate cut or a foray into asset purchases.

Carney, who has another speech scheduled for Wednesday, sidestepped the subject entirely.

The bank has cut rates to a record low of 0.5 percent and has said it will lay out its options for "credit and quantitative easing" in a report on April 23, two days after its next rate decision.

The central bank governor also said he sees no change "for the foreseeable future" to the current system in which the U.S. dollar functions as the world's reserve currency.

He was responding to a question about China's proposal to replace the dollar as the main global currency with a unit used by the International Monetary Fund called the SDR, which is a basket of major currencies.

SHADOW BANKING

As G20 leaders head to London on Thursday to discuss how to fix the financial crisis and lay down rules to prevent repeats in the future, Carney focused his remarks on the role banks should play in financial markets after the crisis passes.

He said the "shadow banking system" - comprised of investment banks, finance companies, mortgage brokers and others -- has moved faster than the regulated banking sector to reduce assets and raise capital in response to the crisis.

"We estimate that to bring leverage ratios down to Canadian levels by raising capital alone, global banks would need more than US$1 trillion in new capital, before any additional writedowns on assets," he said.

Carney warned against what he called financial protectionism, the result of large global banks and hedge funds cutting back their international activities due to the crisis as well as bailouts. He said this trend, if unchecked, could be a setback for the global economy and permanently impair cross-border capital flows.

It is unlikely cross-border financial flows will return to pre-crisis levels after the current crisis passes, he said.

At the same time, Carney warned against overreacting to bank failures by forcing traditional banks to return to their traditional functions of mere deposit-taking and lending and away from interdependence with broader financial markets.

This would be impractical because banks have become major market players and financiers of global trade.

"A better approach is the plan by the G20 to expand the perimeter of regulation" to include nonbank players, he said.

In the short term, extraordinary liquidity provided by central banks has helped keep markets functioning, but it is not enough in the long term. Countries must take a series of measures to improve market infrastructure and other fundamental reforms, he said.

(Reporting by Scott Haggett; writing by Louise Egan; editing by Peter Galloway and Jeffrey Hodgson)