Canadian banks at risk should financial crisis hit again

Canada escaped the last great financial crisis relatively unscathed – at least compared to other major economies like the U.S. However, a report published today by The School of Public Policy heeds the warning that the next crisis could cause serious damage to the country’s financial sector and overall economy because regulators have not addressed some key areas.

“Canadian regulators are part of a class of international regulators who jointly develop initiatives to maintain stability of financial systems,” Chant writes. “The class, as a whole, has spent too much attention on how to pick up the pieces of financial failures and not enough on how to prevent this breakage in the first place.”

One potential hazard that Chant identifies is the overall size of Canadian banks and the risk that carries.

“The Canadian financial sector has a few large banks – some with assets ranging up to 50% of GDP – that could be categorized as “too big to fail,” he writes. “Deposit insurance rates remain low and insurer’s reserves are not sufficient to shield the Canadian public from the costs of institutional failure.”

Because Canada’s banks are so large, their failure would be devastating to the national economy. As such, Chant advocates higher capital standards to safeguard against this scenario.

Another area where Chant urges more attention be paid by Canadian regulators is the evolution of financial instruments.

“Fast paced innovation puts regulators in a continual game of catch-up,” he writes. “The rapid growth of shadow banks and over-the-counter derivatives contributed to the last crisis and the issues they raise have yet to be resolved.”

Overall, the emphasis of financial regulation should be on creating financial institutions that are “too safe to fail,” Chant argues.

The report can be found here.