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Canada may not have had a big banking failure in many years, but “emerging clouds on the horizon” suggest the existing checks and balances may need tweaks to be sustainable in the future, says an official who used to work for the country’s top banking regulating agency.
The failure of several regional banks in the United States and the fall of Credit Suisse Group AG in Switzerland in 2023 means the reforms enacted after the global financial crisis of 2007-08 are not sufficient, said Mark Zelmer, a senior fellow at the C.D. Howe Institute who was once the deputy superintendent at the Office of the Superintendent of Financial Institutions.
“It would be easy to say, don’t worry, be happy because everything has gone well for several decades,” he said. “But I think last year’s events have led me to think that the world is changing. It is better to think when times are calm about how things could evolve in the future as opposed to waiting for the problem. I would hate for Canada to lose its reputation.”
Last year, authorities in both the U.S. and Switzerland had to step in to prevent banking failures from triggering broader disruptions to their financial systems and economies.
Silicon Valley Bank, one of the failed lenders, lost almost 85 per cent of its deposits over a span of two days. This suggests that bank runs — when a large group of depositors withdraw money at the same time due to fears of insolvency — in the “digital and social media age” can take place very quickly, Zelmer said, and that risk is likely to continue growing.
The U.S. situation also indicates that “smaller, less sophisticated institutions” can collectively cause issues if they rely on similar business models and groups of depositors, he said in a commentary published by C.D. Howe on Tuesday.
Zelmer said there has also been a major expansion in regulatory requirements and oversight in the past 15 years, which has its downsides.
“There is a risk that more rules and more intense supervision of non-financial risks and governance practices … could blur the line between bank management and regulatory oversight,” he said. “This approach could also potentially dampen incentives for innovation … they may be tempted to simply manage ‘to the regulatory requirements.’”
Zelmer said there are a number of “options” or steps that the banking sector could take to be more sustainable, although none is a “clear panacea” because they would likely lead to higher costs that would ultimately be borne by Canadian households and businesses.
One of the options is to offer full deposit insurance coverage. Currently, Canadians are insured for up to $100,000 in each deposit category. Increasing the coverage may improve a depositor’s confidence, but he said past experiences show that such steps may not significantly reduce the risk of bank runs.
“This could be a topic worth exploring in the federal government’s planned review of the deposit insurance framework announced in its 2024 budget,” he said.
Zelmer said Canada Deposit Insurance Corp., a federal Crown corp., should also complete its payout modernization project, which aims to build a system that can quickly reimburse depositors in the event of a failure of an institution.
And banks could be encouraged to carry larger stocks of high-quality liquid assets that can be sold as needed in the eventuality of a bank run.
“That way, they would be able to survive for a longer time in the event of a run,” he said.
The Bank of Canada could also play a role by modifying the structure of its emergency liquid facilities to make them easier for banks to access in times of stress.
“The moment a bank goes to the Bank of Canada looking for money, it immediately signals that the bank is in trouble,” Zelmer said. “Nobody wants to do that because it basically says that you have lost the confidence of financial markets at that stage.”
He said none of the options he is presenting are perfect, but his key message is that “people should start talking about what kind of banking system they want in the future given what happened in recent years.”
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