Keep closer eye on financial risks, C.D. Howe urges

Canadian officials constantly say sound regulation and supervision by various agencies helped shield the country from the worst of the 2008-09 global downturn.

While this is largely true, some experts worry there's not enough clarity over who's responsible for safeguarding the entire financial system, something officials call "macroprudential regulation." This is an increasingly important concept, since many argue that the credit crisis in the United States might have been avoided if, for example, a central authority with power to act had seen the systemic danger posed by Wall Street's aggressive selling of securities backed by subprime loans.

In response to the crisis, the U.S., the United Kingdom and Europe have all taken measures to improve their ability to spot system-wide threats and co-ordinate policy responses. In Canada, though, aside from Ottawa pushing unsuccessfully for a national-securities regulator, the approach to systemic oversight is basically as it was before the crisis: an informal group of senior officials from various agencies that advises Finance Minister Jim Flaherty, who decides whether and how to act.

The latest call for change comes from former Bank of Canada governor Gordon Thiessen and former senior deputy governor Paul Jenkins.

In a report for the C.D. Howe Institute, released Tuesday morning, the two ex-policy makers say there needs to be a committee of agency heads with formal power and accountability rooted in legislation. The central-bank chief would be its chairman, but would share responsibility with the deputy minister of Finance, the Superintendent of Financial Institutions, possibly the head of Canada Deposit Insurance Corp., and "someone representing the arrangements that should be set up to monitor and respond to systemic risk in securities markets."

The committee would ultimately be accountable to Mr. Flaherty, and would give him regular reports. Indeed, since the committee would be made up of unelected officials, Mr. Flaherty would have "ultimate ministerial override power" under the authors' proposal, although this would be exercised "only in extreme circumstances of serious irresolvable disagreement."

The authors argue that a committee which shares formal responsibility is preferable to having authority rest entirely in the hands of the Finance Minister, since political considerations might prevent "prompt action" to limit the risk of dangers that have been identified festering until they threaten an actual crisis.

At the same time, they say, giving Bank of Canada Governor Mark Carney full responsibility might make it easier to bring about prompt action, since the central bank is independent from political considerations, but could risk undermining the central bank's crucial credibility on monetary policy. (Currently, unlike in the United States and Britain, the Bank of Canada is not an actual regulator.)

Still, Mr. Carney is best suited to chair the committee, they conclude, because even though his main job is controlling inflation, the central bank has been keeping an eye on potential threats to the financial system more and more since the crisis. (Mr. Carney has often said he retains "flexibility" to use interest rates for financial stability purposes in rare cases, if other avenues for leaning against something like a dangerous buildup of credit have been exhausted.)

"Members of the committee and their agencies would bring the most complete knowledge available in Canada to the task of identifying potential systemic risks and the expertise to use the available tools to counter those risks," the authors write. "Moreover, the joint accountability they would share as a committee should provide the appropriate incentive to act promptly before risks have built up to serious levels that require crisis measures."

The conclusions are similar to those in another C.D. Howe report from January, by McGill University economist Chris Ragan. Prof. Ragan argued the Bank of Canada should play a "clear leadership role" in developing measures to safeguard the country's financial system, with final say over how regulators should address risks, such as record household debt, being left with Mr. Flaherty.

Others, however, say that aside from the generally-agreed-upon need for a national securities regulator, those arguing for a shakeup of the current structure are pushing a solution without a problem.

"It's not clear to me that there's a problem," Ian Lee, a Carleton University business professor who once worked as a banker, said in an interview. "Why would we set up a machinery where there's potential conflict? What if that stronger committee came up with some advice and gave it to the Minister of Finance, and he said no, and then somebody in the organization leaked it to the media? I don't think it would be prudential or wise."

In fact, leaks might not even be necessary under the proposal from Messrs. Thiessen and Jenkins. The committee they envisage would operate mostly by consensus, but when "fundamental disagreements" occur, the "nature of the disagreement and the dissenting member should be made public."

If that member happened to be the deputy minister of finance, it's hard to see how the dissent could be interpreted as anything other than a tacit expression of Mr. Flaherty's view on the subject.

Regardless, it seems unlikely that this will become an issue.

In 2009, after spending six months thinking about whom to entrust with overseeing the country's financial system, Mr. Flaherty ultimately decided that any true authority should rest with the man in the mirror.