The Bank of Montreal and TD Bank towers in downtown Toronto's financial district.Fred Lum/the Globe and Mail
Canadians cannot afford to be smug about the stability of our banks. That’s why it is reassuring to see the Trudeau government in troubleshooting mode.
This week’s federal budget included promising proposals to mitigate risks lurking in the financial sector. They include the possibility of increased deposit insurance, public disclosures of lenders’ exposures to crypto assets and expanded mandates for banking regulators.
These are certainly important first steps. But given the severity of the crises engulfing lenders in the United States and Europe, Ottawa must add more measures to its fix-it list.
The government should start by giving the Office of the Superintendent of Financial Institutions, or OSFI, more power to replace banks’ external auditors.
Why?
Because we’ve learned that both Silicon Valley Bank and Signature Bank failed within weeks of KPMG LLP endorsing their respective audits.
More oversight of auditing firms is also needed because there are new concerns that some U.S. banks have used accounting loopholes to disguise potential losses on bonds, The Wall Street Journal reported this week.
Although Canada’s Bank Act already gives OSFI the ability to revoke a bank’s appointment of an external auditor, it is not clear when or why the regulator would exercise this authority under the legislation. The Bank Act should be beefed up to spell out specific criteria for revocation.
Additionally, OSFI should be working closely with the Canadian Public Accountability Board, the regulator of accounting firms that audit public companies. The board takes a risk-based approach in selecting the audits that it examines, but it is unclear whether they’ve been looking at domestic banks.
OSFI also needs to be more transparent about its own work to better promote public confidence in the financial system. The regulator plays a critical role in ensuring our banking sector’s resilience but it remains a black box to most people.
Too much of what OSFI does is unnecessarily hidden from the public’s view.
That’s partly why OSFI found itself in an awkward position this month when it scrambled to clear up market confusion about the bail-in bonds issued by Canadian banks.
Investors were struggling to understand if OSFI’s view of the creditor hierarchy for additional Tier 1 bank debt, as the bail-in bonds are formally known, differed from that of its Swiss counterparts.
That’s because during the hastily-arranged rescue of Credit Suisse Group AG by UBS Group AG, Swiss regulators broke with convention and gave priority to the troubled lender’s shareholders over the holders of its additional Tier 1 debt. As a result, those bondholders were wiped out to the tune of US$17-billion.
Sure, OSFI wasn’t the only banking regulator that had to clarify that additional Tier 1 bondholders would be given preference over common shareholders if a domestic bank fails (European regulators did so, too). But the lesson here is that OSFI needs to be proactive about communicating with the public – and it should lean on our lenders to do the same.
For instance, both OSFI and the banks should be divulging whether their recent stress-testing scenarios are based on assumptions that reflect the conditions of this crisis.
Canadians also deserve easy-to-understand disclosures from banks about whether any lower-quality securities are included in their Tier 1 capital.
Such transparency would prevent the public, including investors and depositors, from latching onto unfounded fears about bank debt or capital in the future.
The current crises should also motivate the federal government to resurrect plans for a national securities regulator. (Yes, this issue again.)
The now-defunct Capital Markets Regulatory Authority was this country’s best shot at mitigating systemic risks such as those posed by crypto-related assets or other innovative financial instruments.
Moreover, a national securities regulator would have improved oversight of credit rating agencies. That’s another key takeaway for Ottawa from the crisis roiling the U.S. banking sector.
Credit rating agencies are attracting scrutiny once again – this time for missing signs of trouble at Silicon Valley Bank and Signature Bank.
(Earlier this month, as the crisis raged, First Republic’s shares were downgraded to junk status by S&P Global Ratings.)
Credit rating agencies were criticized for blessing toxic subprime mortgage-backed securities that imploded during the Great Financial Crisis of 2008.
Back in 2014, Ottawa drafted legislation that would have improved the supervision of credit rating agencies. It included provisions to give the Capital Markets Regulatory Authority new powers to remedy their public disclosures; strengthen risk management; root out conflicts of interest; and improve governance, compliance and accountability procedures for the determination of credit ratings.
But those measures were later scrapped after industry players kicked up a fuss. It’s time for the federal government to give it another shot.
This is not an exhaustive list of solutions to modernize financial-sector oversight. Indeed, each new banking crisis provides new opportunities to learn about risk management.
To be sure, Canadian banks are among the soundest in the world. To keep them that way, Ottawa must be ever vigilant to the ways that a crisis could happen here.