Julie Dickson, the federal superintendent of financial institutions.Fred Lum/The Globe and Mail
Many financial institution executives are looking forward to ringing in the new year and turning the calendar page on the recession and turmoil of 2009. Julie Dickson is likely to drop a little rain on their parade.
The head of Canada's banking and insurance regulator is always looking out for the next big risk confronting the hundreds of banks and insurers under her watch.
"As we look forward to 2010, while the system has stabilized and there are a lot of comforting reports about the economy and how global institutions are returning slowly but surely to health, considerable challenges remain and they will remain with us in 2010 and beyond," she said in a recent interview. "Serious challenges lie ahead."
What are some of those challenges? The exit strategies that various countries have; very low interest rates can create risks in themselves, and we'll have to see where that ends up. Many people feel that stock markets globally are overvalued. The deleveraging process has a long way to go. There is in some quarters concern about sovereign risk. And last but not least, the fundamental structural changes that have to take place, the U.S. has to start saving more and China has to start spending more, and those are not changes that happen overnight. So those challenges are going to be with us going forward, and they are serious.
What were the biggest developments of 2009? On the regulatory front, I think that the most important development was the too big to fail issue and the realization that there's no market discipline out there as a result of steps taken to support institutions during the crisis. That is good - to focus on too big to fail and market discipline - but some of the suggestions for dealing with that are not appropriate, such as determining which institutions are systemic [too big to allow to fail] and trying to assess some sort of capital charge on them.
There are various reasons for that, but I think that designating institutions as systemic will lead them to take more risk, and I think that coming up with the capital charge would be hugely challenging. We would be more in favour of promoting the idea of contingent capital internationally. So that's where you have a big chunk of subordinated debt that converts into common equity if the government feels that it has to step in to protect an institution or inject money into the institution. So that's the kind of position we're taking internationally, and it's a huge issue.
In terms of the health of the financial system, I think the most important development in 2010 after the stimulus packages were announced would be the stress tests of the U.S. banking system. When that was announced, that was a bit of a tense time because no one knew when those stress tests would come out, no one knew whether that process was going to work, whether that would enhance confidence in the U.S. banking system or detract from it.
Policy makers, especially in the U.S., have come under fire for not moving fast enough on financial system reforms. Are you happy with the progress that's been made globally during the year? I think that a lot of the issues that we're dealing with are quite complex, and I think that you have to take the time to get them right.
Actually, the speed with which some questionable ideas became mainstream, such as publicly designating institutions as systemically important, was quite surprising. I think it's important to take care to ensure that the changes that are being made do not sow the seeds for the next crisis. And while I continue to hear the view that we must act quickly or change will be impossible, I get very concerned with that.
Financial systems are dynamic and you always have to be ready to make changes, not only now but going forward. You have to be prepared to make tough decisions in the good times. This tends to be [the view]internationally, when people in other countries, in particular, say there's only one shot at making changes, that … concerns me.
A lot of other fairly major decisions were made in the past year, such as Britain's tax on bankers' bonuses. Would you characterize any of them as mistakes? Not a lot of final decisions have yet been made. I would say that in the past year there was a lot of discussion about the diagnosis. And I think the diagnosis was incorrect on occasion. So, for example, people identified certain problems, such as innovation.
Innovation was the problem. Use of [risk]models was the problem. Institution activities like proprietary trading were the problem, or size was the problem. At the end of the day though, I think when you look at it, it was risk management around all of those things that was the problem.
So to hear people say that we should put a lid on innovation, we should not let institutions use models, we should ban certain activities - I think you have to be sure that you have the right diagnosis before you come up with solutions.
We recently saw Laurentian Bank raise its dividend, one of the first banks to do so in the wake of the crisis. Are financial institutions entering 2010 with more certainty about what the rules will look like? I think that the environment has changed and the financial system has stabilized.
But I think that it is extremely difficult to predict where the capital rules will end up. … That, combined with all of the other challenges that I talked about - low interest rates, exit strategies, stock markets, deleveraging, etc., make this, I think, a very challenging time.