The era of financial institutions that are too big to fail is over, the head of Canada's central bank believes.
Bank of Canada Governor Mark Carney said countries must find an orderly way to let failing banks stumble, then work to contain the damage, rather than prop up ailing institutions at all costs.
"We have to create a system where individual financial institutions can fail," Mr. Carney said.
"It is not politically acceptable, nor in the spirit of the market that there is a broad range of institutions that: heads they win, tails they win."
His comments, made at a gathering of the financial community in Toronto on Wednesday, come as the G20 countries are set to meet this weekend to discuss global banking reforms.
Canada heads into the Toronto summit opposing the concept of a bank tax put forward by several European nations to pay for recent bailouts, and backstop failures in a future crisis.
Canadian banks, which managed to weather the recent financial crisis better due to higher capital reserves on hand, are pushing for different reforms. They want lenders to be forced to keep more funds on hand to backstop loans, rather than submit to a tax that would cover the cost of bailouts.
A Canadian proposal called embedded contingent capital would see the financial institutions issue debt that would convert to equity in the event a bank is close to failure. However, the idea has not received universal support among the G20.
Meanwhile, the bank tax issue gained momentum this week after Britain, France and Germany said they plan to proceed with various forms of a levy.
Mr. Carney said he is still confident the G20 nations will reach an agreement on bank reforms by November, even as the contentious bank tax issue threatens to dominate meetings in Toronto this weekend.
Though the final decisions on bank reforms will be made at G20 meetings in South Korea in November, Mr. Carney suggested the gathering in Toronto will serve to focus the talks more. He didn't reference the bank tax specifically, but said certain issues have been clouding the talks.
The Toronto summit is an opportunity "to focus the financial reform process back on its core, away from some of the lesser important issues that have grabbed attention," Mr. Carney said.
Speaking at a breakfast hosted by the media company Thomson Reuters Corp., Mr. Carney suggested Bay Street banks could benefit if European countries pursue a bank tax and Canada does not. "It doesn't hurt certainly," he told the audience of bankers.
Echoing concerns raised by Finance Minister Jim Flaherty, Mr. Carney said the bank tax "reeks of moral hazard" since paying into a bailout fund would encourage lenders to take more risks, knowing there is money to backstop them.
He also doubted whether the reserve money collected by a bank tax would be available for bailouts in countries where it is placed into general revenues.
"The money probably won't be there. Dedicated pools of funds seldom exist, particularly if they are just thrown into the general revenue pile," Mr. Carney said.
The concept of a global bank tax to pay for bank bailouts during the 2008-09 financial crisis, and to cover future failures, was put on the table by European governments at G20 meetings in Pittsburgh last year.
"We don't view it as a central issue," Mr. Carney said of Canada's stance. "We've been campaigning hardest on is what's most important - it's capital liquidity, it's market infrastructure, it's how you resolve [a failing] institution."
At issue in the global talks is how quickly banks should be required to increase their capital levels that backstop loans. Mr. Carney avoided suggesting a deadline, but said it should be soon enough that the banks don't get complacent, but not so quickly that financial institutions around the world find themselves in a crunch to raise capital.
"It has to be consistent with the recovery," he said. "We will not create a situation where banks are moving to a new capital standard by shedding assets or by not extending credit that they otherwise would have because the timetable is too short."