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Minister of Finance Jim Flaherty holds a press conference at the National Press Theatre in Ottawa on Thursday, June 21, 2012.Sean Kilpatrick/The Canadian Press

New rules that would allow Canada's banks to pick their own external ombudsmen in disputes with customers are drawing sharp criticism. But the federal government says the changes are needed to help the complaints system be more efficient.

In a series of proposed regulations made public Friday, Finance Minister Jim Flaherty said the government is pressing ahead with plans to open up dispute resolution in consumer banking to private firms.

Under the new rules, banks would be able to pick from a menu of dispute-resolution firms to settle a consumer complaint. The government said it will ensure each ombudsman is independent and closely monitored.

"The regulations will – for the first time – set explicit requirements that external complaints bodies must meet for approval, including high standards for independence, timeliness and transparency," the Finance Department said in a statement.

Until a few years ago, all banks used the federally appointed Ombudsman for Banking Services and Investments (OBSI) to resolve consumer disputes that couldn't be settled by banks' own internal ombudsmen.

That system began to unravel in 2008, when Royal Bank of Canada, the country's largest bank, decided to no longer send cases to OBSI, and hired its own service, ADR Chambers. In 2011, Toronto-Dominion Bank also refused to use OBSI for retail banking complaints.

Both banks said they pulled out of OBSI because of the amount of time it took for complaints to be resolved.

However, sources throughout the industry have said other issues were a factor as well, including the costs of using OBSI and friction over some of its rulings.

Under the proposed regulations, a independent dispute-resolution service approved by the government would have 120 days to resolve a case.

The Financial Consumer Agency of Canada will evaluate and monitor each service that applies to be a bank ombudsman to ensure it is independent and accountable. However, the government provided few details about how it would ensure that a service chosen by a bank does not favour the financial institution over the consumer.

Canadian banks are required to use OBSI for complaints relating to their investment dealers, but are free to choose between dispute-resolution firms for consumer banking complaints such as issues with accounts and loans.

OBSI is financed through group payments from the industry. Under the new regulations, an external ombudsmen chosen by a bank would be compensated directly by that institution.

The proposed regulations were criticized by the opposition in Ottawa as being too weak. "I don't think they do much," said New Democrat MP Peggy Nash. "It still means the banks will get to pay for and choose the moderator they will use … It can strike people as a lack of impartiality, even if it is an independent third party."

Ms. Nash said she would like to see the government follow a recent report by the World Bank, which pointed out problems in countries such as New Zealand that use competing dispute-resolution services.

Concerns have arisen that ombudsmen end up competing for business, and might be tempted to satisfy the financial institution that pays the bill for having a case resolved.

"The World Bank recommends there be a single ombudsmen hearing all complaints. We support having a single ombudsman to handle all disputes," Ms. Nash said.

Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Bank of Montreal all continue to use OBSI to resolve disputes with consumers.

The banking industry created OBSI in 1996, after the government threatened to create a federal ombudsman because of the number of complaints Ottawa was receiving from small businesses about the banks' lending practices.

The proposed regulations will be available online in the Canada Gazette on July 13 for a 30-day comment period.