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Flaherty no fan of 'too big to fail' list

Gordon Nixon, RBC president and CEO


Finance Minister Jim Flaherty said he's not "a big fan" of designating the world's biggest banks as systemically important, suggesting the Group of 20 economic powers is still some way from resolving an issue that was at the heart of the financial crisis.

Mr. Flaherty made the comment Wednesday in Seoul, where he is backing up Prime Minister Stephen Harper at the G20 summit. The Finance Minister said that leaders would discuss how to ensure taxpayers never again pay the bill for financial institutions that are "too big to fail," but that divisions were too great to expect a breakthrough.

"There's more work to be done," Mr. Flaherty said in an interview. "I'm not actually a big fan of 'too big to fail.' Personally, I'm not. I think all financial institutions need to be regulated and supervised properly."

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Taxpayers in the United States, Britain and elsewhere spent hundreds of billions to keep the biggest financial institutions from collapsing in 2007 and 2008, making good on what many market participants always assumed - that governments would catch the largest banks if they fell.

That assumption distorts financial markets because banks that are deemed "too big to fail" or "systemically important" borrow more cheaply than smaller banks because lenders bet repayment is a sure thing, even in the case of bankruptcy. Some analysts say an implicit government guarantee also encourages risky behaviour because executives go to work every day knowing they have a safety net if they go too far.

At their summit in Pittsburgh a year ago, G20 leaders said they would do all they could to eliminate the notion of a government guarantee from large banks. Failing that, they would seek ways to at least make financial institutions pay for the privilege through a tax or tighter regulatory requirements. The deadline they set to achieve this was the Seoul meeting.

But a year on, little progress has been made. From the beginning, Canadian officials have opposed the idea of naming systemically important banks, arguing that regulators risk entrenching the problem by telling market participants explicitly which institutions governments would save.

In addition, Mr. Flaherty argued that lists can create "a false sense of security" by implying that as long as the biggest banks are supervised strictly, the financial system will be safe and sound. "I don't think that's true," he said.

Still, lists are circulating around the G20 gathering. The Financial Times reported Wednesday that authorities are working with two lists: one that includes banks that are so large their bankruptcy would threaten the global financial system, and another that includes financial institutions whose failure would pose a threat to national economies. The newspaper said that Royal Bank of Canada was on the global list.

Mr. Flaherty denied that, saying the report is "something that surfaced a couple of months ago and remains inaccurate."

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Instead, Canada's banks may represent the cutoff point. While as a group, the country's big banks could be considered systemically important, "individually, they are not quite big enough, according to the lists I've seen," Mr. Flaherty said.

Adding weight to that, neither Canada's banking regulator nor RBC has been informed of any such list.

"We are not aware of any list, or RBC being on any list," RBC chief executive officer Gordon Nixon said.

While it's plausible that RBC would not have been told of its inclusion on the list, it is doubtful that one would be compiled without the knowledge of the Office of the Superintendent of Financial Institutions (OSFI), which takes part in the global talks on banking issues.

Further clouding the issue is that the actual criteria for including banks on a too-big-to-fail list will not be drawn up by global regulators until the end of this year. As one banking source pointed out yesterday, "How can you have a list when you don't have any criteria yet?"

OSFI has stated that it believes none of Canada's banks should qualify for the list, and Mr. Nixon said he is confident that RBC wouldn't be singled out in Canada.

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"We have certainly received assurances from our banking regulator that all the Canadian banks will be treated equally," he said.

There is speculation that the list being referred to this week is based on outdated information, possibly one that was drawn up a few months ago. That list included a group of banks that would be invited to attend "supervisory colleges" - presentations by financial institutions to global regulators on their operations. Such a list cannot be viewed as the too-big-to-fail list, since not all of those attending the supervisory colleges would end up on the eventual roster.

As well, it is likely that global regulators will leave the decision up to individual countries on whether to put stricter capital requirements on certain banks deemed systemically important.

While some countries support these requirements for their banks, OSFI head Julie Dickson is not in favour of including Canadian banks.

An OSFI spokesman said Wednesday the regulator believes that deeming banks too big to fail, allowing them to be bailed out, would only result in more risk taking on behalf of financial institutions.

"Public identification of financial institutions as too big to fail should be avoided, as it could create moral hazard and systemic risk," OSFI spokesman Rod Giles said.

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