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Regulators turn their gaze on smaller banks Add to ...

Having spent the past year drawing up new standards for global mega-banks deemed too big to fail, financial regulators will turn their attention this fall to debating requirements for smaller banks that are of national significance - a process that will have direct implications for Canada's financial institutions.

Canada's major banks would shake the country's financial system if any of them were to fail in a crisis, but most are not expected to be named to a list of about 30 systemically important financial institutions (so-called SIFIs) around the world, which will be established in the coming year.

Under an agreement reached two weeks ago in Basel, Switzerland, the global SIFIs will be required by 2016 to hold as much as 2.5 per cent of additional capital on their books compared with their peers, which will serve as an extra buffer against a future financial crisis.

Global regulators were in general agreement about putting extra requirements on the world's biggest banks, but the next round is expected to be more contentious: There is much disagreement about how to treat banks considered systematically important to the well-being of their own countries.

"It's going to be much more difficult to get global agreement on that," Julie Dickson, the federal Superintendent of Financial Institutions, said in an interview. "It's more of a national prerogative on how you want to deal with institutions in your country."

New standards for the world's biggest banks have been the priority so far, given the global domino effect that would result if they were to fail. But Ms. Dickson pointed out that difficulties at medium-sized financial institutions can lead to international problems as well.

British bank Northern Rock was not a large financial institution when it required a Bank of England bailout during the credit crisis, yet its failure would have been felt throughout Europe and potentially around the world. "Circumstances also play a big role in whether an institution is systematically important," Ms. Dickson said.

In Canada, RBC has been mentioned as a possible candidate for the list of global SIFI banks. If RBC does not make that list, it would most certainly join Toronto Dominion Bank, Bank of Nova Scotia, Bank of Montreal and Canadian Imperial Bank of Commerce in a group of banks that would be deemed national SIFIs.

RBC chief executive officer Gordon Nixon could not be reached Thursday, but Mr. Nixon has said he believes Canada's largest bank is not large enough to be classified as a global systematically important bank. He is pushing for Canada's major banks to be treated equally, on a national level.

The list of global SIFIs could a long time coming. In the next month, regulators will issue a consultation paper on the proposed criteria for the list, which will look at how interconnected a bank's operations are with other financial institutions, as well as its cross-border activity and the complexity of its assets.

When the debate turns to a national level, Ms. Dickson said, her preference is to not attach "too big to fail" labels to any of Canada's banks, but instead to introduce a system that would allow for an orderly resolution of a troubled bank, rather than propping it up with a bailout.

Some countries may want banks deemed national SIFIs to hold more of a capital cushion. However, Canada is proposing a series of other measures to safeguard nationally important banks, such as the concept of bail-ins, where debt is quickly converted to equity to inject capital into the bank.

"It's like an army of capital that is created," Ms. Dickson said. "The doors of the bank are left open, they're never shut. But other holders of debt, uninsured depositors, holders of senior unsubordinated debt, are converted into equity holders."

Contingent capital, which Canada put forward at global regulatory talks last year, is one form of bail-in, the Office of the Superintendent of Financial Institutions said. OSFI has already required Canadian banks to draw up "living wills," blueprints for how the organization would be wound up and liquidated in the event of a default.

Rather than label banks as too big to fail, which could lead them to seek bailouts, Ms. Dickson said her focus has been on figuring out how to contain the damage of a failure by resolving the operations. Canada has also laid the groundwork to create a "bridge bank" in the event of a default, which would assume the obligations of imperilled lenders and liquidate the assets.

"If you are talking about an institution that is very important, you need to have tools to deal with its exit from the system," she said. "Otherwise, you will have no choice but to repeat what happened in the financial crisis, where governments had no choice but to bail out certain institutions."

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