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Malcolm Knight, seen here in 2002, will warn against the oversized strength of Canada's five largest banks in a lecture Thursday, May 3, 2012. (Tibor Kolley/The Globe and Mail/Tibor Kolley/The Globe and Mail)
Malcolm Knight, seen here in 2002, will warn against the oversized strength of Canada's five largest banks in a lecture Thursday, May 3, 2012. (Tibor Kolley/The Globe and Mail/Tibor Kolley/The Globe and Mail)

The bigger they are, the harder Canadian banks could fall, expert warns Add to ...

Canada’s biggest banks likely are “too big to fail,” and therefore pose a risk to the country’s financial system, says Malcolm Knight, a former No. 2 at the Bank of Canada.

Mr. Knight, now a vice-chairman at Deutsche Bank in New York, is set to deliver that message in a speech Thursday in Washington, showing a willingness to broach a topic that is little discussed in the five-star reviews of Canada’s banking system.

Canada’s five biggest banks hold combined assets worth $2.8-trillion, twice the size of the country’s gross domestic product.

That outsized economic weight makes them a threat to financial stability because the collapse of any of them would take a toll on hundreds of thousands of customers, on competition in financial services, and on the country’s reputation as a safe place to invest, Mr. Knight says.

Canada’s strict regulatory system makes the banks “less likely to fail,” but failure isn’t impossible, no matter how well the country weathered the financial crisis.

“Should we conclude that banks in Canada are therefore robust in the face of any crisis?” Mr. Knight says in a draft of a speech he is scheduled to give at the Paul H. Nitze School of Advanced International Studies Thursday evening. “The answer, unfortunately, is no.”

Being labelled as “too big to fail” is a touchy subject in global finance because banks that carry the tag face greater regulatory scrutiny and higher fees under the Group of 20’s overhaul of international banking standards.

Canadian banks avoided being designated as global systemically important financial institutions by the Financial Services Board last year, thus escaping a surcharge meant to dissuade banks from growing so large that governments would be left with little choice but to bail them out if they were to fail.

But the FSB, led by Bank of Canada Governor Mark Carney, is now studying whether financial institutions that pose a threat to domestic economies warrant special attention. The FSB is set to decide on a framework for dealing with “domestic systemically important banks” by November.

If the FSB decides to write special rules for banks whose failure would disrupt national economies, it seems likely Canada’s five biggest banks would come under greater scrutiny. The industry isn’t keen for that to happen.

“When we see the criteria, we will work with the [Office of the Superintendent of Financial Institutions]to analyze what it means for the Canadian banks,” said Robin Walsh, chief spokesman at the Canadian Bankers Association. "In the meantime, when it comes to 'too big to fail,' OSFI has said that no bank in Canada is too big to fail."

Mr. Knight, a vice-chairman at Deutsche since 2008, is scheduled to give the inaugural Canada-U.S. Enders Lecture at an event hosted by the Association for Canadian Studies in the United States. He provided The Globe and Mail with a draft of what he intends to say. The remarks may surprise many in his audience by casting a more critical eye on Canada’s financial system.

As Washington policy makers and academics have assessed the Wall Street bailouts of 2008 and 2009, Canada's approach to banking often is held up as a more favourable model. OSFI is presented as the gold standard of supervision, and lenders such as Royal Bank of Canada and Toronto-Dominion Bank are applauded for avoiding the excesses of their American cousins.

Mr. Knight, who left the Bank of Canada in 2003 to head the Bank for International Settlements in Switzerland, also compliments Canada’s regulatory structure and the prudence of its bankers.

However, unlike others who have come through Washington over the past couple of years to discuss banking in Canada, he is perhaps the first to publicly address the downside of a system dominated by a handful of large institutions.

“The banking system remains highly concentrated,” Mr. Knight says in his speech. “Owing to their massive size relative to the Canadian market, the largest Canadian banks create a major ‘too-big-to-fail’ risk.”

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