Canada not immune to risk

“Some concussions were expected as unfortunate byproducts of otherwise great hockey plays; risk has been part of the sport but today there is a growing demand for a less violent game,” said Dickson. “We can say much the same about the world of finance; especially in light of the severity of the global financial crisis.”

While praising the performance—so far—of Canada’s financial institutions in the face of global crisis, she advised the industry to keep its head up.

“In Canada our financial institutions are playing from a position of strength, but we can not let our guard down. We must continue to work hard at maintaining this enviable position,” she said. “Our current strength should not be taken for granted; it was hard won and will be harder to maintain in the future unless it is improved and supported now. We must no become complacent in Canada.”

In view of the ongoing crises in the Eurozone and the U.S., and the IMF downgrade of its global economic outlook, Dickson did admit that global issues are “extremely serious.”

“The global financial crisis that began in 2007 and escalated a year later has forced painful adjustments and as recent events remind us, recovery is neither quick nor smooth,” said Dickson. “Processes like deleveraging by households, firms and governments can not be done quickly or without pain.”

Finding solutions for issues such as Europe’s sovereign debt crisis has been a seemingly intractable problem. Policymakers find themselves in an uncharted territory with rarely used tool such as quantitative easing that could bear unintended consequences down the road.

“The world is not new to financial crises, but the recent worldwide financial crisis current is in an entirely different league,” she said.

Recessions that follow financial crises are more severe than the typical garden variety cyclical recession, she added.

Further, the unusual nature of the current situation makes predictions about the future course of the world economy difficult. “What we now know is that financial crises, like a sever concussion, will have lasting effects and there is no quick fix.”

Dickson asserted economic expectations must be adjusted to reflect the new reality of slower growth, tighter government spending as a result of sovereign debt levels and constrained consumer spending. “This is the new normal and it’s not nice, especially for the unemployed, for investors saving for retirement, for people living in countries undergoing huge structural adjustments.”

It is also the new reality in which financial institutions as well as regulators must learn to operate.

“The governor of the Bank of Canada has warned that consumer debt loads are too high and that Canadians need to understand that eventually interest rates will go up,” she said. “The Minister of Finance has intervened three times in the past three years to instruct the mortgage insurance market to tighten the rules.”

The Financial Stability Board (FSB) created by the G-7 and G-20 countries is also focusing on the issue of lending while developing principles for what constitutes “safe” mortgage lending.

“This work is being done because the global crisis has showed that the consequences of weak underwriting practices in one country can be transferred globally through securitization,” said Dickson.

Individual countries have learned the hard way that imprudent mortgage lending and unconsidered home equity lines of credit can cause major problems.

“Extremely low interest rates will be with us, [both in Canada and the U.S.] for even longer than we envisaged before the summer; this has likely increased the incentive for consumers again to borrow,” warned Dickson while drawing attention to growing concerns over the behavior patterns created by abnormally low interest rates.

Financial institutions should “guard against loosening historical underwriting standards” given that the “current interest rates already make borrowing extremely attractive to all borrowers.”

Dickson conceded the difficulty in sorting out the risks associated with systemically important financial institutions.

“The sheer size, complexity and interconnectedness of these institutions means that a disorderly failure could cause serious disruptions to a wider global financial system and to economic activity.”

There are some who strenuously argue these institutions should be broken up into smaller enterprises to lesson the impact of their failure on the global financial system.

The FSB, however, is suggesting that the best solution is to impose a capital surcharge on the largest banks, while focusing on how to deal with those that get into trouble.

The board has also been clear that the big institutions must be allowed to fail to preclude the assumption that systemically important banks are too big to fail and are therefore safe havens, said Dickson.

The theme of hockey returned as Dickson brought up the issue of supervision. “Ignoring supervision, which many globally do, would be like creating a new rulebook for hockey but taking the referees out of the game and having players themselves decide when the whistle should be blown and who to send to the penalty box.”