December 5, 2007 / 2:28 PM / 10 years ago

Bank of Canada may have overstepped powers: study

OTTAWA (Reuters) - The Bank of Canada may have overstepped its legal powers during the summer credit crunch and legislative changes are needed to clarify its role in future financial market crises, an independent report said on Tuesday.

From August 15 to September 7, the central bank temporarily expanded its list of collateral used when conducting open-market operations to boost liquidity and reinforce its target for the overnight interest rate.

The bank stepped into “questionable legal territory” when it began accepting commercial paper, foreign bonds and corporate bonds in addition to the usual government securities, bills of exchange and promissory notes, argued John-Paul Koning of the C.D. Howe Institute, a think tank.

“The bank’s actions may have exceeded its statutory authority and, if Parliament believes it necessary that the bank should have the scope to act as it did, legislative changes are needed,” Koning wrote.

The law governing the Bank of Canada says that only government-issued and guaranteed securities may be used as collateral for central bank operations designed to influence the overnight lending rate. These include the Special Purchase and Resale Agreements, whereby it buys securities with the agreement to sell them back the next business day.

The list of collateral is less restrictive for lending through the Bank of Canada’s Standard Liquidity Facility. It was this list that the bank adopted temporarily for its purchase and sale operations in the market.

The law gives the central bank extended buying and selling powers in times of financial emergency but only if the governor publicly states that an emergency exists, something Bank of Canada Governor David Dodge did not do in August.

Lawmakers should decide whether they want to give the Bank of Canada the power to use private sector debt as collateral when ensuring short-term financing in times of financial market difficulty, Koning said.

“The Bank of Canada should offer Canadians a comment on its actions of this past August. Policymakers should also revisit the thinking behind certain sections of the Bank of Canada Act,” he said.

“Failure to do so could hamper the bank’s response the next time the financial system runs into trouble.”

Dodge signaled on October 21 that he was mulling possible changes to the bank’s liquidity provisions. In a speech in Washington, he floated the idea of a new central bank facility that would provide liquidity to banks at terms longer than overnight, collateralized with a possibly wider range of securities.

Deputy Governor Pierre Duguay repeated the idea in a November 20 speech. “The types of market failure that such a facility would be designed to deal with would obviously need to be very carefully considered to avoid weakening the incentive for preventive risk and liquidity management by market participants,” he said.

Dodge and Senior Deputy Governor Paul Jenkins will be answering questions from the Senate Banking Committee on Thursday and the incoming governor, Mark Carney, appears before the House of Commons finance committee on Wednesday afternoon.

Reporting by Louise Egan; Editing by Peter Galloway

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