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OTTAWA (Reuters) - A U.S. proposal to limit banking activities must strike a balance between preventing institutions from being "too big to fail" and the need to keep markets functioning effectively, the head of Canada's central bank said on Monday.
Bank of Canada Governor Mark Carney made the comments in an interview with the Financial Times after U.S. President Barack Obama last week proposed barring financial institutions from engaging in proprietary trading -- operations that are unrelated to serving customers and are for their own profit.
"We start from two principles. One is you have to have a system that's robust to failure, so we have to move to a system where institutions can fail in an orderly fashion," Carney said in the videotaped interview.
"Secondly, as a central bank, what we care deeply about is that markets function and to the maximum extent possible that we can enlarge the number of markets that are continuously open ... So we have to work to make these markets open. That means we're going to need firms who are market-makers," he said.
Carney said exactly where to draw the line between banks and their proprietary trading businesses will be the biggest challenge and the answer will differ depending on the country.
"Different judgments will be taken in different jurisdictions about where you draw the line between proprietary businesses and market-making businesses," he said.
Canada has shown little inclination to follow other countries in imposing levies on banks or limiting their activities to prevent future financial crises, mainly because regulatory standards are already higher than elsewhere and none of the major banks needed bailouts.
Carney's focus has been on improving market infrastructure to prevent meltdowns of the kind seen in its non-bank asset-backed commercial paper market.
In that vein, Canada has begun developing a central counterparty clearinghouse for repo transactions, a step designed to reduce risks and keep markets more liquid in times of crisis. Carney said the service should start operating later this year.
On the topic of other countries diversifying their foreign exchange reserves to invest more in Canadian assets, Carney said he expected diversification to continue and that the international monetary system would have to make adjustments to those changes over time.
Russia last week announced it would invest some of its gold and foreign exchange reserves in Canadian dollar assets.
"There's no question that reserves continue to grow, that reserve management strategies are becoming a little more broad in their asset classes and some of that will be reflected in purchase of Canadian assets and other assets," Carney said.
Reporting by Louise Egan; Editing by Jeffrey Hodgson.