June 14, 2012 / 3:00 PM / in 5 years

Bank of Canada pushes reforms to help absorb shocks

MONTREAL (Reuters) - Canada’s financial system is solid but could be hit by a worsening of the European debt crisis, a senior Bank of Canada official said on Thursday, adding that increased use of central clearinghouses would help the country absorb any such shock.

“Canadian markets have remained relatively stable, and our banks continue to have good access to wholesale funding markets,” Agathe Cote, deputy governor of the central bank, said in the prepared text of a speech she was delivering in Montreal. “Nonetheless, a deterioration in the situation could have a considerable effect on Canada through trade, confidence and financial channels.”

She said Canada took a step toward stronger markets with the creation in February 2012 of central counterparty clearinghouse services for the repo market - in which government securities are sold with an agreement to repurchase them at a later date.

The move was part of a broader global drive to strengthen banks and financial markets to reduce the risk of another crippling financial crisis. Regulators say this kind of improved market infrastructure, the plumbing of the trading system, will make markets more transparent and reduce risk.

The bank argues that having a trusted intermediary between buyers and sellers reduces anxiety about counterparty credit risk and prevents funding markets from seizing up as they did in late 2008.

“We will never have a risk-free financial system. That’s why we need to take measures to render it more resilient to shocks that may occur, either from abroad or domestically.”

The repo market is key to ensuring liquidity for banks and money markets overall.

Repo positions represent about 5 percent of Canadian-dollar denominated assets on the books of Canadian banks, at about C$90 billion ($87.4 billion), Cote said.

The industry plans to expand central counterparty services to more complex types of transactions done with cash, sometimes anonymously, and with collateral.

The Canadian Derivatives Clearing Corp (CDCC) operates the clearing services on the Montreal Exchange, both of which are owned by TMX Group (X.TO), which also owns the Toronto Stock Exchange. TMX could be acquired by a consortium of Canadian banks if a deal now proposed is approved by regulators.

VOLCKER RULE

Cote also said the Bank of Canada is concerned about the impact of the proposed U.S. Volcker rule on its financial markets.

“I think it’s clear that we have certain concerns about the potential effects on Canadian markets, particularly the liquidity of the market in government securities, so that’s an aspect that worries us,” Cote told a business audience, speaking in French.

The Volcker Rule limits the ability of banks to make speculative bets with their own funds and is a key plank of the 2010 Dodd-Frank financial reform law in the United States. It has been seen as a critical tool to rein in the type of excessive risk-taking that fueled the 2008-09 financial crisis.

Both Canadian Finance Minister Jim Flaherty and Bank of Canada Governor Mark Carney have conveyed their concerns about the rule formally to their U.S. counterparts, saying it would inflict unintended harm on parts of the Canadian market.

“As you know, this is an enormous bill and so we hope there will be some adjustments made to this element in particular, but at this stage I don’t really have any information about how this is all going to end up,” Cote said.

($1=$1.03 Canadian)

Reporting By Louise Egan; Editing by Peter Galloway

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