February 17, 2010 / 5:43 PM / 8 years ago

Bank of Canada may retain crisis tools for future

TORONTO (Reuters) - The Bank of Canada says it may retain in its toolbox some of the emergency liquidity facilities it introduced during the financial crisis, but markets should not expect it to use them in normal times.

<p>The Bank of Canada building is pictured in Ottawa July 30, 2009. REUTERS/Chris Wattie</p>

The central bank designed a variety of instruments to support money markets at the height of the financial crisis and while it has been gradually withdrawing its support, some of those instruments could prove valuable in future crises, Deputy Governor David Longworth said in a speech on Wednesday.

“For the bank, the primary facilities used during the crisis, the term PRA and the term loan facility, should continue to be a part of the bank’s tool kit, as is our emergency lending assistance,” Longworth said in Toronto.

The term PRA, or purchase and resale agreement, is a program under which the central bank buys securities in the market with an agreement to resell them at a later date.

Longworth said the central bank would also consider using a term securities lending facility in the case of a crisis where market participants do not have good quality collateral, but that further study was required to determine the right tools to use in the future if necessary.

As credit markets improve and economic recovery appears to be under way, the bank is hailing its intervention as a resounding success.

In fact, Credit Suisse economist Jonathan Basile said Longworth’s view that financial conditions have “improved significantly” was more upbeat than the bank’s previous language. A better financial outlook could mean a better economic outlook, he said.

“An upgrade to its GDP forecast could be next,” Basile said’

Longworth told markets not to count on the bank’s support as the system normalizes.

“As we move forward, it is important that financial system participants do not believe that our intervention in times of crisis implies a willingness to intervene in normal times,” he said

Longworth, who plans to retire at the end of March, gave no monetary policy guidance in his speech.

In the latest sign of confidence in the recovery, the Bank of Canada announced on January 19 it would further scale back on extraordinary money market operations.

The bank is cutting the maturity of the longest-term PRA to three months from six months for its upcoming auctions so maturity dates will roughly correspond with the end of the second quarter.

Late last year, it discontinued two other temporary facilities.

Longworth said the bank would continue to act carefully in unwinding its support, for example by providing advance notice to markets of changes and only gradually reducing the frequency and amount of its auctions.

The old tools the bank used before the crisis -- aimed at reinforcing the bank’s overnight interest rate -- will continue to exist, he said.

Regulatory reform will also make financial markets more resilient to future shocks, Longworth said. The Bank of Canada is working closely with the banking regulator on a range of changes to rules on liquidity and capital requirements as well as market infrastructure such as a central counterparty for repo trades.

In addition, Canada needs a broader regulatory body that would monitor risk in the financial system as a whole, Longworth said.

“I think it is well recognized that there has to be an appropriate governance situation in each country to deal with the question of systemic oversight. And so, yes, it’s absolutely necessary to have something in that area, and I think a lot of thought is being given to that domestically and globally,” he said.

Reporting by Claire Sibonney; writing by Louise Egan; editing by Peter Galloway and Rob Wilson

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