Plea for global banking regulations

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Internationally co-ordinated financial regulation can reduce the frequency and severity of financial crises like the one which sideswiped us three years ago, says former Bank of Canada governor Gordon Thiessen.

Thiessen is this year's Reserve Bank professorial fellow at Victoria University and in a lecture on Tuesday evening he welcomed moves by the G20 powers late last year to toughen banks' capital, liquidity and leverage requirements.

"But we still need to finish the job," he said. As memories of the financial crisis faded world leaders' focus had inevitably shifted and the tendency for countries to go their own way on regulatory reform had increased.

Requirements for banks to hold more capital and for more of it to be common equity would strengthen the resilience of the financial system, Thiessen said.

But less progress had been made on the issue of banks too big to fail and on how to deal with systemic risk - trends and developments which threatened not individual institutions but the financial system as a whole.

Identifying banks as too big to fail inevitably created moral hazard. In the expectation that the taxpayer would always bail them out, they would be likely to take more risks and to attract more investment than their smaller competitors.

The solution, he suggested, lay in "bail in" arrangements under which some of a troubled bank's debt would get converted to equity.

The risk of that happening would give private debt holders an incentive to monitor the bank's risk-taking. "I think that offsets the moral hazard issue."

Market-based solutions were always attractive, Thiessen said. "The problem is, when you get down to it, most regulators don't feel comfortable enough relying on them."

Meanwhile, agencies tasked with keeping watch for systemic risk would face the double problem that identifying such risks was never going to be easy and the instruments to respond to them were largely untried.

One is a counter-cyclical capital ratio.

"It is something you would use only infrequently when you really do see a build-up of systemic risk. You would respond by increasing the ratio."

But there are concerns giving such a task to central banks could muddy their mandate and all-important credibility.

"Independent central banks with a clear inflation mandate have served us remarkably well over the past 20 years," he said.

"Financial stability obligations are never going to be as clear or straightforward."