Turning to Canada to reform financial regulation

Creating new relationships between the financial pillars will not be easy, writes LAURA SLATTERY.

AH, CANADA, a country with a reputation, whether earned or not, for being boring. But when it comes to the scandal-stricken world of banking and financial regulation, “boring” is sounding better and better by the day.

Taoiseach Brian Cowen’s pledge to create a new system of financial regulation that will “build on best international practice, similar to the Canadian model” has prompted some debate about his intentions.

Does he actually want to replicate the Canadian regulatory system or does he simply aspire to the kind of banking conservatism that has seen all five of Canada’s big five banks post first-quarter profits?

The Taoiseach told the Fianna Fáil ardfheis that he would establish a new central banking commission and a separate financial services consumer agency in order to “mark an end to a sorry chapter in Irish banking history”.

In the weeks ahead, he said, he would introduce “new standards of banking regulation and new standards of corporate governance” as part of a “radical reform” of the system.

The central banking commission would incorporate both the responsibilities of the Central Bank and the supervision and regulatory functions of the Financial Regulator, creating a “seamless powerful organisation with independent responsibility” and new powers for ensuring the prudential health, stability and supervision of the banking and financial sector.

Within the new central banking commission, the Government will appoint a new head of banking regulation to be recruited from overseas, while a financial services consumer agency will be created by merging the existing consumer directorate of the Financial Regulator and the Office of the Financial Services Ombudsman.

So is this really radical reform or just a cost-cutting exercise? Given that the Financial Regulator already exists under the auspices of the Central Bank and Financial Services Authority of Ireland (CBFSAI), is this just a rearranging the deckchairs? And what has Canada got to do with it all?

Dr Jonathan Westrup, faculty member of the Irish Management Institute (IMI) and an expert on financial regulation, says the reference to Canada is “intriguing”, largely because the distinguishing feature of the Canadian regulatory system is that its central bank, the Bank of Canada, has never had responsibility for regulation.

Instead, its Office of the Superintendent of Financial Institutionshas regulated both the banking and insurance sectors while, unusually, regulation of securities is devolved to the individual Canadian provinces, although a draft Securities Act proposes to centralise this function.

These provincial bodies also have a consumer protection mandate in relation to securities but, for the broader sphere of financial services, consumer protection and education has rested since 2001 with the Financial Consumer Agency of Canada.

Despite a positive response to its role from Canadian consumers, the Financial Consumer Agency of Canada’s budget is, by its own admission, “limited”, forcing it to develop partnerships with a number of consumer associations, not-for-profit associations, provincial departments and other agencies to get its job done.

Its 2008-2009 annual budget is only 10.7 million Canadian dollars (€6.6 million), which includes government funding of two million Canadian dollars (€1.2 million) for a financial literacy initiative.

To put this into context, the Financial Regulator’s consumer directorate’s expenses came to €16.2 million in 2007 (out of total expenditure of €49.3 million at the regulator), while the budget of Financial Services Ombudsman Joe Meade’s office was €3.7 million in the same year.

“On the face of it, the relevant part of the Canadian model to which the Taoiseach refers, is the hiving off of the consumer protection aspect of regulation,” says Westrup.

It is a concern that appears to be shared by the regulator’s consumer director and acting chief executive, Mary O’Dea. A statement issued by the regulator the morning after the Taoiseach’s ardfheis speech stressed that the consumer directorate had, to its mind, “worked extremely well” for consumers.

“It is important that this level of consumer protection is maintained in any new structure,” the statement said.

For its part, the regulator reviewed its business practices late last year and concluded that what it needed, or wanted, was not two directorates (prudential and consumer) but three.

The prudential directorate, it believes, should be split in two, with banking and insurance on one side and markets and securities on the other.

But what power, or lack of power, the new consumer agency gets is just one of the as-yet unanswered questions. How the ombudsman’s office, which has a semi-judicial role, would slot into the proposed new consumer agency, is unclear, as is what the Government intends to do with insurance and securities regulation.

For Westrup, who believes the Taoiseach’s comments do amount to a potential radical reorganisation rather than a tinkering around the edges, one of the most important issues relates to the position of the new head of banking regulation – the much-vaunted overseas recruit who, it has been implied, will come in and fix the cracks in the regulatory system.

“What will be the relationship between the governor of the Central Bank and the head of banking regulation?” he asks.

It’s a pertinent question because of the extent to which the lines of responsibility between the Central Bank and the Financial Regulator have been blurred.

One of the more likely features of the new head of banking regulation post is that it will come imbued with explicit accountability direct to the Minister for Finance rather than to the governor of the new central banking commission. For its part, the regulator has asked the Government for clarity in relation to its enforcement powers.

In any case, the concept of a standalone financial regulator, completely separate from the Central Bank, which is the practice in many European countries and the ignored recommendation of the 1999 McDowell report, appears to be off the menu.

It may well prove to be the case that it is not the precise regulatory quirks of the Canadian system that the Government envies, but rather its overarching culture of financial prudence: maximum loan-to-values (LTVs) on household loans are commonly 75 per cent compared to the 100 per cent that existed here at the peak of the housing bubble.

Last month, Canada’s banks even secured the Barack Obama seal of approval, when the US president noted that the difference between its profit-making banks and US ones was “striking”.