Consider cost cutting to pay for reforms, Carney tells banks

OTTAWA — Bank of Canada governor Mark Carney says commercial banks can pay for the cost of financial system reform by cutting expenses — particularly personnel expenses — without passing on costs to customers.

OTTAWA — Bank of Canada governor Mark Carney says commercial banks can pay for the cost of financial system reform by cutting expenses — particularly personnel expenses — without passing on costs to customers.

In an address Tuesday to business executives and academics in Germany, the head of Canada’s central bank gave an unqualified thumbs up to the G20 reform process that calls on banks to load up on capital, even though it makes the cost of operations higher.

“In an increasingly multi-polar economy, we simply cannot afford to lurch from crisis to crisis every five years,” he says in notes of the text released in Ottawa.

“To reduce this frequency, we need a strong, universally applied framework. The Basel III rules, combined with (other initiatives), have the potential to be just that.”

Carney said proposals from the Basel III process that require lenders to retain more equity and add a buffer to core reserves strikes the correct balance between “resiliency and efficiency.”

But while Carney said the payoffs will be substantial in the long term, asking banks to hike capital ratios by two percentage points and strengthen liquidity standards will impose costs, both on banks and on the economy.

Past experience suggests Canada’s chartered banks will pass on those costs by increasing borrowing spreads to their clients, Carney said. This could result in a one-time, 0.3 per cent reduction in Canada’s gross domestic product.

Other alternatives, he says, include raising additional capital by issuing equities, holding on to earnings, or shedding assets.

But he adds banks should consider another option —cutting operating costs by reducing personnel expenses, which could involve downsizing or reducing executive bonuses.

“Consider the alternative,” he says. “If banks were to reduce personnel expenses by only 10 per cent, they could lower spreads by an amount that would completely offset the impact of a two percentage point increase in capital requirements.”

Meanwhile, Carney warned that there is no question the system needs reform after its most recent implosion resulted in the worst global economic downslide since the Second World War.

In studies released last month, the Basel Committee proposing reforms has estimated the cumulative loss of past financial crises are significant and long-lasting.

Carney agrees, saying the world, including Canada, will keep paying for the wreckage wrought by the recent financial crisis for years to come.

“The Bank of Canada forecasts that as a result of the crisis, cumulative foregone economic output from 2009 to 2012 will be 16 per cent of gross domestic product in Europe and nine per cent of GDP in Canada,” he says.

Over the long term, we estimate that these shortfalls could grow to about 40 per cent and 30 per cent of respective GDPs.“

Although Canada’s banks held up during the most recent crisis, Carney says those who argue the benefits of reform in Canada will be minimal are mistaken.

He notes the Bank of Canada recently estimated the cumulative payoff for Canada of a more stable global system, fewer failures, and increased competition amounts to about $200 billion, or 13 per cent of current gross domestic product.