The banking system needs to serve the real economy and not the inverse, Bank of Canada governor Mark Carney, shown speaking in March 2009, told a Montreal business audience Monday. (Jimmy Jeong/Canadian Press)

Governments, regulators and central bankers must be diligent in building a global financial system that has learned the lessons of the recent collapse, Bank of Canada governor Mark Carney told a Montreal business audience in a speech Monday.

Following three quarters of sharp contraction, it is becoming clear that an economic rebound is underway in Canada as profits return to financial firms and economic activity is rebounding globally, Carney said.

"What is perhaps less evident is that these returns are largely the product of public policy."

Amid the demand to get tough on financial firms to ensure they can't repeat their own mistakes, there are concerns that implementing heavy-handed regulations on them now could stifle nascent economic growth.

But the timing of financial reform will not hurt global recovery, Carney said, if it is handled responsibly.

In recent months, governments and central banks have poured money into the global economy in an attempt to stimulate them back into growth. Some industrialized nations have committed a "remarkable" 25 per cent of gross domestic product to their financial sectors, Carney said.

He lauded the G20's recent pronouncements on reshaping the financial system.

The goal should be a system "where financial institutions and markets play critical — and complementary — roles to support long-term economic prosperity," Carney said.

Up to Canadian levels

In September, Carney was one of several central bankers to agree at a conference in Switzerland to a set of standards to strengthen financial regulation globally. Those principles were later adopted by the G20 nations at the Pittsburgh summit.

Most of those rules dealt with how much leverage banks can take on and how much capital they must keep on hand to offset loans. They essentially brought the rest of the world up to the level that Canadian banks have been at for years, Carney said.

Still, he cautioned against complacency, despite tentative signs of growth.

"After a series of extraordinary measures to keep the system functioning, we are awash in moral hazard," Carney warned. "The financial system must transition from its self-appointed role as the apex of economic activity to once again be the servant of the real economy."

The bank has a strong preference for principles-based regulation and reliance on the judgment of people, rather than blind faith in the security blanket of excess capital, Carney said.

'Fevered battlefield vows'

"We will not remind market participants of the many oaths they swore a year ago; nor do we expect scores of financiers to join religious orders," Carney said. "However, we do expect those fevered battlefield vows to be respected."

Ultimately, Carney said, the system must be set up so that risk is again assumed by financial institutions. But if they fail, so be it.

On Thursday, the Bank of Canada revealed its latest economic forecast, calling for a 2.4 per cent contraction in the Canadian economy in 2009 followed by growth of three per cent in 2010 and 3.3 in 2011. He reiterated those forecasts on Monday.

And earlier last week, the bank elected to hold its benchmark lending rate steady at 0.25 per cent. Once again on Monday, Carney poured cold water on any idea that the bank would change rates any time soon.

"To put it simply, the bank looks at everything through the prism of achieving our inflation target," Carney said.

With files from The Canadian Press