Canada’s finance minister and the governor of the Bank of Canada have formally complained to their American counterparts that proposed banking reforms intended to address the excesses that led to the 2008 financial crisis could harm Canadian banks, business, investors and the government itself.
In a letter Monday to Treasury Secretary Timothy Geithner, Finance Minister Jim Flaherty warned that the reforms could have "unprecedented extraterritorial reach and significant cross-border effects" in Canada.
"I am particularly concerned that the proposed rule could severely impact the liquidity of Canadian government debt markets and interfere with the risk management practices of Canadian banks," Flaherty said.
In his letter to Federal Reserve chairman Ben Bernanke, Bank of Canada governor Mark Carney argued the changes have the potential for "unintended impacts" on the Canadian financial system.
Carney also raised the possibility that the so-called Volcker rule could weaken the resilience of global banks and insurance companies rather than strengthen it.
Flaherty warned that the reforms prohibit a Canadian bank from sponsoring a mutual fund if the fund bought from and sold to Canadian unit holders who were even temporarily resident in the U.S.
Carney said that Canadian banks play a "critical role" not only in lending to domestic businesses but also in giving investors willing buyers and sellers of their shares in Canadian companies.
Reforms could affect Canadian economy
Such stock market activity supplies about two-thirds of Canadian businesses’ overall financing needs.
The U.S. reforms would appear to limit how Canadian banks could share the risks of holding Canadian shares or Canadian government bonds by entering into arrangements with American banks or insurance companies that effectively insure against those risks.
Carney’s letter pointed out that in Canada approximately 20 per cent of all federal and provincial government debt is held by non-residents, and that of transactions in Canadian bonds done with non-residents, two-thirds are done with Americans.
"If the liquidity of corporate debt and government debt is somehow compromised, that will have a ripple effect on the economy as a whole and will impact corporations' ability to grow and create jobs," said Terry Campbell, president of the Canadian Bankers Association.
"The problem is that the rule does not just apply to Canadian bank operations in the United States, it would apply to their operations around the world."
The Volcker rule is named after former Federal Reserve chairman Paul Volcker, who was commissioned by the White House to come up with U.S. financial reforms.
The reforms aim to lower the exposure of banks holding personal and business cash deposits to the risks from speculative trading for their own profit, something known as proprietary trading.
Changes take effect in July
Those deposits, to a large extent, are insured by the U.S. taxpayers.
Risky bets by big global banks forced the U.S. government to bail out the American banking system in 2008.
The Volcker rule would also end the banks’ practice of holding a controlling ownership in hedge funds or private equity firms.
Canadian banks and insurance companies have significant activities in the U.S. not only through ownership of subsidiaries there, but also by their services to Canadians visiting there and by their roles in the American financial system.
Flaherty and Carney are concerned that American attempts to get their own banks under control could intrude into the area of regulation over low-risk activities by Canadian banks, which both say are widely acknowledged to be part of one of the world's soundest financial systems.
Monday is the final day for public comment on the reforms, which are proposed to take effect in July.
Other countries have also lodged protests, including the United Kingdom and Japan.
Volcker was expected to issue a defence of his proposal, which has also come under attack from U.S. financial institutions, later in the day.