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IMF Country Report No. 14/67

CANADA

FINANCIAL SECTOR ASSESSMENT PROGRAM

March 2014

CRISIS MANAGEMENT AND BANK RESOLUTION FRAMEWORK—TECHNICAL NOTE

This Technical Note on Crisis Management and Bank Resolution Framework on Canada was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed in February 2014.

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Front Matter Page

CANADA

FINANCIAL SECTOR ASSESSMENT PROGRAM

February 2014

TECHNICAL NOTE

CRISIS MANAGEMENT AND BANK RESOLUTION FRAMEWORK

AD REFERENDUM

Prepared By

Monetary and Capital Markets Department

Contents

• Glossary

• EXECUTIVE SUMMARY

• INTRODUCTION

• INSTITUTIONAL ARRANGEMENTS, COORDINATION, AND PREPAREDNESS

• A. Features of Effective Crisis Management Frameworks

• B. Domestic Safety Nets

• C. Coordination and Cooperation before and during Crises

• FEDERAL CRISIS PREVENTION AND MANAGEMENT FRAMEWORK

• A. Early Supervisory Intervention

• B. Official Financial Support

• C. Orderly and Effective Resolution

• D. Federal Deposit Insurance

• IMPROVING THE RESOLVABILITY OF D-SIFIS

• A. Recovery and Resolution Planning

• B. The Non-Viability Contingent Capital Framework

• C. Bail-in

• PROVINCIAL ARRANGEMENTS FOR CRISIS MANAGEMENT

• A. Characteristics of the Provincial Safety Nets

• B. Provincial-federal safety net interaction

• C. Recommendations

• CROSS-BORDER COORDINATION AND EXCHANGE OF INFORMATION

• BOXES

• 1. Lessons from the ABCP Market Turmoil

• 2. The BOC’s Policy Statement on ELA

• 3. Government Support Programs During the Crisis

• 4. Canada’s Experience with Recovery and Resolution Plans (RRPs)

• 5. CDIC’s Provincial Links

• FIGURES

• 1. Financial Sector Structure

• 2. Federal and Provincial Safety Nets

• 3. Inter-agency Committees’ Coverage of Financial Sector Areas

• 4. Use of Bank of Canada Liquidity Facilities

• TABLES

• 1. Main Recommendations Crisis Management and Bank Resolution

• 2. Overview of Inter-agency Committees

• 3. Summary of the Guide to Intervention

• 4. Triggers for Resolution and Winding-Up

• 5. Resolution Tools Available to CDIC

• 6. Provincial Allocation of Prudential Supervision and Deposit Insurance Functions

• 7. Characteristics of Provincial Deposit Insurance Schemes

• APPENDICES

• I. OSFI’S Intervention Powers

• II. Considerations in Introducing Depositor Preference

• III. Observations on the Federal Deposit Guarantee Scheme

• IV. Bail-in Within Resolution

Glossary

Executive Summary¹

This note elaborates on the main recommendations made in the Financial Sector Assessment Program (FSAP) Update for Canada in the areas of crisis management and bank resolution. It summarizes the findings of the FSAP Update missions undertaken during June 19–23, 2013 and September 9–20, 2013 and is based upon the analysis of the relevant legal and policy documents and intensive discussions with federal authorities, the Autorité des Marchés Financiers (AMF), and private sector representatives. The key findings and recommendations of this technical note are summarized below.

The resilience of the Canadian financial system is a testimony to strong prevention policies. The country’s longstanding financial stability was underpinned by traditionally strong prudential supervision and regulation, conservative financial sector policies and business models of banks, as well as sound economic fundamentals. The authorities continuously improved and adapted the legal and institutional arrangements to reflect evolving market conditions and risks. Canada was consistently a frontrunner in implementing the key elements of the global financial reforms before and following the recent crisis.

The Canadian safety net is complex well established, and enjoys a high level of credibility. A substantial part of the financial sector is covered by the federal safety net, while each of the ten provinces has functionally-independent crisis management arrangements. At the federal level, the Minister of Finance (MOF) is legally and operationally the financial stability “gatekeeper”. The government has broad intervention powers and can supersede certain decisions of both the Office of the Superintendent of Financial Institutions (OSFI) and Canada Deposit Insurance Corporation (CDIC) based on financial stability grounds. The OSFI, CDIC, and Bank of Canada (BOC) have each established leading practices in their areas of responsibilities. The provincial deposit insurance systems (DIS) and resolution frameworks are highly heterogeneous and the FSAP’s analysis, based on extensive discussions with the AMF and publicly available information, suggests that the preparedness to overcome financial stress should be enhanced.

The federal legal and institutional arrangements for resolving individual financial institutions are robust. The intervention framework is well articulated, underpinned by strong legal powers, and transparently communicated to the industry in the form of a joint OSFI-CDIC “Guide to Intervention.” CDIC has a broad resolution toolkit, although some important tools (i.e. those provided under the Financial Institution Restructuring Provisions—FIRP from the CDIC Act) can only be activated based on a decision of the Governor in Council following a recommendation from the MOF. The CDIC has developed a detailed operational framework for resolution and has recently introduced a single depositor view system. BOC has a strong emergency liquidity framework. A set of committees brings together the main regulatory authorities at federal level and provides a strong level of coordination and communication. The well-known mandates of participating agencies facilitate clarity of responsibility; and a high degree of informality permits flexible operation and a nimble response to arising issues.

However, the lack of a mandate in some specific areas means there is a risk of gaps in coverage, which could weaken the ability of the authorities to spot emerging problems and to respond in the most effective manner. The BOC conducts regular assessments of the stability of the financial sector, but this exercise is hindered by data gaps and lack of access to some important information. No-one has a mandate to collect and analyze data for the financial system as a whole—federally and provincially regulated entities, unregulated entities, and markets. In the absence of such a mandate, a complete set of information is not collected on a systematic and regular basis and the policy actions to the buildup of systemic risks may be delayed. Moreover, an overarching policy and operational guidance to respond to a system-wide crisis is missing. Coordination failures could be accentuated by shortfalls in communication between federal and provincial authorities.

Clear mandates should be assigned (i) to monitor systemic risk in order to facilitate macroprudential oversight, and (ii) to carry out system-wide crisis preparedness. For performing the macroprudential oversight, such entity should have participation broad enough to allow a complete view of systemic risks, and powers to collect all necessary data for systemic risk analysis. For crisis preparedness purposes, such entity should operationalize a coordination framework composed of policies, procedures, and operational guidance to support timely and effective decision making in a crisis situation. Comprehensive simulations to test the capacity of the authorities (federal and provincial) to respond to broad and severe scenarios should be performed on a periodic basis. The cross-sectoral resolution frameworks should also be better articulated.

The CDIC’s autonomy in activating resolution tools needs to be improved and its resolution powers further strengthened. The CDIC should have greater independence in activating various resolution tools (including those provided in the FIRP of the CDIC Act), while governmental approval would be maintained in situations which may involve public funds or ownership (e.g. bridge banks). The CDIC should be empowered to require companies in the same group to ensure continuity of essential services in a resolution and be equipped with explicit powers to terminate contracts. Furthermore, its power to temporarily stay the exercise of early termination rights should be enhanced, in line with the Financial Stability Board (FSB) Key Attributes of Effective Resolution Regimes. The merits of introducing some form of depositor preference should be considered, which could mitigate legal risks during a resolution and better protect the resources of CDIC.

The ex-ante funding of CDIC should continue to be bolstered. To achieve the targeted 100 basis points coverage of the insured deposits (from the current 39 basis points), an increase of the premiums paid by financial institutions will be necessary. Enhanced data collection on depositors would ensure that the coverage limit and the target ex-ante financing strike the right balance between depositor protection, financial stability, and market discipline. The proposed simplification of the rules for eligibility for deposit insurance of complex deposit products is welcome.

The provincial arrangements for crisis management and the cooperation with federal authorities need to be enhanced. The provincial safety nets should be reinforced to ensure: (i) enhanced supervision of provincial institutions that may be deemed to be systemically important; (ii) well-funded and prepared deposit insurance systems; (iii) comprehensive resolution frameworks; and (iv) clear policies and operational guidance for crisis management. The longer-term objective should be to introduce more uniformity across the operating standards of the provincial safety nets and convergence towards leading practices. A more integrated communication on financial stability issues at both provincial and federal levels is recommended, while active cooperation on systemically important financial institutions should be a priority.

Table 1.

Main Recommendations for the Crisis Management and Bank Resolution Framework

Table 1.

Main Recommendations for the Crisis Management and Bank Resolution Framework

Coordination	Priority
➢ Provide a clear mandate to an entity (i) to carry out macro-prudential oversight with participation broad enough to allow a complete view of systemic risks, and with powers to collect all necessary data for systemic risk analysis and (ii) to carry out system-wide crisis preparedness	High
➢ Perform regular system-wide crisis simulation exercises	Medium
➢ Enhance cross-sectoral coordination in the supervision and resolution of groups which span over both federal and provincially regulated areas; give priority to communication and cooperation on systemically important institutions (federal and provincial)	High
Provincial safety nets
➢ AMF: Enhance early intervention powers; increase ex-ante funding of deposit insurance fund and introduce a capitalization target and a single customer view system; establish a crisis intervention framework	High
➢ Other provincial authorities: Undertake a self-assessment of the adequacy of safety nets and pursue necessary enhancements to ensure: well funded local deposit insurance schemes, broad resolution frameworks, and operationalized contingency planning	High
➢ All: Review and update, where necessary, cooperation agreements and contingent operational arrangements with federal authorities	Medium
➢ All: Introduce a more uniform approach on coverage levels of provincial deposit insurance schemes	Medium
Resolution powers
➢ Improve autonomy of CDIC in activating a broader range of resolution tools	Medium
➢ Enhance the CDIC’s resolution powers in line with the Key Attributes, including the power to bail-in for D-SIBs	Medium
➢ Introduce legal requirements for the preparation of recovery and resolution plans and powers to change a firm’s structure in order to enhance resolvability	Medium
➢ Consider introducing some form of depositor preference	Medium
Deposit insurance
➢ Bolster the ex-ante resources of CDIC	Medium
➢ Improve data collection on depositors’ profiles	Medium
➢ Simplify the rules for complex deposit products	Medium
Emergency Liquidity Assistance
➢ Remove the legal restriction which prohibits the BOC from taking mortgages as collateral when providing liquidity assistance	Medium

View Table

Table 1.

Main Recommendations for the Crisis Management and Bank Resolution Framework

Coordination	Priority
➢ Provide a clear mandate to an entity (i) to carry out macro-prudential oversight with participation broad enough to allow a complete view of systemic risks, and with powers to collect all necessary data for systemic risk analysis and (ii) to carry out system-wide crisis preparedness	High
➢ Perform regular system-wide crisis simulation exercises	Medium
➢ Enhance cross-sectoral coordination in the supervision and resolution of groups which span over both federal and provincially regulated areas; give priority to communication and cooperation on systemically important institutions (federal and provincial)	High
Provincial safety nets
➢ AMF: Enhance early intervention powers; increase ex-ante funding of deposit insurance fund and introduce a capitalization target and a single customer view system; establish a crisis intervention framework	High
➢ Other provincial authorities: Undertake a self-assessment of the adequacy of safety nets and pursue necessary enhancements to ensure: well funded local deposit insurance schemes, broad resolution frameworks, and operationalized contingency planning	High
➢ All: Review and update, where necessary, cooperation agreements and contingent operational arrangements with federal authorities	Medium
➢ All: Introduce a more uniform approach on coverage levels of provincial deposit insurance schemes	Medium
Resolution powers
➢ Improve autonomy of CDIC in activating a broader range of resolution tools	Medium
➢ Enhance the CDIC’s resolution powers in line with the Key Attributes, including the power to bail-in for D-SIBs	Medium
➢ Introduce legal requirements for the preparation of recovery and resolution plans and powers to change a firm’s structure in order to enhance resolvability	Medium
➢ Consider introducing some form of depositor preference	Medium
Deposit insurance
➢ Bolster the ex-ante resources of CDIC	Medium
➢ Improve data collection on depositors’ profiles	Medium
➢ Simplify the rules for complex deposit products	Medium
Emergency Liquidity Assistance
➢ Remove the legal restriction which prohibits the BOC from taking mortgages as collateral when providing liquidity assistance	Medium