The Bank of Canada will maintain some of the emergency lending programs that helped keep markets humming during the worst days of the financial crisis, but investors shouldn't interpret that as an open-ended "willingness to intervene" on institutions' behalf in normal times, a deputy governor said Wednesday.
"It is important that financial system participants do not believe that our intervention in times of crisis implies a willingness to intervene in normal times," David Longworth, one of Governor Mark Carney's five deputies on the panel that sets interest rates, said in a speech to the C.D. Howe Institute in Toronto. "It is also important that we retain considerable flexibility about when and how to intervene in the next crisis to fulfill our mandate to be liquidity lender of last resort to the financial system in the event of a systemic shock."
The central bank's implication is - in keeping with what Mr. Longworth called the need to guard against "moral hazard" - now that the crisis has "subsided," policy makers will carefully consider whether an institution in need of emergency cash, or the market in which it participates, is important enough to the overall financial system to warrant assistance.
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"The financial crisis has subsided, and financial conditions have improved significantly over the past 10 months, both globally and in Canada," Mr. Longworth said in his speech, the text of which was published on the Bank of Canada's website.
Still, crisis-linked programs such as the so-called term purchase and resale agreements, which are cash auctions that form a key part of the inner workings of bank lending, and other term loan facilities should stay part of policy makers' "toolkit," Mr. Longworth said.
The term PRA facility, for instance, was "used heavily" through the crisis, he said, and "appears to have contributed to reduced market stress and a return to well-functioning money markets.'' The bank has already ended two of its emergency programs and Mr. Longworth said policy makers will act "deliberately and thoughtfully" as they work to unwind others.
While no major Canadian bank required a government bailout over the past year-and-a-half, Mr. Longworth said even lending programs that were little used during the crisis helped maintain a sense of certainty and stability in markets.
Mr. Carney said in June that he was considering making permanent the special cash auctions because it would be "totally unacceptable" to allow critical credit markets to seize again.
"The performance of core funding markets during the crisis intensified the financial panic and helped trigger the recession," Mr. Carney said in Regina. "As the ultimate provider of liquidity to the system, the bank is thinking through whether to adapt its facilities to support continuous private liquidity creation."
Those remarks were among the first indications of Mr. Carney's efforts to craft a post-crisis Bank of Canada with a mandate that goes well beyond raising or lowering interest rates to control inflation.
In December, a central bank assessment of the financial system showed that Mr. Carney was devoting significant effort to making the arcane markets that cycle money through the financial system more resistant to the types of shocks that brought down the world economy last year.
The article also for the first time identified "core funding markets" that the Bank of Canada considers necessary for the proper functioning of the financial system, implying policy makers would do whatever necessary to keep them from collapsing.
They included repurchase agreements, or repos - essentially, cash loans backed by collateral, with a promise to repurchase the collateral at a future date - markets for government debt, securities lending, bankers' acceptances, and foreign exchange.
While the identification of those markets as systemically important creates implicit government backing, it also means policy makers will be taking a more active role in oversight to minimize the risk of collapse.
With files from Kevin Carmichael in Ottawa and Boyd Erman in Toronto