The relative soundness of the Canadian domestic financial system throughout the crisis suggests that Canada’s regulatory framework does not require a major overhaul. But Canada could benefit if other countries introduced reforms to improve their macroeconomic stability. Other reforms are needed.international policy, monetary policy, Bank of Canada

Alexandre Laurin

Finn Poschmann

Robin Banerjee

English

Research Papers in Economics

e-brief
International Policy Responses 
to the Financial Crisis: A Canadian Perspective
By Alexandre Laurin,
with Finn Poschmann and Robin Banerjee
Introduction
The recent financial crisis has prompted governments around the world to respond with both conventional and uncon-
ventional economic policy tools. It has also given rise to calls for greater international coordination, or even a complete
overhaul of the global financial regulatory architecture. This e-brief summarizes how governments around the world
have responded to the current financial crisis, and draws some short- and long-term lessons for Canada.
Review of Government Interventions
Among the first government responses were monetary interventions; that is, reductions in monetary policy interest
rates and provision of liquidity to the banking system. Almost every country reduced its policy interest rate. Canada,
which reduced its rate by 75 basis points starting at the beginning of September 2008, reflected both the international
trend and policy coordination among major central banks.
Steps to provide liquidity to the banking system have varied (Table 1). The Bank of Canada and most others have
directly increased liquidity available at regular auctions. Canada and Australia widened the range of assets the central
bank can accept as collateral when lending and others, such as Indonesia and Saudi Arabia, have lowered the reserve
requirements for banks.
Government purchases of bank assets also provide liquidity to the banking system. The United States original-
ly pledged more than $700 billion to buying distressed assets – the plan is now refocused on buying equity stakes and
boosting consumer credit availability. Canada’s plan was different – an initial schedule to buy $25 billion (now $75 
billion) of government-insured mortgages from banks, healthy assets for which the government was already the guaran-
tor of default risk. Australia also announced a plan to purchase residential mortgage-backed securities from banks.
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November 14, 2008
 The recent crisis demonstrated how quickly and devastatingly problems 
originating in one market can spread to others, and how interventions in one
country may help or hurt others.
.
 The relative soundness of our domestic financial system throughout the crisis 
suggests that Canada’s regulatory framework does not require a major overhaul.
But Canada could benefit if other countries introduced reforms to improve their
macroeconomic stability.
 On the multilateral front, global stability could be improved if there were agreed 
principles on monetary policy focused on inflation control and targeting. Improved
risk management practices, through better credit ratings systems and more 
diversified measures of capital adequacy, should also be on the agenda.INDEPENDENT REASONED RELEVANT
| 2 e-brief
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INDEPENDENT REASONED RELEVANT
e-brief /3
Table 2: Leverage Ratios for Selected Large Banks, as of Q2 2008INDEPENDENT REASONED RELEVANT
| 4 e-brief
Figure 1: Spreads between 3-month LIBOR and Overnight Indexed Swaps, January 2007 
to November 2008
Sources: TD Bank; Bloomberg.
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sReductions in policy rates and liquidity provisions did not quickly reduce international financial institutions’ reluctance to
lend or borrow, as reflected by very high interbank lending rates (Figure 1). In part, the high leverage of large banks is an impor-
tant contributing factor to this credit freeze. Canada’s large banks have leverage ratios – bank assets to equity – in the low end
among international financial institutions, meaning they were relatively well capitalized entering the crisis. Others, such as
Barclays, ING Group, Deutsche Bank and Dexia, had leverage ratios well above that of Canadian banks (Tables 1, 2).
Concern over high leverage ratios has been magnified by uncertainty about the quality of assets held by some banks;
European banks, for example, tended to hold shaky US-origin mortgage-backed assets. They also had been large purchasers of
private credit insurance: the near demise of AIG sent a shock to the global financial system, as banks had relied on private credit
insurance to maintain their regulatory capital at acceptable levels. 
France, Germany, the US and the UK, among others, also undertook bank recapitalization, buying equity stakes in numer-
ous large institutions, typically in the form of preferred shares. European governments’ recapitalization plans could amount to
about US $2.5 trillion while the US plans could amount to less than $700 billion. Many countries offered lending guarantees:
Ireland, France, Germany, Australia, Canada and others offered guarantees on interbank loans. Italy and South Korea offered to
guarantee new bond issues and external debt, respectively. The US and the UK offered to guarantee bank issues of debt. 
Governments have also increased the thresholds on savings eligible for deposit insurance. All European Union member-
countries agreed for one year to guarantee savings of i50,000 or more. Australia guaranteed the deposit base for three years,
and Ireland guaranteed i400 billion of retail and corporate deposits at the country’s six largest institutions. The United States
increased the deposit guarantee to $250,000 from $100,000 per depositor.
Governments have also pursued extraordinary regulatory actions. Restrictions on short selling were imposed in several
countries, including in Canada, Australia, United Kingdom, France and Germany, following the United States lead. Argentina
announced plans to nationalize $30 billion in private pension funds. In the United Kingdom, Brazil and the United States, govern-
ments encouraged mergers and acquisitions of weakened financial institutions.
What Canada Has Recently Done
On November 12, the Bank of Canada announced a series of term loan auctions, at which non-mortgage loans would temporarily
be accepted as collateral, on terms implying a 40 percent “haircut.” The Department of Finance announced an expansion of its pur-
chases from banks of mortgage-backed securities, improvements on the terms under which it would insure banks’ wholesale lend-
ing, and a relaxation of the definition of bank capital for the purpose of meeting regulatory standards. The stated rationale for these
actions was to ensure Canada’s “financial system is not put at a competitive disadvantage by developments in other countries.”
These actions should improve Canadian credit market conditions – however, they are clearly also responses, in the first
instance, to external policy actions.
What Canada Should Still Do
On the domestic front, the Bank of Canada should continue to supply liquidity to financial markets as necessary; the 
existing supply of liquidity may need to be drawn back as the crisis ebbs, to avoid future inflation. Meanwhile, the C.D. Howe
Institute’s Monetary Policy Council recently recommended that the Bank of Canada’s overnight interest rate target be further
reduced, to 2.0 percent.
If these actions prove insufficient in improving stability in credit markets, then Ottawa should consider the following actions: 
￿ Ease the de facto prohibition on large financial sector mergers, and remove existing restrictions on foreign ownership in
the sector. This approach would permit strong institutions to subsume weaker ones, and would also represent a market-
oriented solution. Government purchases of equity stakes in financial institutions would remain a subsequent option. 
￿ Maintain a flexible approach to interpreting capital adequacy requirements, recognizing the need to rely on a diversity of
standards. In the Canadian case, this includes nuanced assessment of lending risks, so that capital set-asides appropriately
reflect risks to which lenders are in fact exposed.
INDEPENDENT REASONED RELEVANT
e-brief /5At the multilateral level, it bears repeating that private and public balance sheets in Canada, notably in the financial sector,
were in relatively good shape going into the crisis. For that reason, Canada can and should act differently from other countries
– in particular, avoiding fiscal interventions that are extremely costly or raise the threat of politicized allocation of credit now
and in the future.
At the same time, however, the crisis has demonstrated how quickly and devastatingly problems originating in one market
can spread to others, and how interventions in one country may help or hurt others. For example, the US government’s rescue
of AIG has been beneficial not only to the US financial system, but to European financial institutions which relied on the 
company’s credit insurance. By contrast, extensions of deposit insurance or bank lending guarantees in some countries have
prompted shifts of deposits or credit flows away from others. These positive and negative spillovers suggest the advantages 
of international policy cooperation in responding to financial market crises.
The relative soundness of our domestic financial system throughout the crisis suggests that Canada’s regulatory framework
does not require a major overhaul. Regulatory spillovers, however, suggest that Canada could benefit if other countries intro-
duced reforms to improve their macroeconomic stability.
In Canada, for example, protecting the inflation-targeting framework underpinning our monetary policy is of paramount
importance; it should be retained, and other nations encouraged to adopt it. Global stability could be improved if there were
agreed principles on national monetary policies focused on inflation control and targeting. Multilateral agreement on principles
underpinning the monetary framework and on regulatory oversight could also be helpful in the following areas: 
￿ principles guiding national policies on consolidated and comprehensive regulation of all financial market participants
and activities; 
￿ improved risk management practices, through better credit ratings systems and more diversified measures of capital
adequacy, including the recognition of differing risks as between retail and wholesale lending; and
￿ increased transparency and disclosure, especially with respect to the balance sheets of large, highly leveraged 
institutions.
As to new multilateral regulatory and supervisory institutions, such as those proposed by France and others, obstacles remain,
owing to uncertainty over what responsibilities would be assigned to a new body, what authority it would have to act on those
responsibilities, and what accountability mechanisms would govern such oversight powers. This raises questions about national
sovereignty and could pose challenges to domestic legislation and regulation, given the need to reconcile a new body with 
existing federal and provincial institutions that provide prudential and conduct oversight.
Conclusion
Throughout the storm that recently hit global credit markets, the Canadian banking sector has exhibited resilience. The federal
government and the Bank of Canada should remain ready to provide additional support for Canadian credit markets as needs
arise. While better multilateral policy coordination is desirable, a selective approach, with respect to international calls for
changes to the regulatory framework, seems wisest.
INDEPENDENT REASONED RELEVANT
This e-brief is a publication of the C.D. Howe Institute.
Alexandre Laurin is a Senior Policy Analyst, Robin Banerjee is a Policy Analyst and Finn Poschmann is Director of Research 
at the C.D. Howe Institute.
This e-brief is available at www.cdhowe.org. Permission is granted to reprint this text if the content is not altered and 
proper attribution is provided.
| 6 e-brief

International Policy Responses to the Financial Crisis: A Canadian Perspective

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