Canada needs to prepare as the risk of bank runs rises, warns report

Canada may not have experienced a significant banking failure in many years, but there are "emerging clouds on the horizon" suggesting the current safeguards may require adjustments to remain effective, according to a former official from the nation's top banking regulator.

Mark Zelmer, a senior fellow at the C.D. Howe Institute and former deputy superintendent at the Office of the Superintendent of Financial Institutions, highlighted that the collapse of several U.S. regional banks and Credit Suisse in Switzerland in 2023 shows that the reforms implemented after the 2007-08 global financial crisis are no longer sufficient.

“It would be easy to say, don’t worry, be happy because everything has gone well for several decades,” Zelmer remarked. “But I think last year’s events have led me to think that the world is changing. It is better to think when times are calm about how things could evolve in the future as opposed to waiting for the problem. I would hate for Canada to lose its reputation.”

In 2023, authorities in the U.S. and Switzerland had to intervene to prevent these banking failures from sparking broader disruptions in their financial systems. For example, Silicon Valley Bank lost almost 85 percent of its deposits within two days, demonstrating how quickly bank runs can occur in the digital age, Zelmer explained, adding that this risk is likely to grow.

He also pointed out that smaller, less sophisticated institutions could collectively cause problems if they follow similar business models, as seen in the U.S. bank failures.

Zelmer warned that the significant expansion of regulatory oversight in the past 15 years could blur the lines between bank management and regulatory supervision. He added that such an approach could stifle innovation, as banks may simply manage “to the regulatory requirements.”

Zelmer proposed several options for making the banking system more sustainable, though none are a "clear panacea" and could lead to higher costs for Canadian households and businesses. One option is to offer full deposit insurance coverage. Currently, deposits in Canada are insured up to $100,000 per category. While expanding this coverage could boost depositor confidence, Zelmer noted that past experiences show it might not significantly reduce the risk of bank runs.

“This could be a topic worth exploring in the federal government’s planned review of the deposit insurance framework announced in its 2024 budget,” he said.

He also recommended that the Canada Deposit Insurance Corporation (CDIC) complete its payout modernization project to ensure depositors can be reimbursed quickly in the event of a bank failure. Additionally, banks could be encouraged to hold larger stocks of high-quality liquid assets to help them survive longer in the event of a run.

Zelmer suggested the Bank of Canada could modify its emergency liquidity facilities to make them more accessible during times of stress. “The moment a bank goes to the Bank of Canada looking for money, it immediately signals that the bank is in trouble,” he said. “Nobody wants to do that because it basically says that you have lost the confidence of financial markets at that stage.”

While none of these options is perfect, Zelmer emphasized that the key takeaway is that “people should start talking about what kind of banking system they want in the future given what happened in recent years.”