Consultations on the Bank of Canada Emergency Lending Policies: Summary and Responses to Comments Received

On 5 May 2015, the Bank of Canada published a consultation document entitled “Bank of Canada Emergency Lending Policies.” The consultation period ended on 4 July 2015. The following summarizes the comments received and the Bank of Canada’s responses to those comments.

The Bank thanks all parties for the comments they provided during the consultation process. Taking into consideration the feedback obtained, the Bank has decided to implement the changes that were proposed in the May consultation paper. These changes, effective immediately, were related to the following areas:

• The role of ELA in effective recovery and resolution of financial institutions (FIs)
• ELA for provincial deposit-taking institutions (DTIs)
• Acceptance of mortgages
• ELA for financial market infrastructures (FMIs)

The Bank will publish an updated ELA policy statement later this year to reflect these changes.

The Role of ELA in Effective Recovery and Resolution of Financial Institutions (FIs)

Proposal

The Bank of Canada will eliminate its requirement for a solvency opinion as a condition for the provision of ELA. Instead, a new requirement for a credible recovery and resolution framework will be established.

Comments

• Commenters were overall supportive of ELA’s role in both recovery and resolution but questioned how the credibility of recovery and resolution plans (RRPs)would be judged (e.g., authorities responsible, criteria, frequency of assessments).
• A commenter noted that the Bank’s expectations for small- and medium-sized banks should be proportional to their size, consistent with OSFI’s approach to setting expectations for recovery and resolution plans for non-domestic systemically important banks (non-D-SIBs).
• Other commenters proposed that the Bank implement a standing bilateral “recovery-only” facility (in addition to ELA) to provide short-term liquidity to financial institutions. In their view, users of this facility would suffer less of a stigma than those using ELA.

Response

The Bank will determine whether the preconditions for ELA are met prior to and at the time of an ELA request. The opinions of the relevant supervisors and resolution authorities will be a key determining factor influencing this judgment. In the case of federally regulated FIs, the Bank would consult with other federal agencies through the Financial Institutions Supervisory Committee and the Board of Directors of the Canada Deposit Insurance Corporation.

The Bank does not intend to develop any specific criteria or requirements for recovery and resolution frameworks beyond those that have been or will be developed by the relevant supervisors and resolution authorities. Accordingly, institutions should continue to respect the guidelines and expectations for recovery and resolution planning established by their supervisors and resolution authorities. Before providing an ELA loan to an institution, however, the Bank will undertake the necessary due diligence to satisfy itself that all ELA preconditions have been met.

A recovery and resolution framework consists of the governance arrangements, strategies and tools that would be used by the firm to recover from stress, as well as the powers, governance arrangements, strategies and tools that the authorities would use to support orderly resolution. A recovery and resolution framework is credible if it provides the relevant authorities, including the Bank of Canada, with a high degree of confidence that a troubled institution can be returned to long-term viability or be resolved in an orderly manner, without systemic disruption. This is consistent with the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions.

Documents describing a firm’s crisis-management or contingency planning would help inform the judgment of the Bank and the relevant authorities regarding the credibility of the firm’s recovery and resolution framework. Recovery and resolution plans (RRPs) are not necessarily required of every financial institution in order to achieve a credible framework, but as an institution increases in size and complexity, such plans provide greater assurance that a framework is credible.

The Bank will not create a standing bilateral recovery-only facility. Such a facility was considered under the latest review of the Bank’s tools for liquidity provision. After careful consideration, the Bank concluded that, with the addition of the Contingent Term Repo Facility (CTRF), its toolkit for addressing both idiosyncratic and market-wide liquidity shocks is adequate at this time. The CTRF is described in the document, “Changes to the Bank of Canada’s Framework for Financial Market Operations.” When activated at the Bank’s discretion, the CTRF can provide liquidity to institutions under stress on a bilateral basis, enhancing the Bank’s ability to respond to market-wide stress. Moreover, the CTRF is designed to balance a reduction in the stigma attached to its use and in moral hazard risk.

ELA for Provincial Deposit-Taking Institutions (DTIs)

Proposal

For a provincially regulated credit union, caisse populaire or central to be eligible for ELA, the Bank would require (i) the firm to be a member of the Canadian Payments Association (CPA); (ii) a provincial indemnity against losses incurred by the Bank; (iii) the ELA to be necessary to support the stability of the Canadian financial system; and (iv) the firm to have a credible recovery and resolution framework.

Comments

• Commenters were supportive of a framework that clarifies the eligibility of provincial co-operatives for ELA.
• Some commenters disagreed with the eligibility condition requiring a provincial government indemnity.
• Some commenters disagreed with the eligibility condition that ELA be necessary to support the stability of the Canadian financial system. They perceived this requirement to be unreasonable, since small provincially regulated institutions may not be eligible for ELA (as they pose little risk to the stability of the Canadian financial system), whereas small federally regulated financial institutions (FRFIs) are eligible to receive ELA and are not subject to this requirement.

Response

The provincial indemnity requirement will be a legislative requirement under the Bank of Canada Act, implemented as part of Bill-C43. Bill C-43 was passed in December 2014.

The requirement that ELA be necessary to support the stability of the Canadian financial system encourages credit unions to obtain access to other liquidity resources such as assistance from credit centrals or provincial authorities as first lines of liquidity defence. The Bank serves as a liquidity backstop to such facilities and acts as lender of last resort where the financial stability of Canada is threatened, should these facilities prove insufficient.

The Bank is committed to working with provincial authorities and their financial institutions to ensure that indemnity agreements and other arrangements are in place to pre-position institutions for ELA access if needed.

Acceptance of Mortgages

Proposal

The Bank of Canada will, at its discretion, take mortgages as eligible collateral for ELA: first, indirectly through the pledging of private-label residential mortgage-backed securities (RMBS), then, directly by taking assignments of the mortgages, but only as a last resort to maintain financial stability.

Comments

• Commenters were supportive of the Bank accepting mortgages as ELA collateral. They expressed interest in working with the Bank to resolve legal and operational challenges associated with the pledging and acceptance process.
• Commenters indicated that they would not pledge private-label RMBS either because they are unattractive, owing to the lack of ongoing end-investor demand for such securities, the long lead times required to create them, or institutions’ lack of capacity to create such securities. One commenter suggested that, as an alternative, the Bank could take own-name covered bonds backed by mortgages.

Response

The Bank looks forward to working with market participants to address the challenges associated with pledging RMBS and the direct assignment of mortgages. Given the associated legal and operational risks, the Bank will only take direct assignment of mortgages as a last resort when other viable sources of collateral have been exhausted.

ELA for Financial Market Infrastructures (FMIs)

Proposal

The Bank of Canada could provide ELA to designated FMIs in support of credible recovery and resolution actions. The minimum rate charged would be the Bank Rate, and the Bank would be willing to accept a broad range of collateral at its discretion (and subject to operational constraints).

Comments

• One commenter was supportive of the framework but pointed out the importance of strong risk management for FMIs and stressed the importance of credible FMI recovery and resolution regimes.

Response

The Bank agrees that sound risk management by FMIs is essential for fostering a resilient financial system and to minimize the likelihood that ELA would ever be required. The Bank of Canada’s risk-management expectations for designated FMIs set a high standard and are consistent with the international standards set out in the Principles for Financial Market Infrastructures (PFMIs).1 Designated FMIs are required to have sufficient liquid resources to cover the default of their largest participant under extreme market conditions. The Bank expects FMIs to perform liquidity stress testing on a daily basis to assess their liquidity needs and to verify the adequacy of their total liquid resources at least on a monthly basis. FMIs are also required to have clear procedures to determine whether their liquid resources are sufficient and to adjust their available liquid resources when necessary.

Through its risk-based oversight activities, the Bank monitors liquid resources on an ongoing basis and annually conducts a thorough review of the risk controls of designated FMIs. The Bank also participates in a CPMI-IOSCO review of the implementation of the PFMIs that address financial risk of CCPs, including liquidity stress testing. As noted by the CPMI and IOSCO in March 2015, additional guidance will be provided if warranted.

Designated FMIs are currently in the process of developing their recovery plans. The Bank will review these plans to ensure that they are robust and appropriate. In addition, the Bank of Canada has begun developing an FMI resolution regime.