J. Conclusion

• Author: M.H. Ogilvie
• Profession: LSM, B.A., LL.B., M.A., D.Phil., D.D., F.R.S.C. Of the Bars of Ontario and Nova Scotia Chancellor's Professor and Professor of Law, Carleton University
• Pages: 81-82

Page 81

Modern states have many reasons for regulating banks and other financial institutions as demonstrated by the regulatory bodies discussed in this chapter. Central banks such as the Bank of Canada were originally established to give advice on national economic policy and to conduct one aspect of that policy: monetary policy. A central bank is at the heart of any country’s economy and its banking system because it is both the government’s bank and the banks’ bank. As the government’s bank, it gives advice; ensures monetary stability through supporting the currency, maintaining price stability, controlling the amount of money and credit provided through the banking system, and providing for adequate reserve requirements; and it is the lender of last resort to the commercial banks. In addition to managing monetary policy, however, the activities of a central bank also point to other reasons for regulation.

A second reason is to control systemic risk, that is, the possibility that the entire banking system might collapse as a result of one significant incident, and with it, a national economy. Systemic risk is derived from the linkages that necessarily exist among financial institutions through the clearing and settlement systems, so that if one member has a liquidity problem and cannot make payments, the entire payment system has the potential to collapse. Related is another type of systemic risk, where one institution becomes known to have solvency problems and the public responds by making a run on other banks, which are perfectly stable and solvent. As a lender of last resort, the central bank can guard against such risks by ensuring the efficiency and security of the clearing and payments system and being a last resort lender to a financial institution in difficulty, in order to keep the entire system operating. Systemic risk is the main reason for regulation of and by a central bank and of any organization, such as the Canadian Payments Association, which operates national payment and settlement systems or the Office of the Superintendent of Financial Institutions, which works to ensure that no financial institution reaches a solvency situation that could put the entire system at risk.

A third reason for state regulation of the banking sector is to minimize fraud through money laundering and terrorism. Markets require honesty and trust if they are to operate smoothly; fraud must be kept to a minimum and be known to be an...