A former senior bank regulator is warning the country’s largest financial institutions that rising geopolitical tensions — including a changing relationship with the United States — is increasing the risk of their assets being stranded abroad.

In a

paper published by the C.D. Howe Institute

on Thursday, Mark Zelmer, former deputy at the

Office of the Superintendent of Financial Institutions

, warns that authorities have begun to test the waters of preventing “repatriation” of assets to a lender’s home country in times of stress, and that rising tensions with U.S. makes the risk especially acute for

Canadian banks

that have large operations there.

Zelmer said that Canada’s decision to ring-fence the Canadian assets of Maple Bank, a small German lender that ran into financial difficulty in 2016, was something of a precedent for how regulators in other countries might respond.

“We should not be surprised if the United States and other countries would be willing to ring-fence a much larger Canadian bank with many foreign depositors,” he wrote.

“The risk of such behaviour becomes more acute in the current geopolitical environment, where international cooperation is generally becoming more challenging, especially when it comes to dealing with the United States.”

Despite a raft of post-financial-crisis reforms introduced to encourage more cross-border cooperation, this growing risk is especially acute for Canada because the U.S. operations of

Bank of Montreal

and

Toronto-Dominion Bank

rival the size of their Canadian operations in terms of both assets and revenues, said Zelmer, who was deputy superintendent of financial institutions at OSFI from 2011 to 2016.

In his paper, he urged major Canadian banks and insurers to keep more of their surplus capital and liquidity at home — despite the potential appeal of investing a large portion of assets backing surplus capital offshore to minimize tax and other expenses — so foreign jurisdictions would have less leverage in times of stress.

He also pushed for more public information about how interconnected parent companies are with their foreign operations, including branch networks and subsidiaries, warning that if a bank got into trouble, it might be restricted in accessing money invested abroad or held in foreign custody accounts until that country’s stakeholders are satisfied — which could hurt Canadian depositors and creditors.

“To the extent that these investments are held in foreign financial infrastructure or foreign custody accounts, there is a risk that they … could be potentially blocked or ring-fenced (frozen) by foreign regulators and courts,” he said, adding that Canada’s six biggest banks have large credit exposures and investments abroad and carry significant investments in foreign securities and other assets on their domestic balance sheets.

“(Given) how bank runs can destabilize even a solvent bank (such as Home Capital’s experience in 2017), it is important that OSFI and policymakers pay close attention to bank practices … to ensure that they are closely attuned to the risk of surplus assets being frozen or ring-fenced by foreign authorities from a liquidity management perspective.”

Zelmer said he understands that OSFI is in talks with the Big Six —

Royal Bank of Canada,

TD, BMO, Bank of Nova Scotia,

Canadian Imperial Bank of Commerce

and National Bank of Canada — about geopolitical risk. But he offered regulators and policymakers ideas on how they and internationally active Canadian financial institutions could start to manage these risks.

Among his recommendations is to look at tightening risk weights applied to parent bank exposures to foreign branches and subsidiaries. While these were set by OSFI in 2023 as part of new “solo capital” requirements, Zelmer said they should be revisited “given the changes that have taken place in Canada’s relationship with the United States” since then.

“They also appear to be very generous relative to the Bank of Nova Scotia’s experience in selling its Argentinian operations more than 20 years ago and compared to the solo capital requirements imposed by many other jurisdictions,” Zelmer said.

He acknowledged that such suggestions may seem out of step considering OSFI has taken the position recently that Canadian banks’ strong capital position should be deployed in some instances to help with a broader economic and trade pivot away from dependence on the United States, through more business loans, for example.

“To be clear, we are not going so far as to advocate that major Canadian banks need to carry more common equity capital,” Zelmer wrote. “Instead, we are simply suggesting … that those institutions may need to consider making changes to the mix in their sources of debt funding.”

Issuing more bail-in bonds — a post-crisis debt security created to reduce the potential for a government/taxpayer bailout of a bank — could ensure banks’ investments in their foreign subsidiaries would be fully capitalized, he said.

“This would not meaningfully increase the cost of funds to the banks and, therefore, to the cost of credit supplied to the economy.”

Zelmer said policymakers could do more than simply urge Canadian banks and other financial institutions to volunteer to hold more of their surplus capital at home, and the best way to do that would be to dig in to why they are putting so much abroad in the first place.

“In this new geopolitical environment, we would as a society be well served to do what we can to reduce the leverage that foreign authorities can deploy should we ever have to coordinate with them in the management of a distressed Canadian financial institution,” Zelmer wrote.

  • Banks could lend an additional $1 trillion to help economy adapt
  • Fitch expects Canadian banks to come under increased scrutiny

“But we would encourage governments to first clearly identify the root cause of why banks are investing their surplus capital and liquidity offshore. That way, any new tax or other public measures can be clearly targeted at addressing the root cause to minimize the risk of unintended economic or financial stability consequences from the introduction of such measures.”

• Email: bshecter@postmedia.com