Downfall of a dynasty

Downfall of a dynasty

The last days of Ricardo Salgado and Banco Espírito Santo

Emerging Europe: Special focus

Emerging Europe: Special focus

Exploring the banking and capital-market landscape

October 2012

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Mark Carney: Finance’s new statesman

Regulators have regained their reformist muscle in the shape of Mark Carney, Bank of Canada governor and chairman of the Financial Stability Board. In a wide-ranging interview, Carney talks about recent banking scandals, the Volcker Rule, and why fears about Basle III are wide of the mark.

In September 2011, at a now-infamous closed-door meeting in Washington of global bankers, under the purview of the Financial Stability Board (FSB), JPMorgan chief executive Jamie Dimon launched an ill-tempered tirade against Mark Carney, Bank of Canada governor.

At the meeting, Dimon charged that the Basle III framework was ill conceived both in theory and in practice and would greatly increase the cost of capital in an already subdued global economy. Dimon also argued that the capital surcharge for systemically important institutions (Sifis) was disproportionate and, in particular, penalized US banks in capital calculations.

The attack on the Bank of Canada governor – who was accurately tipped at the time to become the next FSB chairman – was promptly leaked, grabbing global headlines. The outburst nurtured a narrative in the court of public opinion: global bankers had launched a full-scale assault on root-and-branch regulatory reform, led by the pugnacious JPMorgan chief.

"Dimon was being very aggressive in order to intimidate Mark," said one person privy to the meeting. Carney – who was visibly unsettled by Dimon’s attack – delivered a public speech a couple of days later to the Institute of International Finance (IIF). He remarked: "If some institutions feel pressure today, it is because they have done too little for too long, rather than because they are being asked to do too much, too soon". Although the speech had been written at least a week before Dimon’s tirade, it was widely seen as a riposte to his detractors, highlighting Carney’s reformist resolve and desire to mitigate the systemic excesses of the industry.

Dimon – who promptly apologized to the governor for his outburst – is no longer feted as the last banker standing post-crisis. Although JPMorgan has emerged larger and healthier than many of its rivals since the Lehman Brothers collapse, Dimon’s leadership and reputation was tarnished in May when his bank’s opaque chief investment office (CIO) lost up to $5.8 billion in trades, which he attributed to "errors, sloppiness and bad judgement". The losses put the spotlight on a seemingly unreconstructed deposit-guaranteed industry that garners profits on proprietary bets, with little operational or regulatory scrutiny.

Carney, who was appointed FSB chairman in November 2011, is tasked with implementing the Basle III accord. His in-tray is groaning under the weight of the reform agenda and the ostensibly insurmountable challenges: crafting a regulatory system that reduces the prospect of another financial meltdown, but without choking off capital formation in an already depressed global economy.

Carney is staking his credibility and reputation that Basle III – the third global regulatory effort in around two decades – is the world’s best bet to reduce the risk of another financial Armageddon. In his capacity as chairman of the global agenda-setting and co-ordinating body, which works with the Basle Committee on Banking Supervision, he is executing changes to the composition and definition of capital, liquidity and counterparty credit risk, capital buffers and the leverage ratio, while crafting a single rule book, enhanced supervisory measures and sanctions for noncompliance.

These regulatory efforts have been given renewed vigour as global banks’ business practices are once again in the spotlight this year, from HSBC’s money-laundering drama, JPMorgan’s CIO loss, Nomura’s insider-trading scandal, Barclays and the Libor manipulation, and the probe of Standard Chartered’s dealings with Iran.

The instinctive defence from some quarters of the banking industry – that these are, generally speaking, unrelated cases of risk-management or governance failings that existing market and supervisory mechanisms will address – clash with the emerging narrative.

Put simply, despite four years of ground-breaking global cooperation, tougher supervisory codes, G20 summits, and market pressures for reform, calls are growing for ever-tighter financial regulation to reduce the incentives for risk-taking. The jury is out on whether global universal banks are still too complex to manage or simply too big.

What’s more, these developments have taken place amid a leadership vacuum in global banking. There is a vanishingly small number of senior international banking executives with the guts and personalities to defend publicly the size and structure of their multi-product, multinational business models at a time when recent scandals have emboldened the reformist mission.

Against this backdrop, it’s not hard to draw a cartoonish caricature portraying Carney as the hard-nosed reform advocate, battling valiantly against the forces of incompetent or casino banking that perennially threaten to besiege the financial system.

But when Euromoney sits down with Carney in the Bank of Canada’s headquarters in Ottawa, the FSB chairman, who succeeded Mario Draghi in the post, is circumspect and thoughtful, attempting to strike a judicious balance between economic stability and credit expansion. He also refrains from caricatured judgements, perhaps unlike some of his peers in the policymaking community.

"The reform agenda is being pursued with a legitimate effort to increase the resilience of the system in the most efficient way possible. We could build capital to the moon and we would not have to worry about an institution failing but the economy would not be there," he tells Euromoney. "The interests of the private financial community should be absolutely aligned with those of the regulatory community to grow the real economy in a sustainable way. And the more enlightened members of the financial community have that perspective."

Carney cuts a statesman-like figure, rising above partisan affiliation, respected even by his detractors, and consistently open to dialogue, say bankers, all of whom are critical of the intellectual and operational thrust of Basle III.

Rick Waugh, chief executive of Scotiabank, who witnessed Dimon’s onslaught, says: "Even when he had that unfortunate incident – and he has had many since then – that has not stopped him from collaboration. He is aware of the risks of Basle III; he is concerned about its complexity and encourages dialogue with the private sector. So that’s his strength – that he is trying to understand [our] position."

Gordon Nixon, chief executive of Royal Bank of Canada
Gordon Nixon, chief executive of Royal Bank of Canada
Gordon Nixon, chief executive of Royal Bank of Canada, agrees: "He acknowledges the fact that the complexity and over-reach of regulation inflicts economic damage and he is fighting to achieve a better balance between regulation and growth within a very constrained political context. I would rather have him fighting for that balance than anyone else I have ever met in the regulatory or political world."

Although recent scandals have reintroduced calls to break up the big banks even as they maintain their argument that the universal banking model benefits from diversification of geographic exposures and earnings by business type, Carney’s assessment is more nuanced. He principally cites the failings in operational oversight and culture, rather than the inherent structural risks of scale and complexity, in the most recent scandals.

"In these [recent] episodes there were fundamental issues of conduct, and troubling issues of oversight, be it risk management or operational oversight," he says "It is not truly accurate to say they prove something systemic. A common aspect in several cases is that the people involved did not appear to take into account wider societal norms or the implications between what they did and their institution’s ultimate relationship with the real economy." He cites money-centre and deposit banks in the US and elsewhere as evidence that it is possible to run well-managed large, global institutions, although he refrains from naming specific banks.

Meanwhile, JPMorgan’s trading losses have given ammunition to enthusiasts of the US’s Volcker Rule, which, as proposed, allows deposit-guaranteed banks to hedge against risk, but does not allow principal trading for profit. Carney, though, in his capacity as Bank of Canada governor, formally complained in January to the US Treasury that the planned rule might place Canada at a competitive disadvantage by reducing liquidity in the country’s sovereign debt market. He says the distinction between market-making and proprietary trade is not made clear in the draft rule, which exempts trades in US treasuries from the prohibition.

Asked if the JPMorgan CIO losses offer a lesson for regulators, Carney doubles down in his critique of any rule that attempts to make a workable distinction between proprietary trading and hedging, although he refrains from mentioning the JPMorgan case specifically. He adds: "Even spot market-making has an element of positioning so the question is when do relatively short-lived positions – in order for market-makers to build a market – become a truly prop trade?"

His doubts about the practicality of the Volcker Rule clearly hold more weight by virtue of his status as FSB chairman – and demonstrate how he strikes a fine balance between his international and domestic commitments. From a systemic risk perspective, Carney believes recent dramas add momentum to Basle III’s fundamental review of the trading-book capital rules, which, along with increased capital requirements, includes a more objective boundary between the trading book and banking book to reduce regulatory arbitrage, a move from a value-at-risk model to expected shortfall, to capture tail risk, and more risk-related and liquidity-related stress-testing under a standardized framework.

"It matters whether Basle III and the new trading-book rules have actually been implemented for the scale of risk a bank can take on a portfolio hedging strategy that is more of a directional bet or prop-like, as opposed to pure hedging," he says. "That additional capital not only provides an extra cushion if there is a loss but makes the trade less profitable and disincentivizes it."

Carney seems comfortable with the universal banking model – if buttressed by low leverage, prudent lending practices and strong supervision, as Canada’s success lays bare – but his ideological antipathy to Dimon’s views runs deep. Dimon’s attack on Basle III – reflecting the views of many of his global banking peers, who rarely speak on the record with such candour on regulatory affairs – is rooted in a laissez-faire view of the world. In an illuminating testimony to US policymakers in January 2010, Dimon incurred the wrath of reformers with the following statement: "My daughter asked me when she came home from school, ‘What’s the financial crisis?’ and I said, ‘It’s something that happens every five to seven years.’"

Carney has repeatedly attacked this type of fatalism, a view of the world that is typically romanticized by the US right as a reflection of capitalism’s creative destruction. After all, this philosophy was, to a large extent, the bedrock of the US economic and monetary order pre-Lehman. As Greenspan said in 2009: "We will have more crises and none of them will look like this because no two crises have anything in common except human nature."

Christopher Whalen, co-founder of Institutional Risk Analytics, caricatures the US libertarian perspective that indicts the Basle III project: "The statist, anti-democratic construction of Basle III is out of step with traditional ideas of American democracy and free enterprise. The world of Basle III is all about top-down management of the economy," he notes in a Reuters blog.

Global bankers know they have lost much of the pro-laissez-faire argument and are prepared to make some concessions. Conscious of sailing against the regulatory wind, bankers, particularly at multinational multi-product institutions, publicly say they accept Basle’s call for higher capital requirements, and most have indeed made progress in amassing capital. They generally say they now wish to water down some of the proposals, such as capital surcharges, restrictive definition of capital, as well as liquidity frameworks, and, more generally, slow down the process, to assess the costs and benefits of reforms implemented thus far in a weak global economy.

For Carney reform is do or die. He says: "The major emerging market economies, having been side-swiped by the last crisis, have a concern about the health at the core of the global financial system, so the idea that we can somehow slow down the reform process and release capital rather than build it, and somehow that will help reinforce an open global economy, is fanciful."

He is aggressive in battling off one of the central, and most emotive, arguments advanced by banks: that higher capital requirements and restrictive capital formation frameworks threaten to torpedo an already weak global economy while exacerbating pro-cyclical debt deflation. "The argument that financial reform is causing a shortfall of capital fails to take into account the fact that there are jurisdictions where there appears to be a fundamental shortfall of capital in a material number of institutions that is preventing the functioning of that financial system," he says. "The shortfall is down to the fact that these banks are a long way from a reasonable level of capitalization in any way that’s transparent."

This hard-line stance accords with most-recent research from the IMF, squarely contrasting with IIF projections and oft-touted criticisms from bankers. In September 2011, the IIF estimated that all the regulatory measures combined would greatly boost the capital needs of banks relative to a base scenario of an additional capital requirement of $1.3 trillion by 2015. This central scenario could push up bank lending rates by over 3.5% over the next five years, resulting in 3.2% lower output and 7.5 million fewer jobs, it said. Although the cost of regulation would fade by 2016, the IIF reckoned the global regulatory agenda exacted a heavily pro-cyclical economic toll.

The FSB, the OECD, the Bank for International Settlements and the IMF dispute this projection. Their studies suggest that regulation will impose a mild, manageable and necessary increase in capital in the short run, with the benefits far outweighing the costs. For example, in September the IMF estimated that the cost of regulation to long-term average bank lending rates will be around 28 basis points in the US, 17bp in Europe and 8bp in Japan. What’s more, Carney reckons bearish projections of the cost of regulation fail to take into account broader structural deleveraging forces, and market pressures on banks to raise their levels of capital, regardless of regulation. The IMF has also mentioned the scope for banks to cut costs.

Mark Carney, Bank of Canada governor
Mark Carney, Bank of Canada governor
Carney says: "According to our research, for the large US banks, their residual requirements to meet Basle III, plus a Sifi surcharge, where applicable, amount to around 1.5 times last year’s after-tax profits for these institutions. And they have six years to do it and we are going to sit here and say Basle III is causing the shortfall? No, there are many more fundamental reasons for this. In many cases, the problem is the absence of credit demand, not supply, and we are in a global economy where there is a need to delever to repay credit so there will be this weakness, and that’s not a reform question."

He cites the successful regulatory momentum in non-crisis G20 economies, such as Canada, as vindication for this argument. "Our view and experiences show that in those non-crisis economies where reform has proceeded, where capital has been built, where there is transparency about the progress that has been made, and where the infrastructure has been improved, the pace of credit growth has arguably been too strong."

Canada’s central bank governor is something of a rare breed in international finance. True, he is just one of a long, and oft-criticized, line of former Goldman Sachs bankers to enter into high public office. What marks him out is that this background is rarely held against him.

Indeed that banking experience, which included a stint for Goldman in London as a co-head of sovereign advisory for the EMEA region, means Carney is credited for his market-based judgements of regulatory and monetary affairs, when necessary. "When Carney speaks, people listen" is the typical refrain from the financial and policy community, particularly during international meetings, from the IMF to G20, to Davos.

Dynamic, engaged and quick-witted are three qualities frequently cited by those who have worked for him. Carney – Euromoney’s central bank governor of the year for 2012 – has injected dynamism into the Bank of Canada. The epoch-making feature of his tenure as governor remains the decision to cut the overnight rate by 50bp in March 2008, just one month after his appointment.

While the European Central Bank delivered a rate increase in July of that year, Carney’s market instincts rightly judged that the leveraged-loan crisis would trigger global contagion. And when policy rates in Canada hit the effective lower-bound, the central bank combated the crisis with the nonstandard monetary tool: the "conditional commitment’" in April 2009 to hold the policy rate for at least one year, in a boost to domestic credit conditions and market confidence more generally. Output and employment began to recover from mid-2009, in part thanks to monetary stimulus.

"He is an incredibly astute economist and has real-world experience," says Craig Alexander, chief economist of TD Bank, echoing the positive views of many Canadian economists. "The economic community give him very high marks: Canada experienced a very negative external shock that drove the economy under water and monetary stimulus has helped significantly."

Carney is thus rightly credited for his pre- and post-Lehman fire-fighting skills, joining such peers as Stanley Fischer, Bank of Israel governor, whose reputation as a policymaker has grown through the crisis. This prestige, combined with in-the-trenches market experience, has boosted Carney’s credibility when he talks about banking reform and monetary economics more generally. It’s a testament to his reputation – and he remains untainted by scandal – that speculation was rife in August that he might be a contender to run the Bank of England, although he denies he was ever approached and has ruled himself out of the race.

The FSB chairman has many a battle left to fight. He is under attack from some reputed policy officials, ironically including those in the Bank of England. In a radical speech to central bankers at Jackson Hole in Wyoming in September, Andy Haldane, executive director for financial stability at the BoE – and Carney’s ideological nemesis – sounded the alarm over the complexity of the current regulatory push and, in effect, recommended that the G20 tear up the seemingly quixotic Basle III.

Haldane favours fewer and simpler standards on capital – reducing the dependence on risk-weighting of assets – complemented by moves to restrict the build-up of debt on any given institution’s balance sheet, that is, a higher leverage ratio than the initial 3% Basle norm, which will not be a binding requirement until 2018. Haldane said last month: "Modern finance is complex, perhaps too complex... as you do not fight fire with fire, you do not fight complexity with complexity. Because complexity generates uncertainty, not risk, it requires a regulatory response grounded in simplicity. Less may be more." His call for simpler rules, buttressed by a more aggressive leverage ratio, was echoed in mid-September by Thomas Hoenig, a board member of the Federal Deposit Insurance Corporation, who called on the US authorities to exit the Basle accord.

Is the thrust of Haldane and Hoenig’s contention correct? Did the use of risk-weighting pre-Lehman fail while triggering, intentionally, or otherwise, innovations to reduce equity commitments, such as the creation of triple-A mortgage-backed securities? Carney agrees with aspects of Haldane’s assessment of the regulatory challenge but his conclusion is starkly different: the crisis highlights that the risk-weighting of assets and a leverage ratio need to work in tandem.

"I thought Andrew Haldane’s speech was uneven," Carney says. "I disagree with the conclusion that was the ordering of the leverage ratio and the risk weights. To have the leverage ratio bind before a risk-weighted approach, as Andy suggests, then the natural incentive of an institution is going to be to fill up the leverage ratio with the riskiest assets." The leverage ratio protects banks from the mis-calibration of risk weights, he says. "The things people thought were riskless turned out to be very risky in the run-up to the crisis. A big chunk of this crisis was caused by things that people thought were risk-free – superior-senior triple-A assets on bank balance sheets, or in SIVs or in the heart of the repo market. One of the reasons Canadian banks did not have a ton of it but the UK banks did was because of the leverage ratio, so I don’t need anyone to tell me the leverage ratio is valuable. It’s in the system and there for a reason."

Carney is riled by Haldane’s speech, which has made waves in the financial and policy community, serving as a laissez-faire call to arms for bankers, who are struggling to find their voice on the international stage. Carney says: "Is the basic point that one would want institutions to have these measures buttressed by relatively simple checks? Yes – and that will influence shadow-banking reform efforts, especially. Basle I was simple and it drove us off a cliff. Andrew Haldane’s conclusion is not supported by the proper understanding of the facts."

Data released by the US Federal Reserve in April show that five banks – JPMorgan, Bank of America, Citi, Wells Fargo and Goldman Sachs – held $8.5 trillion in assets at the end of 2011, equal to 56% of the US economy. The institutions combined are now around twice as large as a decade ago relative to the US economy, sparking concern over the concentration of banking risk and rising fiscal liabilities, a fact that triggers consternation from banking reform critics, who fear the monstrous size of banks has sparked regulatory capture.

Carney is clearly sensitive to the attack from the left and other sources: that Basle III does not go far enough. Moves by UK and Swiss authorities to further tighten the noose around capital requirements confirm the regulatory desire for tighter, more exacting standards. Indeed, if he is so sanguine about the negative-growth threat from higher capital ratios, shouldn’t the optimal risk-weighted ratios be higher? Carney rebuts this critique, arguing that stronger capital backstops are structurally entrenched into the global financial system, boosted by the Sifi surcharge and counter-cyclical buffers, as confirmed by robust stress-testing.

But he is open to discussions with respect to an increase in the leverage ratio. "If there is a groundswell of opinion that we should tighten it then the Basle committee and the FSB will look at it. At present, we are building substantial capital in the system and capital in effect for some institutions will increase four-fold. In the analysis we have done, if you look at where capital is coming from for systemic institutions, add in tier 1 and tier 2 and bail-in debt, I think the current levels of capitalization are appropriate."

Analysts cite the role of sovereign debt in Basle III as evidence of the political challenges ahead and the pitfalls of regulation, more generally, which fights yesterday’s battles with flawed modelling of current and prospective risk. Of particular concern is the treatment of government debt – a now seemingly toxic asset class in developed markets – in banks’ capital and liquidity requirements.

Basle’s zero risk weighting of high-rated sovereign debt, to determine capital ratios, has been criticized for encouraging European banks to gorge on dodgy sovereign debt given the favourable capital charge. Some analysts had hoped that Basle would adjust this risk-weighting matrix to ensure there is always some capital held against even the highest-rated sovereign debt. But Carney denies this is currently on the agenda.

Nevertheless, moves are afoot to expand the range of instruments in Basle’s liquidity framework to include non-sovereign assets, and Carney strikes a bullish tone as to the possibility of including highly liquid stocks and corporate bonds in any permissible pool of liquid assets.

But as the eurozone sovereign debt crisis rages and the US, UK and Japan’s debt stock soars, Carney denies that European governments, in particular, are perceiving this pillar of Basle reform through a self-interested lens, amid the high stakes involved: the trillions of dollars of sovereign debt regularly held and traded by financial institutions.

He says: "The European position has been fairly expansive about what they think constitutes a liquid asset; it’s been a professional discussion about liquidity and appropriate haircuts."

A risk lurks on the horizon: the concentration of regulatory risk. The financial crisis threw into sharp relief how national regulatory regimes and global co-ordination are needed given the complex interplay between different parties involved in crisis management: co-ordination between different banks, central bank liquidity, regulators, deposit insurance and fiscal authorities.

So aside from the need to build up global banks’ capital and liquidity buffers, a consensus post-Lehman emerged that to boost crisis management and curb the risk of regulatory arbitrage, a more uniform regulatory framework was needed to oversee capital and liquidity frameworks, securities trading, systemic risk, and disclosure standards.

But surely this push has gone too far, breeding a one-size-fits-all regulatory system? Is there not an irony, asks Euromoney, that one of the lessons from Canada’s relative financial resilience is the efficacy of a principles-based system with a strong supervisory role, rather than the flurry of prescriptive rules, which run the risk of negative unintended consequences.

Carney is sensitive to this critique but is sanguine. "What’s important is that our overall approach is based on minimum standards as opposed to a one-size-fits-all approach. For all the hue and cry about Basle, remember that most jurisdictions will have more than the Basle capital minimum – most emerging economies already do and most developed markets will as well. In other words, banks will have varying degrees of capital and that, to some extent, provides diversity."

He adds: "We should be careful about treating everyone as a bank and telescoping the asset/liability horizons for an insurance group or a hedge fund over the same horizon as banks. We are careful not to force absolute commonality in the financial system as this would reduce diversity in the market."

The home bias of global banks in recent years has kicked in as banks reassess their business models in a more challenged market environment. But many bankers cite the rising costs of Basle regulation, and its stricter emphasis on asset/liability matching. The FSB chairman flatly denies this charge, arguing, by contrast, that regulation is helping to reconsolidate the global banking business model.

He says: "We are ensuring that institutions are well capitalized, creating stronger cross-border infrastructure, such as central counterparty clearing houses for derivatives, encouraging cross-border cooperation of supervisors and negotiating recovery resolution plans across jurisdictions. All these factors are helping to reinforce the global system."

Canada is well suited to the art of shuttle or megaphone international financial diplomacy. Canadian policymakers can claim a rare degree of objectivity by virtue of the small size of the country’s economy, constituting about 3% of the world’s GDP. The country lacks emotional bias given the banking industry’s resilience in the crisis. Canada is neither a fading superpower nor an upstart emerging market but a stable, non-threatening industrialized economy.

To put it crudely, Canada’s tripartite motto, "peace, order, and good governance", encapsulates the regulatory Zeitgeist in contrast to the US values enshrined in the Declaration of Independence of "life, liberty and the pursuit of happiness". Carney then is investing the country’s reputational capital, playing the role of international financial peacekeeper. RBC’s Nixon says: "There is huge tension in all of these international finance committees and you have all these vested interests – often driven by politics between America and Europe. The challenge for a Canadian is getting caught in the cross-fire between the US and Europeans."

Rick Waugh, chief executive of Scotiabank
Rick Waugh, chief executive of Scotiabank
Waugh of Scotiabank, which as the most international Canadian bank has the most to lose from Basle, adds: "The G20 supervisors are under a single mandate to make sure that the financial system never takes taxpayers’ money, so they have a one-way mandate – so he is constrained."

Nevertheless, Carney has some breathing space – and benefits from a degree of good luck – as he occupies arguably the least-challenging central banking post in the G20 in the current market environment, helping to free up time for his FSB responsibilities. Some 20 years of phenomenally successful inflation-targeting in Canada has anchored expectations of price stability, giving the Bank of Canada the space to conduct a loose monetary policy. As governor, Carney is responsible only for the conduct of monetary policy, with one formal price-stability mandate. What’s more, Canada is the only G7 economy that boasts an efficient monetary transmission channel thanks to its clean banking system, a source of pride among the Canadian public.

In short, Canada is a world away from the rest of the G7, with policymakers grappling with broken credit-transmission channels, rising sovereign debt levels, negative sovereign-bank feedback loops in a heavily politicized environment, and friction between fiscal and monetary authorities. While the Canadian government is grappling with an external demand shock that has savaged output, Carney has the time to combine his monetary responsibilities with his FSB role. But Carney shares one chief concern of his G7 counterparts: low policy rates could be sowing the seeds of a localized credit bubble. And, echoing his regulatory philosophy, he has secured a mandate to address this threat in a counter-cyclical framework, in an anti-Greenspan fashion.

The national regulator and finance minister have imposed tighter macro- and micro-prudential standards in a bid to curb spiralling mortgage debt fuelled by high property prices, low interest rates and low savings. Carney has repeatedly sounded the alarm that the era of prolonged low rates in Canada has fed a consumption bubble, with the ratio of debt to personal disposable income around 150%, higher than in the US pre-crisis. "In every central bank statement and speech he warns about rising debt levels, so much so that I often think he is overdoing it," says Sherry Cooper, chief economist of BMO Financial Group.

Carney’s loud alarm signals reflect his fear that low rates have fed a US-style consumption bubble, which could tarnish his legacy, say economists. Under the shadow of this risk, at the end of 2011, the government and the Bank of Canada announced its operating framework would be renewed for another five years with a 2% inflation target. However, this framework, for the first time, includes the possibility of a "flexible" approach in determining the time-horizon when its 2% target will be achieved. In other words, the interest rate policy tool could be used to stabilize domestic financial conditions even when inflation deviates from target and, more interestingly, could be deployed in a counter-cyclical fashion to address asset bubbles, since a financial stability objective is compatible with price stability, Carney says. "We all know in the long history of finance and boom-bust cycles that people don’t always listen to their central banks," he says. "There is potentially a role for monetary policy to ‘lean against the wind’ and reinforce other measures, and this is part of our framework. We are not part of the caricature of inflation-targeting regimes, which has been described as a mechanistic, dogmatic-based approach to monetary policy."

Inflation-targeting puritans – a vanishing monetary breed – are predictably up in arms. "Some of us are extremely uncomfortable with the Bank of Canada’s foray into the regulatory side as we believe that it is a distraction from monetary affairs. We have a coherent monetary order: a flexible exchange rate and inflation-targeting regime. If you layer on another mandate – a regulatory mandate or counter-cyclical mandate – it detracts from monetary affairs," says Finn Poschmann, vice-president of research at CD Howe Institute, a Canadian public policy think-tank in Toronto, and a rare critic of the Bank of Canada.

The zeal with which Carney introduced this financial stability objective into the central bank’s mandate reflects the same philosophy that underpins his approach to regulation: the financial bubbles in the pre-Lehman Greenspan world order highlight the foolhardy contention that market forces can regulate finance. By contrast, ex-ante regulation, fleshed out in a necessarily imperfect framework, can and should mitigate excesses, he reckons. It’s a belief that also reflects Canada’s intellectual heritage, in the vein of William White, former chief economist at the Bank for International Settlements, and Malcolm Knight, the BIS’s former chief executive, two Canadians who have occupied senior posts in international finance. Both White and Knight sounded early alarms over weak regulation and excess risk-taking that fed the US sub-prime mortgage bubble, with White currently an influential proponent of the view that the loose G7 monetary policy cycle is fuelling asset bubbles.

It’s clear Carney is no career-serving technocrat or a soldier simply executing the regulatory battle for his G20 generals. Although David Dodge, Carney’s predecessor as governor, occasionally commented on public policy challenges, Carney "has played a more active role in economic affairs than any other central banker in recent Canadian history," says Nixon. "He has rightly broadened, informally, the central bank’s mandate and has done so because he has the platform, the economic skills and practical working knowledge of capital markets."

Carney’s common touch belies his status as an Oxford- and Harvard-educated economist with 13 years’ service at Goldman Sachs. He has expressed sympathy with the Occupy movement and beaten up corporate Canada for its high cash reserves. His well-timed populist overtures highlight his political skills. Carney, therefore, has defied common wisdom in the court of public opinion that former investment bankers will be less welcome in the corridors of power. As one Toronto-based analyst says: "Even though he comes from Goldman it does not seem to bother him one bit that he is reducing the earning potential of banks."

Accordingly, speculation is brewing that the former Goldman Sachs executive, G7 policy wonk, and sophisticated central bank operator turned global regulatory statesman might one day pursue a political career. Carney, 47, who has been said to spend summers polishing his French-language skills, presumably to boost his political credentials, might one day assume the mantle of Liberal Party leader, say analysts.

Although his political affiliation remains undeclared, seasoned Carney followers reckon his zeal for regulation and government supervision, combined with a zest for sustainable development, reveal a centre-left posture. In any case, few Canadians have led institutions with global reach, boosting his profile domestically. Knight recently headed the BIS, an opaque and esoteric body, while Donald Johnston headed the OECD, whose soft power has waned in recent years. Although the FSB lacks the institutional and legal clout of the main pillars of international economic governance, Carney’s three-year tenure at the FSB could, in the years ahead, boost his credentials to hold high office in Canada or for an IMF candidacy.

In this context, the more Carney expresses his views on global macroeconomic issues, and commands attention on the international stage, the louder the chatter in Bay Street, Toronto’s financial district, about his next mission, once his term as governor ends in 2016.

However, in finance, three-and-a-half years is a long way away. Accordingly, his reputation will hang in the balance until the effects of Basle III are fully felt.

The narratives that could shape his legacy veer in extremes: a Basle III world that sacrifices innovation and credit growth on the altar of high capital requirements while encouraging the growth of an opaque shadow-banking industry. Or a Basle framework that increases the risk of another banking crisis thanks to low equity thresholds and lax or counterproductive rules on risk. Naturally, there is little consensus on whether the FSB and Basle regulators are striking the right balance between risk-taking and crisis prevention in these minimum capital standards. But many bankers have already nailed their colours to the mast.

Scotiabank’s Waugh, an outspoken critic of the Basle regime and vice-chairman of the board of the influential Institute of International Finance, draws a sobering conclusion: "Basle III was rushed. Regulators should try to figure out the best long-term solutions to getting a productive financial system. Until you go through the diagnosis don’t know what the cure should be... Basle III is not the cure."

Final days of Ricardo Salgado and Banco Espírito Santo

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When BES collapsed earlier this year, markets briefly feared a return of the crisis to Portugal and to Europe. Even after the bank's bailout, investigators still pore over bank documents, transfers and deals, trying to make sense of Salgado’s last days battling to keep his empire afloat. The backstory is of an extraordinary decades-long rivalry between the country's two pre-eminent business families.