Traditionally, government has exercised oversight and regulation of the banking sector because it is through that sector that an efficient and stable payments system is achieved, and sound intermediation between investors and savers occurs. The growth of more traditional banking activities has taken much the same path. In the process, market participants have diversified their risk exposure with a wider array of existing or new financial instruments that allow capital to flow more freely towards higher returns. But these carry their own risks. While they have greatly increased the ability of investors to hedge against price or exchange rate volatility, some of the most spectacular financial losses in recent years have been linked to misunderstandings of their risks, or plain misuse.
Derivatives are typically leveraged.
They allow banks and other financial institutions to take excessive risks through large positions. And they can also be used to elude oversight, particularly where the regulator is less familiar with the instrument than the traders. The point is that the waves of innovation, liberalization and globalization that have reshaped the banking industry in recent years demand but do not promise disciplined in-house financial management. The rules and surveillance of OSFI have limited application to some of the new international market activities. And the proposed mergers will further limit competition among the banks.