WHEN: Today, Friday, September 24th at 10am ET
WHERE: CNBC’s “Squawk on the Street”
Following is the unofficial transcript of a CNBC EXCLUSIVE interview with Mark Carney, Bank of Canada Governor, today, Friday, September 24th at 10am ET on CNBC’s “Squawk on the Street.” Excerpts of the interview will run throughout CNBC’s Business Day programming.
All reference must be sourced to CNBC.
STEVE LIESMAN: Mark, thank you very much. I am here with Mark Carney, the Governor of the Bank of Canada. And I have to say-- Governor Carney, thank you for joining us. It’s been a couple years since I’ve interviewed a central banker who’s actually raised rates in.. I didn’t know that I could actually do that. So-- welcome. Thanks for coming on this morning.
MARK CARNEY: We had to do that to get you up here, Steve. Thanks for coming to Ottawa.
STEVE LIESMAN: Let me ask you-- you-- you-- the Canadian economy, obviously, very tied to the U.S. economy. How much concern do you have of the slowdown and what impact do you think it would have on the Canadian economy.
MARK CARNEY: Well, the slow-- the recent weakness in the U.S. economy is of-- some concern to us. We’re the largest trading partner of the United States. The U.S. is a predominant destination for our exports. And-- we-- we-- the-- the nature of the slowdown, both the past recession and the recent slowdown is particularly concerning for Canada, given the concentration in areas such as housing, autos-- parts of the economy that are really leveraged-- to Canada.
STEVE LIESMAN: You-- you just raised rates on September 8th, another quarter point, bring it up to one percent. Do you feel like that was premature, given that we don’t know what the outcome of the slowdown is here?
MARK CARNEY: Well, we’re in-- quite a different situation than the United States. Our economy’s back at it’s-- it’s pre-recession peak, both in output and employment. We have a financial system that is-- fired on all cylinders here. So, monetary policy has been extremely accommodative. And it’s had an impact. So, credit growth has been-- growing to the household sector, seven, eight percent, through the entire course of the recession. So, we have different dynamics here. All of that said, what goes on in the United States does have significant impact on Canada and we’re watching it very closely.
STEVE LIESMAN: Does monetary policy have more of an impact here, because your banking system is functioning in a way that ours isn’t?
MARK CARNEY: Monetary-- yes, I think the short answer is the transmission mechanism in Canada is much stronger. It’s functioning as it always did. And I just referenced a credit growth number. The fact is with-- exceptionally low rates-- Canadians have-- seen fit to borrow, consume—
STEVE LIESMAN: Isn’t that the biggest concern here right now is that Canadians are borrowing too much? And that’s one of the reasons you raised rates?
MARK CARNEY: We are concerned about the level of con-- household borrowing in Canada, yes.
STEVE LIESMAN: If you could give me two reasons why you think the Canadian banking system made it through the financial crisis, whereas the U.S. has had so much trouble, even getting out. What would those two reasons be?
MARK CARNEY: Well, the first is capital. We had higher capital. We had better quality capital. We had real equity. Secondly, related to that, is we had an absolute limit on leverage. Forget about all the fancy risk weighting. We just had a very simple leverage test on-- on our institutions. So, they didn’t end up with the leverage superseding your other structured products that were supposedly risk free, but as I think we all have found out are incredibly risky. So, a couple of regulatory aspects really helped-- us-- weather this.
STEVE LIESMAN: You’re deeply involved in what’s going on internationally, the Basil capital standards. There’s some complaints out there-- Sandra O’Neil just wrote-- a piece yesterday, which said this is gonna raise-- capital costs for banks. It’s gonna also reduce profitability in a meaningful way. What’s your response?
MARK CARNEY: Well, I-- a couple of things. One-- the-- the system was-- horribly undercapitalized. Effectively, under the old regime, you could run 100 to one leverage on a risk weighted basis. 100 to one. And a lot of people did. No wonder-- R.O.E.s are up in the 20 percent range. Now, ultimately that was ephemeral, that was short lived, because of the crisis. But to put it into context-- two percentage points of additional capital, that’s equal to ten-- ten percent of the compensation costs of banks. So, I-- I think we have to have a bit of-- a bit of context for all this.
STEVE LIESMAN: Let me just make clear what you’re saying so that-- you’re saying banks could lower their-- their capital by ten percent-- or lower their salaries by ten percent and just-- raise that extra capital?
MARK CARNEY: That’s the effective-- the-- the effective flow through of the capital.
STEVE LIESMAN: Let me turn back to the economy here. One of the concerns out there is deflation. How much concern is there here in Canada about deflation both in the U.S. and broadly on a global basis?
MARK CARNEY: Well, we’re concerned about the-- the functioning of the global monetary system-- because-- the fact-- that major currencies are not moving. You’re gonna get a real adjustment. That means higher inflation in emerging markets. It-- it will mean lower inflation in core-- industrialized economies, such as, most importantly, the United States. Given the debt overhang in the United States, that is pushing inflation to very low levels. And it may necessitate a Fed response. They’ll take that decision, and we’ll deal with a consequences.
STEVE LIESMAN: How do you deal with that? I mean, the Fed might be on the verge of something going the exact other way of Canada. What impact do you think quantitative easing might have-- if the Fed goes forward on-- on the Canadian economy as a policy?
MARK CARNEY: First and foremost, the issue is why do they do it? So, the renewed weakness in the United States, if it prompts-- quantitative easing or-- other action by the Fed has-- has been discussed-- then we deal with the direct consequences. Obviously, we’ll adjust-- monetary policy to Canadian circumstances. There are limits to-- the divergence that there can be between Canada and the United States.
STEVE LIESMAN: Talk about divergence. One of the things that hasn’t happened is-- China has not been very flexible with its currency. You recently praised China and said the-- it looks like they’re-- they’re taking a step towards flexibility. Were you speaking prematurely? Are you-- satisfied with how much China’s done in terms of-- letting its currency be-- float?
MARK CARNEY: Well, leaders crafted an agreement at the Toronto summit, which included increased flexibility for major emerging markets, including China. Fiscal-- responsibility in major economies and financial reforms. People are starting to deliver on fiscal responsibility. We just got the Basil Accord through. Currency flexibilities up until now has been a slogan, not a reality.
STEVE LIESMAN: So, you-- you’re not satisfied with how far China’s come?
MARK CARNEY: We expect China to-- increase the flexibility of their currency in due course.
STEVE LIESMAN: Very, very quickly. How much concern do you have about deficit reduction around the world? The O.E.C.D. just suggested that maybe G7 countries should not reduce deficits as fast as they planned.
MARK CARNEY: It’s our view that-- G7 countries need to be on a sustainable fiscal path. And that’s going to have to start in 2011.
STEVE LIESMAN: Mark Carney, thank you for joining us here.
MARK CARNEY: Thank you very much, Steve.
STEVE LIESMAN: From Ottawa, the Governor of Bank Canada, Mark Carney.
STEVE LIESMAN: The price of gold is at a record now. What signal about inflation do you take from the price of gold?
MARK CARNEY: Very little, actually. I-- I think we take a signal from the price of gold of-- concern in-- overall monetary and fiscal management amongst a subset of the investor community. And it’s-- it’s a signal that-- should be-- should be noted.
STEVE LIESMAN: So, it’s a security issue not-- not a price issue, really, as far as you’re concerned?
MARK CARNEY: Yeah. I think it’s a risk aversion trade. And-- it’s important to understand-- that dynamic.
STEVE LIESMAN: There’s been-- also increases in prices of commodities is that a concern from a central bank’s standpoint?
MARK CARNEY: It’s welcome from the-- the standpoint of the Bank of Canada. I mean, we are a net beneficiary of-- higher commodity prices, without question. And one of the dynamics, if I may, that-- that’s going on in the Canadian economy is we’re getting more of a divergence between what goes on in the United States and where commodity prices go, obviously. Because of emerging markets. And so, we’ve got a little more diversification for Canada because of that.
STEVE LIESMAN: There’s some talk that because of regulation in the U.S., the Dodd/Frank Bill, that some hedge funds might be coming north to Canada. Is that a phenomenon you’ve seen? Is that people may be opening up in Canada because-- for that reason?
MARK CARNEY: Well, we-- we’ve seen a couple of things in Canada. One, we’ve seen a lot of movement of-- back office prophesying in mid-office type operations for prime brokers and hedge funds. We’ll probably-- continue to see that. Because the infrastructures here, the peoples here, the proximity to New York-- is here. And-- and, you know, quite frankly, corporate taxes are much lower in Canada than they are in the United States now.
Secondly, on the-- on the actual hedge fund side, there’s a bit of that. There’s a bit of it in commodities. And-- we’ll see where it goes. But given all the reasons I just outlined. I think just on a fundamental basis, we’re gonna see some reallocation.
STEVE LIESMAN: Well, what about the notion that they’re moving here because regulations aren’t as tough here as they are in the United States?
MARK CARNEY: I-- well, I-- regulations in Canada, I think, have-- over the course of time been a little tighter-- than they have been in the United States. The Dodd/Frank will-- will change that. But-- and maybe a little more consistent. Ultimately, you know, the-- it’s important that we get the right regulation for the-- the core of the financial system. And appropriate light touch regulation for the shadow banking-- sector. And remember always that the link between the two is have-- a liquid markets-- function.
STEVE LIESMAN: At the same time, there is talk and we’ve seen this actually, Canadian banks moving into the United States increasingly, because they are-- they have-- a little bit more money to-- to come in. Is that something you’re watching?
MARK CARNEY: We’re watching it. And-- you know, those are decisions for those institutions. They are-- there is a real-- strength in retail banking in Canada. That is-- that is an exportable skill, if you will. And so, they’re looking at opportunities in the United States and that’s natural.
STEVE LIESMAN: Does that concern you at all in terms of the ability to regulate these banks if they move further-- more of their assets come from the United States?
MARK CARNEY: It-- well-- our regulator is not the Bank of Canada, so it doesn’t concern me directly. But-- no, we-- we-- have very good-- regulatory relationships with the-- relevant U.S. authorities. So, we have visibility into what our institutions are doing.
STEVE LIESMAN: Fed Governor, Dan Turullo in a recent speech, suggested that tougher regulation in the-- in the regulated sector of the United States would push more banks-- I’m sorry, more capital and more financial activity into the unregulated sector. Given what’s happening with Basil III and-- Dodd/Frank in the United States, how much concern do you have that what we’re doing is pushing more-- money into the unregulated shadow banking system?
MARK CARNEY: Well, I-- certainly, what we’ve done is focus on the-- on the regulated sector first, because the shadow sector had collapsed. And-- the question is-- and it’s still collapsing, as you know, in terms of-- in terms of trends. The issue is-- you know, bringing it back on a sustainable-- basis. ‘Cause it’s-- look, it’s a great form of competition, diversification, if done right. What we need to do, in our opinion, is get core market infrastructure right. Particularly for repo and for O.T.C. derivatives, ‘cause those are the cha-- that plus-- liquidity support from the regulated sector, through prime brokerage, through stock lending, through repo, as well. That’s the link, and that’s the most important link that can cause systemic-- crises. So, individual hedge funds aren’t gonna cause systemic crisis. We welcome-- growth in shadow banking.
STEVE LIESMAN: Speaking of systemic crises, you said in a recent speech, "We are awash in moral hazard."
MARK CARNEY: Sadly, yes.
STEVE LIESMAN: Yeah, sadly you said that or sadly--
STEVE LIESMAN: How does-- how-- how do bank regulators around the world dry up that moral hazard?
MARK CARNEY: Yeah, it’s gonna be a long process. And I think the-- the-- the sector-- needs to understand that that’s the long term goal is to get to a position where large institutions can fail. So, what do we need to do? Well, first off, you-- you capitalize them better, so it’s less likely, but what you have to do is make sure that all elements of the credit stack can bear losses. You can do that through bail-in (?) capital, contingent capital, better resolution mechanism.
The other thing you need to do is get market infrastructure that survives if a major player fails. Now, when Lehman went down or when Bear Stearns went down, the repo market itself, alone, was reason enough to come in and have some ac-- you know-- some support there. That’s unacceptable. And so, we need to change the-- fundamental market infrastructure. It’s a radical change, but we’re doing it here in Canada. And I suspect we’ll do it elsewhere, as well.
STEVE LIESMAN: Last thing-- Mark, you said in another-- maybe the same speech. "Every bank that failed had capital levels in excess of Basil II."
MARK CARNEY: Yeah.
STEVE LIESMAN: Why should anybody have any confidence at all that Basil this time around gets it right, when they clearly didn’t have it right the last time around?
MARK CARNEY: Yeah, well, we had-- we-- we’ve gotta live up to that. I mean, the-- there were two problems with Basil II. There’s three problems with Basil II. One of them was-- the risk weightings were wrong, obviously. Secondly, capital wasn’t really equity, it wasn’t loss-bearing capital. So-- the-- the actual equity that was there when those institutions failed was which is part of the reason why the market pushed them over the edge. The third thing we got wrong is we thought we knew everything.
So, we could-- we could-- we could accurately predict the risk of all assets. Now, what we more or less got right were the risky assets, but what we really got wrong is things that we thought were riskless or relatively riskless. Most famous, AAA structured products. Lev-- leveraged. That had tremendous risk. And so, naturally, banks just loaded up. And that’s why you need a simple leverage test on top of it, because regulators aren’t that smart.
STEVE LIESMAN: I think that’s it, Mark. Is there anything else you want to-- you want to add?
MARK CARNEY: I just want to-- thank you for coming to Ottawa
MARK CARNEY: All right. It’s my pleasure.
STEVE LIESMAN: Great. Bye, bye.
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