456 PA R T V Central Banking and the Conduct of Monetary Policy INSIDE THE CENTRAL BANK Emergency Lending Assistance to Troubled Banks Canadian Commercial and Northland In 1985, there was public concern over the quality of the assets of two small Alberta-based banks the Canadian Commercial Bank and the Northland Bank which had made many bad loans Larger depositors, whose accounts exceeded the $60 000 limit insured (at that time) by the CDIC, began to withdraw their deposits, and the failure of the banks was imminent Because the immediate failure of Canadian Commercial and Northland would have had repercussions on other vulnerable banks, the Bank of Canada, under the advice from the Inspector General of Banks (the predecessor of the Office of the Superintendent of Financial Institutions Canada) made extraordinary advances Total emergency lending assistance amounted to $1.8 billion so that depositors, including the largest, would not suffer any losses In doing this, the Bank of Canada was following the precedent established in 1984 by the Federal Reserve s rescue of Continental Illinois National Bank Continental Illinois had made bad loans (primarily to businesses in the energy industry and to foreign countries), and rumours of financial trouble in early May 1984 caused large depositors to withdraw over US$10 billion of deposits from the bank The Federal Deposit Insurance Corporation (FDIC) arranged a rescue effort in July 1984 that culminated in a US$4.5 billion commitment of funds to save the bank Still the Fed had to lend Continental Illinois over US$5 billion making the Bank of Canada s $1.8 billion advances to Canadian Commercial and Northland look like small potatoes! Although Continental Illinois was taken over by the FDIC, the Fed s action prevented further bank failures, and a potential bank panic was averted The Bank of Canada, however, was not as successful in preventing a bank crisis With the failure of Canadian Commercial and Northland, rumours of financial trouble caused many large depositors to withdraw large deposits from the Bank of British Columbia, Mercantile Bank, and Continental Bank By the time Mercantile was acquired by the National Bank of Canada, the Bank of British Columbia by the Hongkong Bank of Canada, and Continental by Lloyds Bank of Canada, the Bank of Canada had provided emergency lending assistance of more than $5 billion (see Figure 17-11) The loss of public confidence in the Canadian banking system led to the financial reforms of 1987 1992 and the consolidating of financial institution supervision under the Office of the Superintendent of Financial Institutions Canada Term PRAs are similar to special PRAs (see Figure 17-6), but have a term longer than one business day, typically a term of 28 business days They are offered to primary dealers and used at times of crisis, when asymmetric information among market participants impairs their ability to buy and sell an asset class or maturity, thereby distorting liquidity premiums in the money market For example, against the backdrop of widening spreads and increased volatility in the term interbank market in the second half of 2008, the Bank of Canada announced that it would enter into a series of 28-day PRA transactions, thereby injecting huge amounts of liquidity into the markets Moreover, the Bank expanded its list of acceptable collateral to include bank-sponsored asset-backed commercial paper and U.S Treasuries It also expanded its list of eligible counterparties In engaging in these trades, the Bank takes securities onto its books in exchange for borrowings from the Bank s standing lending facility TERM PRAS