(Chris Wattie/Reuters)

In the long run, “heads-I-win-tails-you-lose finance” catches up to you. That was the message Bank of Canada Governor Mark Carney delivered to an audience of finance majors at Western University’s Richard Ivey School of Business today. In other words: “don’t you kids try to play that game.”

It’s in the banks’ own interest to embrace stricter regulation aimed at restoring the public’s confidence in the financial system, Carney said in prepared remarks. Lower levels of trust since the financial crisis are harming the economic recovery and  the banks’ own business, the governor noted.

“Most major banks outside Canada are now trading well below their book value, indicating shareholder concerns about a combination of the quality of bank assets and the value of their franchises,” Carney said.

Credit rating downgrades of many big banks are another sign of that lack of trust, not just between financial institutions and the general public but among financial players as well. Even recent credit upgrades are due more to governments guarantees than debt-holders’ confidence in the banks themselves, Carney said. (The governor didn’t mention this, but Canada’s big banks have seen ratings cuts too recently, albeit not as a consequence of the 2008 meltdown.)

The governor also noted that creeping distrust among national bank regulators might lead to a “balkanized” financial system, with governments trying to insulate their country’s banks from the fallout of foreign crisis by restraining cross-border financial flows. Some euro zone countries, in particular, are known to be flirting with such options. These measures, though, tend to exacerbate rather than reduce risk, Carney noted. As Econowatch explained a few months ago (see slide 11):

Governments [are] concerned that they might have to use taxpayers’ money to bail out foreign banks that have a large customer base in their own country (remember the case of Icelandic banks and the U.K. government?). As a result, they are increasingly relying on domestic banks and investors for financing: German banks are lending to the German government, and Italian banks to the Italian government.

Financial institutions in vulnerable countries, in other words, are loading their balance sheets with bonds investors see as increasingly risky. If these banks lose access to credit markets—and some of them are already struggling to borrow— the whole continent would likely experience a banking crisis.

In sum, if money makes the world go ’round, trust is what makes money do the rounds. Money multipliers have fallen by 55 per cent in the U.S. and 40 in the European Union between 2006 and 2012. And while banks lending less is partly by design — in order to ensure they have enough cash at hand to weather emergencies — “the magnitude of the decline indicates the extent to which trust has been shaken,” Carney said.

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