Peter Redman/National PostToronto's financial district, where the U.S. Federal Reserve hopes to find potential buyers.

In a desperate bid to help U.S. banks recapitalize, Washington is dropping its inhibitions and reaching out to Canadian financial institutions to gauge their willingness to participate in rescue operations.

The Federal Reserve has activated a back channel that puts the central bank in direct contact with chief executives at Canada's largest banks and insurers, according to a person familiar with the dialogue.

They are approaching "banks with major assets in the U.S. like [Toronto-Dominion Bank] and Royal [Bank of Canada], because when they have a bailout situation they want everyone who is a potential buyer to look at it," the source said.

The ongoing conversations between the U.S. central bank and Canadian executives reflects the challenge facing Washington as it seeks to address both short-term liquidity and permanent capital needs of financial institutions crippled by more than $500-billion in losses and limited access to financing.

The communications have included phone calls from Fed officials pitching potential sales of assets of U.S. financial companies and at least one intensive discussion of a major rescue operation, according to people familiar with the contacts.

The Fed has been steadily widening the circle of foreign institutions it is working with as the banking crisis has deepened, according to a former Fed official now on Wall Street.

The outreach to Canadian companies signals a more permissive environment in which U.S. authorities would look very favourably on an intervention by a Toronto-based institution.

It comes as Washington deploys greater reserves than initially anticipated to restore liquidity, while still facing an uphill battle to help banks recapitalize at a point in the crisis when projected losses of up to $1-trillion still ahead for the global banking system.

The engagement of Canadian institutions follows U.S. federal assent for the acquisition of assets in bankrupt Lehman Brothers by the U.K.'s Barclays, in a deal that followed intensive discussions with the Federal Reserve and U.S. Treasury.

That deal was smoothed by good relations between the London and Washington and a lower level of resistance to a deal with the U.K. on Capitol Hill, where political disquiet over foreign interventions has helped keep some buyers at bay.

"Canada is not China," said a former Fed official.

A lobbyist for a Canadian bank said the political climate in Washington had changed markedly since the passage of a $700-billion bailout and that this country is now seen as a potential source of support.

Executives and advisors in the Canadian financial services industry indicated they still saw live opportunities for their sector to help drive consolidation and recapitalization in the U.S., despite limited flexibility at a time when sinking markets were lowering all boats.

"I don't think Canadian banks want to take a lot of balance sheet risk but I don't think they are going to have to," the source said, adding that while the target banks have many subprime mortgages, the Federal Reserve will backstop these high-risk liabilities.

"We could end up in a funny situation two years from now saying this was a once in a generational opportunity for Canadian banks."

U.S. regional banks remain in deep distress and an acquisition of this scale is seen as possible in the coming months, as Canadian banks cautiously explore possible buys and after TD Bank Financial Group put its name forward during an auction of Washington Mutual.

A broad sell-off in the U.S. insurance sector has also cut into the valuations and capital positions of U.S. insurers seen as possible matches for Sun Life and Manulife, the Canadian life insurers.

Sun is actively weighing the likelihood of an intervention in the U.S., according to one person in the industry.

A foreign bank executive who participated in a recent round of rescue talks with the Fed said U.S. authorities were also keeping national regulators informed of high-stakes negotiations.

It was not clear how deeply involved Canadian authorities were in the discussions.

The Bank of Canada declined to comment.