* Carney says lack of trust in bank system slows recovery
* G20 has made progress; but bankers must build core values
* Progress overshadowed by Libor, other banking scandals
* Carney sees 2013 progress on "too-big-to-fail" banks
By Russ Blinch
LONDON, Ontario, Feb 25 (Reuters) - Banks and regulators must do much more to rebuild the trust in the financial system that was shattered in the recent crisis, Bank of Canada Governor Mark Carney, head of the G20's Financial Stability Board, said on Monday.
The Group of 20 leading economies has made progress on financial reforms and that will go a long way, but these alone will not be sufficient, Carney said in a speech to business students at the University of Western Ontario in London, Ontario.
"Virtue cannot be regulated. Even the strongest supervision cannot guarantee good conduct. Essential will be the rediscovery of core values, and ultimately this is a question of individual responsibility," he said.
Carney's comments on regulation are being closely watched by British bankers. He will leave Ottawa to become governor of the Bank of England in July, taking over as the UK's central bank expands its oversight of the financial industry.
The lack of trust in major banking systems "deepened the cost of the crisis and is restraining the pace of recovery," Carney said in the speech.
"There is a growing suspicion of the benefits of financial deregulation and cross-border financial liberalization, a suspicion that could ultimately undermine support for free trade and open markets more generally," he said.
Carney said progress in the G20's financial reforms was "not yet fully reflected in market valuations or public attitudes," lamenting that the good work done so far had been overshadowed by a spate of scandals, including one involving the rigging of Libor interest rates.
In a question-and-answer session, Carney said he expected to make major progress this year on banks deemed too big to fail.
"We have not ended too-big-to-fail for individual institutions. We did not expect that we would have ended too-big-to-fail at this point in time, particularly in the major crisis economies, given the scale of the organizations, given their own liquidity needs and other factors," he said.
"But what's required to move this forward ... is to ensure that there is a large component of the capital structure that can be converted effectively into equity if they run into stress."
Progress in this regard is most advanced in Britain and the United States, he said.
Reduced trust in the financial system has increased the cost and lowered the availability of capital for non-financial firms, with access to credit remaining strained despite the massive response of central banks, he said.
Carney spoke of the risk of the balkanization of the banking system as some supervisors try to ring-fence bank subsidiaries in their own jurisdictions to make sure they are resilient on a stand-alone basis.
Ironically these efforts would reduce the resilience of the global financial system, and if left unchecked could substantially decrease its efficiency, he said.