* Banks should know they might not be rescued

* Canada not necessarily closer to quantitative easing

* Does not see return to recession despite high C$

OTTAWA, Oct 26 (Reuters) - The international financial system must be changed so that banks can go belly up without bringing the whole economy down, Bank of Canada Governor Mark Carney said on Monday.

“We have to have a system where you could have an institution going bankrupt. One of the problems during the crisis was that each institution that goes bankrupt had to be saved, and that’s not acceptable,” Carney told the French division of CBC television.

“It’s necessary to do that (let banks go bankrupt) and it’s essential that the institutions themselves think it’s possible.”

Earlier on Monday, he had said in a speech that the risks should return to the financial institutions and no longer be borne by the government.

In his speech he reiterated that the bank retained considerable flexibility, even though its rock-bottom interest rates cannot be cut further, in keeping the economy and therefore inflation on an even keel.

That is code language for saying the bank could, if necessary, engage in quantitative easing, essentially printing money, particularly if the Canadian dollar rose too far too fast.

But, asked if this prospect were now closer given the strong rise in the currency, he said: “Not necessarily. We just decided on our monetary policy last Tuesday and we reiterated our conditional commitment (to keep rates steady till mid-2010) and that’s the appropriate policy to reach our target.”

In making its interest rate announcement last week, the bank said the currency’s strength could more than fully offset recent developments since July.

But asked on Monday if the economy could slip back into recession in 2010 or 2011 if the Canadian dollar continued to rise, he demurred.

“That depends,” he said. “It’s a question of other factors, the reasons why the dollar rose. But currently the forecast of the Bank of Canada is that our economy will grow by 3 percent in 2010 and 3.3 percent in 2011.