There Is More to Why Canada's Banks Are Better

by Kindred Winecoff

Yes, yes, Tim Horton's and poutine and health care and immigration and Oatley's beloved Habs. But why has Canada's banking sector held up so much better than... everyone else's?

The first answer given, like that given by Canadian Prime Minister Steven Harper, is often that they have a much stronger regulatory regime than the U.S. This is not entirely false... Canada does have stricter capital adequacy requirements for Tier 1 capital than the U.S. But as this Economix post describes, there is more to the story:

[G]overnment rules prohibit anyone or any company from owning more than 20 percent of a Canadian bank, effectively making it impossible for foreign competitors to enter the market through an acquisition.

All that makes for what Ms. Lum described as “an orderly market.”

While such order may seem desirable compared with the current alternative in the United States, it is not without significant side effects.

A report by the International Monetary Fund last year found that the resulting lack of competition makes life difficult for small borrowers.

“A range of analysts and business representatives have argued that the major banks, comfortable in their entrenched positions, have little incentive to venture into areas where borrowers are small, the cost of ascertaining creditworthiness may be higher and returns are more uncertain,” the I.M.F. paper said.
Catherine S. Swift, a former government and bank economist who is now the chairwoman and chief executive of the Canadian Federation of Independent Business, a lobbying group, criticized the banks for “going around and beating their chests right now.”

“While the United States has what we economists refer to as destructive competition, in Canada we have the opposite: ultraconservative financial institutions,” she said. “What we’d like to see is some true competition in the Canadian market.”

There is a tradeoff between competitiveness and stability. Taking one approach over the other may seem prudent or prudish, depending on the course of events. But perhaps a more flexible system -- balancing competitiveness against risk as times change -- would be best. It may not be possible, but a counter-cyclical regulatory regime, similar to a counter-cyclical central bank, would stand a better chance of allowing greater competitiveness and systemic stability.

Disclosure: No positions

Comments

[The Real Deal:]

The real difference is not what you described or quoted.

The real difference is economic philosophy driven by cultural preference. Yes Canada has a market-based capitalist competitive economy. But the country is keenly aware of its downside and therefore shy away from Utopian excess. It therefore implemented a financial system, including regulatory regime, that clips at the excess BEFORE it happened. The regulators dare not go to bed with the regulated, nor asleep at the table, because they know the public won't stand for it, and will call for severe punishments when things go wrong. Canada has a parliamentary system - meaning the government can be replaced at moment's notice if big bad things happen. Politicians are always insecure, always on the lookout. They have no time for corruption.

On the contrary, the US economic system has shifted from a reasonably good check-and-balance of the 70's - 80's into a utopian fundamentalism of the past 2 decades, where everybody - from the hotdog guy all the way to the Fed chair, bought into a $10 trillion dollar nonsense. Not only are the financial regulators went to sleep, the whole country got dis-regulated. The national hubris is so great even the penguins in Antarctica smell it. Except the country of course.

Jun 15 02:59 PM

[conceptwizard:]

Prime Minister Jean Chretien is to thank for the success of the canadian banking sytem, by holding back lobbyiists in 1995. He had this to say in Oct 2008.

"People will remember how much hell I received in 1995 because I refused to let the banks merge," he said. "They said, `We need Canadian big banks who can compete with the world, so stop regulating the banks; we need the freedom of the market,"' Chretien told a graduation ceremony.

"Today in the turmoil, because we said no in 1995, you read any newspaper talking about stability, they all say the best stable banks in the world are in Canada today."

There is a lesson to be learned here, but Canadian banks did nt get away unscathed.

"Canada Mortgage and Housing Corporation (CMHC) will purchase up to $25 billion in insured mortgage pools as part of the Government of Canada’s plan, announced today, to maintain the availability of longer-term credit in Canada." (Canada Mortgage and Housing Corporation Supports Canadian Credit Markets, CHMC Press Release, 10 October 2009)

The decision implies a money transfer into the coffers of Canada's financial institutions. The money is "fungible" and can be used by the banks as they see fit:

"The Honourable Jim Flaherty, Minister of Finance, today announced the Government will purchase up to an additional $50 billion of insured mortgage pools by the end of the fiscal year as part of its ongoing efforts to maintain the availability of longer-term credit in Canada.

This action will increase to $75 billion the maximum value of securities purchased through Canada Mortgage and Housing Corporation (CMHC) under this program.

So as the population of Canada is 33 million one tenth of the USA then it seems fair to multiply this 75 billion amount by ten times to arrive at 750 billion. Well this sounds more like an Obama 750 Billion Stimulus does it not?

Canada's banks got hurt as well.

Jun 15 05:19 PM

[E Nuff Sed:]

CMHC is a government owned entity which guarantees mortgages (like Ginnie Mae in the US). So the only the government is doing is increasing liquidity - not taking on any incremental credit risk. This is not the same as the Obama stimulus program.

Jun 15 07:21 PM

[Bull Run:]

Baiscally 2 reasons why CDN banks have remained strong 1) No interest only morgages, No sub-prime morgages, No ARM morgages. 2) No Wall Street connection. Banks took these quasi morgages then resold them to Wall Street, who then repackaged them as CDO's and insured them with CSDS's to later slip them out the back door into Grama's retirement plan. CDN banks are responsible for the morgages they underwrite. The morgage nonpreforms they "eat it". The 5 major banks are not the only game in town as the article would imply.. there's plently of small credit unions, to give competition

Jun 15 10:34 PM

[Michael Terry:]

Is it the banks or their market? These are not global banks, they are what could be considered super-regional banks whose influence is mainly limited to their domestic market. They did not get into "toxic" investments like CDOs... as they had no natural market to sell them into. They had some markets - ABCP ring a bell - but these were mostly contained as the investor base has a different approach. Sounds like the chicken and the egg dillema - is it the banks are more conservative or is it the investors?

Jun 15 10:46 PM

[hoser2:]

"A report by the International Monetary Fund last year found that the resulting lack of competition makes life difficult for small borrowers."

Life always has been and always will be difficult for small borrowers.

Jun 16 11:37 AM

[RJMoran:]

While there is a painful Canadian trait I call "Pat ourselves on the back-itis", the fact is that borrowing there is extremely difficult and VERY costly! The 'spread' and their conservative, restrictive banking habits may be good for their bottom line but it chokes off commerce, growth, etc! "...Difficult for small borrowers" is being overly polite.

Jun 16 11:58 AM

[jigglylizard:]

The credit standards are more strict. Even for something like credit cards, a Canadian bank refused me for a $500 credit card (ridiculous considering my credit score and income). Then I got approved by MBNA (1 week later) for $5,500. Perhaps a bit TOO strict sometimes...

On Jun 16 11:58 AM RJMoran wrote:

> While there is a painful Canadian trait I call "Pat ourselves on
> the back-itis", the fact is that borrowing there is extremely difficult
> and VERY costly! The 'spread' and their conservative, restrictive
> banking habits may be good for their bottom line but it chokes off
> commerce, growth, etc! "...Difficult for small borrowers" is being
> overly polite.

Jun 16 12:51 PM

[whidbey:]

Try doing business in Canada, even investment they want. They are crabs: if one starts to get over the edge of the bucket another grabs his leg and pulls him back. Just a circulation of the mediocre. I will say the same for their universities, higher education. They do "OK" but never excel. Why? Cultural problem?

Yes, Competition hurts, but fractured business sectors typically means none excel. Of course these damned recessions we cause for ourselves, will that is a real nuisance.

Jul 06 11:42 AM