Canadian Banks VS The World
Why Canadian Banks Survived Unscathed
By Andres Pozo, Contributor
Slow, stupid and unambitious. Short sighted, dull and loan thwarters. These were just some of the many unflattering descriptions the rest of the financial world deemed appropriate when describing Canada’s banking system.
Fortunately, we were not sufficiently swayed by peer mockery. As they grew fast and fat, we humbly kept on trucking. It would eventually take a global financial crisis to show the world that prudence and conservatism were actually positive attributes for a banking system. While many countries’ financial footing crumbled beneath them, ours barely had a few cracks. Here’s a look at what made us ask; Really? A global financial melt down, eh? You don’t say … .
Well, credit must be given to the firm and uncompromising Canadian regulatory system, considered the most conservative in the world. Based on the Basel Capital Accord in 1988, banks were required to hold no less than four dollars in “tier 1 capital” (common equity, published reserves and equivalents) for every $100 they lent out. The regulators in the U.S. considered a six per cent ratio more appropriate, while Canada took it a notch further, setting theirs at seven per cent. In reality we have been operating with 10 per cent, much greater than the regulatory standard.
This was not simply a case of deregulation vs. regulation. In the past decade, American banks have not gone through any deregulation, nor has there been any further regulation in Canada. Subprime mortgages still accounted for seven per cent of the Canadian market. Although American banks were normally more leveraged, higher capital ratios would not have necessarily made things better due to the American banks’ strong reliance on securitization (selling mortgages to third parties). This was done to get these toxic assets off their books, in order to not have them counted against their capital. And so, further regulation might have encouraged even more securitization.
In some respects, Canadian banks are not as regulated as their American counterparts. For example, Canadian banks do not have to adhere to the American Community Reinvestment Act, which forces American banks to extend mortgages to low-income households. This in turn brings down their usual leading standards. We also do not have the equivalent of Fannie Mae and Freddie Mac, government-sponsored enterprises, which heavily provided funding for subprime mortgages that set off the melt down.
Another contributing factor to the stability and cohesiveness of Canadian banks came when North American banks became free to own other financial institutions. In Canada, the Big Five swallowed up most of the large investment houses. Major banks in America did likewise, with the exception that each subsidiary of an American bank would be subjected to a different regulatory authority, depending on its classification (insurance company, investment bank, or commercial bank). In Canada they all adhered to the OSFI to oversee and regulate the whole entity. Instead of destabilizing the banks, the brokers’ absorption into the banks stabilized the banks. This was unlike the Lehman Brothers or Bear Stearns, which did not have an overseer with deep pockets or strict regulation to prevent them from collapse.
Furthermore, it was Canada’s stance on bank mergers that kept us from harm as well. Canadian banks, like most banks of the developed world, wanted to merge and form global banks to better participate in the global growth of financial markets. The Canadian government has always firmly vetoed these mergers.
The cost of achieving greater size and presence at an international level meant that there would be a reduction of competition in the domestic market. The Canadian Competition Bureau indicated that such mergers would result in a decrease for a number of financial products in submarkets, such as: portfolio management, credit cards, loans etc. Losing an important advantage in the domestic market for an uncertain share of the financial market was therefore seen as unwise.