Friday, June 12, 2009

Why Canada Is Better

. Friday, June 12, 2009

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.


Thomas Oatley said...

With respect to all things Canadian, I think this gives far too much credit to regulation. I point the finger at the simpler fact that Canada had a current account surplus for a full decade (until the end of 2008) and a very weak currency.

Not really the macro environment typically associated with asset bubbles, and nothing whatsoever to do with regulation.

Toronto Condos said...

More competition is needed in the Canadian banking system indeed. IT served us well in these tough times but it might not be such a great idea for the future. Lack of competition always results in agreements in which the customer is ripped off. So like Ms. Lum said our banking market needs to open up a bit in the nearby future. I can't but agree with her.

Take care, Elli

Why Canada Is Better
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