In a commentary in The Globe and Mail, JD student Grant Bishop looks at various studies examining the reasons behind the stability of Canadian banks ("Canadian Banks: Bigger is better," April 11, 2013). Bishop was formerly an economist at a major Canadian financial institution.
Read the full commentary on The Globe and Mail website, or below.
Canadian Banks: Bigger is better
Grant Bishop
April 11, 2013
A recently published paper by Columbia University’s Charles Calomiris argues that banking crises have political foundations. He contends that anti-populist political structures guard against the capture of the banking system by voters seeking easy credit. But parts of Mr. Calomiris’ thesis have raised eyebrows: he implies that the British aim of oppressing French Canada is the indirect root of Canada’s long-term banking stability.
There is something to Mr. Calomiris’ broad argument even if his linkage to English-French tensions is overstated.
More generally, Mr. Calormis contends that Canada’s stable, nationwide banking system is a result of the constitutional assignment of federal jurisdiction over banking and other economic heads of power. He hypothesizes that Canada’s political institutions shielded banking regulation from populist politics. In contrast, he argues that the development of a pan-national U.S. banking system was stymied by coalitions of local bankers, who were interested in safeguarding local monopolies, and farmers, who were suspicious of large, national banks.
What policy-makers should take away from Calomiris’ account is the importance of keeping politics away from banking regulation. As Anita Anand and Andrew Green of the University of Toronto also argue in a recent paper, the independence of financial regulation from politics in Canada is a cornerstone of the integrity of our system. This is something that Ottawa seems to have forgotten of late with partisan sparring over mortgage rates.
But there is much more to the story of Canada’s banking stability than Mr. Calomiris’ political capture story. Our banking system has benefited from the interplay of cautious regulation, a prudent banking culture and a highly concentrated industry structure that reinforced prudence.
Compared with the hundreds of U.S. bank failures just since 2008, Canada over the past century has seen only three – one in 1923 and two in 1985. No Canadian banks failed during the Great Depression. Yet, central banking came relatively late to Canada: the Bank of Canada’s creation in 1935 post-dated the U.S. Federal Reserve by more than two decades and the Bank of England by more than 200 years. Somehow Canadian banks had, without crisis, been capable of co-ordinating access to liquidity across our branch-banking system.
In another recent paper, UBC’s Angela Redish and her colleagues ask “Why didn’t Canada have a banking crisis in 2008 (or in 1930, or 1907, or…)?” They conclude that, in contrast with the fragmented U.S. system, Canadian banking stability owed to the single overarching regulator and the high concentration of the sector.
A cross-country study by World Bank researchers reaches a similar conclusion: more concentrated banking systems appear to be more stable.
Of course, we want our banks to compete rigorously so that they must remain efficient (and recent Bank of Canada research finds no efficiency gap between our banks with their stateside counterparts). However, policy makers don’t want banks to pursue risky lending strategies that will imperil the banking system (and the economy) as a whole.
In other industries, creative destructive is ideal. We want companies to perish if they can’t innovate to keep up with their competitor. But banking is different. The value of a bank to the customer is that it will still be there when you want to draw on your deposits.
To this end, Canada’s concentrated banking structure nurtures a more conservative banking culture. Canadian banks think of themselves as in it for the long haul. In contrast, in a fragmented U.S.-style banking system, some local subprime lender may not think about the increased risk to the system when they make that next risky loan. They might not be around next year so they might as well go for broke today. Only when all those loans go bad does the herd realize that they’ve charged together off the cliff.
Canada’s pan-national banking system also buttresses systemic stability. With branches nationwide, Canada’s banks can easily use deposits in Alberta to fund credit in Ontario and vice-versa. A national banking system is also more resilient to regional shocks. A drought in Saskatchewan or a manufacturing downturn in Quebec doesn’t produce a rash of bank failures.
The opposite is true stateside, and their notoriously shaky “shadow banking” system has arguably grown up because of the fragmentation. Similarly, while we’ve heard much about the lack of European fiscal integration, there has been unfortunately less attention on vulnerabilities from lack of banking integration across the euro zone.
As other countries seek to rebuild their tattered financial systems, there are abundant lessons from Canadian banking history. Our outgoing Bank of Canada Governor, Mark Carney, will no doubt help export this experience when he assumes his post at the troubled Bank of England this summer.
