Contrasting Canadian and U.S. banking, regulation

by John Geddes

Reading Andrew Coyne never fails to make me to think harder. His current piece “Our so-called genius banks,” a welcome assault on conventional wisdom, is no exception. After mulling it over, though, I don’t buy key parts of my colleague’s bid to debunk the by now familiar story of how, in the financial crisis, Canada’s banking regulation and culture have proven superior to other systems, notably the American alternative.

Andrew calls it a “historical accident—dumb luck, in other words” that U.S. banking policy tilts toward encouraging borrowers, while Canadian regulation leans toward making sure lenders are sound. But wouldn’t that distinction—which of course is grounded in different national histories—be better described as a fundamental contrast in policy aims and regulatory philosophy? It’s no more accidental, dumb, or lucky than any difference in the way the two countries are run.

Largely as result of this particular difference, Canadian regulators have tended to be more assertive. Consider this observation from the New York Review of Book’s Feb. 12 article “How We Were Ruined & What We Can Do”: “[Allan] Greenspan had been given the authority to examine the quality of mortgage lending by Congress in the 1990s, but simply did not use it, pleading free-market principles. The SEC under Bush appointee [Christopher] Cox could have examined the books of investment banks, but again mostly did not bother.” Here in Ottawa, I’ve never heard of Office of the Superindendent of Financial Institutions shrinking from scrutinizing our banks, or the brokerage houses they bought after 1987.

One way in which American banking regulation is more intrusive than the Canadian system is the U.S. federal Community Reinvestment Act, which forces banks to lend in low-income areas. Andrew points to this as a mistake, which perhaps it is, but I haven’t read a persuasive case for the CRA being much of a factor in the subprime meltdown. On the contrary, Businessweek’s Aaron Pressman wrote last fall that the CRA can’t be plausibly blamed, since “50 per cent of subprime loans were made by mortgage service companies not subject comprehensive federal supervision and another 30 per cent were made by affiliates of banks or thrifts which are not subject to routine supervision or examinations.” Pressman went on: “Not surprisingly given the higher degree of supervision, loans made under the CRA program were made in a more responsible way than other subprime loans.”

Andrew cites Washington’s sponsorship of the mortgage giants Freddie Mae and Fannie Mac as another dubious U.S. government intrusion in lending markets that’s not paralleled in Canada. He’s got a point here. Yet it’s worth noting that Freddie and Fannie have been publicly traded companies since 1989, and thus driven by the usual stock market forces. For example, the New York Times reported on how Fannie’s big plunge into the risky end of the loan market in 2000 “helped supercharge Fannie’s stock price and rewarded top executives with tens of millions of dollars.” The Times concluded that Fannie “was under pressure from Wall Street firms, Congress and company shareholders.” To me, it sounds as if they were driven largely, though not wholly, by the the same distorted incentives as the rest of the subprime circus.

Overall, it seems to me that the broad thrust of Canadian banking regulation, and the resulting banking culture, while hardly perfect, stand up pretty well. As for the idea that what was really wrong in the States was too much regulation, rather than too little—that still looks to me like a stretch.




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Contrasting Canadian and U.S. banking, regulation

  1. John,

    I think you’re finding more disagreement than is actually there. I certainly agree that Canada’s superior regulatory approach played a part in our banks’ relative success. My point was only that this approach, while tighter than the American in some ways, was looser in others.

    The reflexive response of many Canadians, and our admirers in other countries, was to assume that Canadian regulators must impose far stricter constraints on the banking system than elsewhere. Hence the strange assumption, which you can find repeated by any number of commentators, including Paul Volcker, that the lesson from the Canadian banking experience is that banks should be prohibited from owning investment banks — when in fact such restrictions were removed more than 20 years ago, long before a similar deregulation in the US. Conversely, far from the laissez-faire madhouse of caricature, the American banking system is in fact riven with state intervention, much of it aimed at steering credit to dodgy borrowers. We can disagree on how much of a factor this was in the current debacle, but it would be hard to argue it didn’t play some part.

    The distinguishing features of the Canadian regulatory approach is not that there is more of it, but that it’s better designed: broader in scope, covering all federally-regulated financial institutions, and yet less intrusive, more narrowly focused on risk. And it is national. So whereas American banks and bank holding companies, depending on their precise ownership structure, may be regulated by any number of different agencies, federal (Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, Federal Reserve, Securities Exchange Commission, etc.) or state, ours all answer to OFSI.

    You’re right that our happier recent experience is more than mere “dumb luck.” But whatever the merits of our system, it did not prevent our banks from getting into all sorts of trouble in the past. This was really what I meant: our banks got their wild days out of the way in the 80s and 90s, before things really got crazy. Lucky us.

    • “But whatever the merits of our system, it did not prevent our banks from getting into all sorts of trouble in the past”

      Doesn’t that imply that a combination of lower risk appetite and intelligent leadership decisions were an important part of keeping our banks out of trouble? As far as I know, even the Canucks with significant US retail operations – TD Commerce/Banknorth, RBC Centura, BMO Harris — stayed out of trouble.

      There are a confluence of factors to be sure – luck, smart regulation, risk appetite, prudent management – all of these seemed to play an important role.

    • You know, I certainly agree with this comment, and it seems to frame the topic a lot differently than your story did. Perhaps stories need to have a more sensational focus than “hey, it isn’t tighter regulation, it’s just better regulation” – I didn’t really get that from the article, which seemed overshadowed by the historical retellings and the “dumb luck” comments.

      I think we really do have a better system, but perhaps a better way to look at it is that the Americans just have a really bad system, which seems to be true in pretty much every way! Good old USA.

  2. Here was my leading indicator that something was amiss.

    Did you ever watch any of those American house flip shows (TLC or HGTV) over the past two or three years where someone would buy a run down / poorly maintained house (maybe not so much) for say $250k, put maybe $100k of renos into it and a couple of months of work, and then list it for like $650k+, and when they had an open house, you’d be amazed at the quality of the potential buyers who were in the market for houses in that price range? You knew something was wrong with that whole storyline.

    Meanwhile, in Canada, we had Mike Holmes redoing bad renos and complaining about building standards and enforcement.

    I think SAB may have touched on something – there may be a cultural difference in management between Canada and the US. We, generally, tend to be more risk adverse – which probably is good in banks and insurance companies, maybe not so much in other areas that can be subject to “hollowing out”.

  3. I prefer dumb luck as a reason. Canadian banks did not need, by historical accident, to deeply participate in the market with these over-valued securities, and thus did not get left holding a bunch of worthless paper when the pyramid scheme collapsed. The UK bank RBS was in a crazy over-leveraged game of its own across the world and could not survive any kind of problem, but HSBC came through this crisis quite nicely, while operating in many countries, so regulations played a minor part in both cases.

    Also, many, perhaps most, American banks are doing just fine. Some are actively resisting having to take the TARP funds, and others have prudently managed their assets and liabilities and maintained a positive balance sheet throughout.

    I don’t see any big lessons in governance in all this, except that the bailout is a deeply flawed and largely corrupt exercise.

  4. Canada also has less of the, how shall we say, default prone borrowers. The one thing the news isn't reporting is the different default rates by race, education levels, and other socioeconomic datapoints.

  5. Thank God for internet banking, I say. I have three very active accounts, three very active children and one very time-consuming job, so going to the bank became almost impossible for me and my husband. But, nowadays we have an iphone and do most our banking online while on the move. It has made my life so much simpler. Many of the sites listed athttp://www.dozenbanks.com have the online banking facility and I hope they all develop iphone banking apps.

  6. Thank God for internet banking, I say. I have three very active accounts, three very active children and one very time-consuming job, so going to the bank became almost impossible for me and my husband. But, nowadays we have an iphone and do most our banking online while on the move. It has made my life so much simpler. Many of the sites listed athttp://www.dozenbanks.com have the online banking facility and I hope they all develop iphone banking apps.

  7. Thank God for internet banking, I say. I have three very active accounts, three very active children and one very time-consuming job, so going to the bank became almost impossible for me and my husband. But, nowadays we have an iphone and do most our banking online while on the move. It has made my life so much simpler. Many of the sites listed athttp://www.dozenbanks.com have the online banking facility and I hope they all develop iphone banking apps.

  8. Thank God for internet banking, I say. I have three very active accounts, three very active children and one very time-consuming job, so going to the bank became almost impossible for me and my husband. But, nowadays we have an iphone and do most our banking online while on the move. It has made my life so much simpler. Many of the sites listed athttp://www.dozenbanks.com have the online banking facility and I hope they all develop iphone banking apps.

  9. Please explain to me how $75 billion through the CMHC in an ‘asset swap’ is any different from a bailout beyond the phrasing, and another $111 billion from the FED, reported by Globe & Mail.

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