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Opinion: Should America follow Canadian-style banking? I say no!

There is an op-ed in the New York Times where it is suggested that America should follow Canadian-style banking. I don't think America should.

(source: The Great Solvent North, Theresa Tedesco. The New York Times. Published: February 27, 2009)

The Canadian banking system, which proved resilient in the global economic crisis, is finally getting its day in the sun. A recent World Economic Forum report ranked it the soundest in the world, mostly as the result of its conservative practices. (The United States ranked 40th).

President Obama has joined the adoring throng. He recently said that Canada has “shown itself to be a pretty good manager of the financial system in the economy in ways that we haven’t always been here in the United States.” Paul Volcker, former chief of the United States Federal Reserve, commented that what he’s arguing for “looks more like the Canadian system than the American system.”

Most people don’t know that the vision behind Canada’s banking system, made up of a few large, national banks with branches from coast to coast, actually had its beginnings in the United States. Canada’s system is the product of a banking framework inspired by Alexander Hamilton, the first American secretary of the Treasury. Hamilton envisioned the First Bank of the United States, chartered in 1791, as a central bank modeled on the Bank of England.

Canadians found inspiration in Hamilton’s model, but not all Americans did. In the 1830s, President Andrew Jackson opposed extending the charter of the Second Bank of the United States, perceiving it as monopolistic. Money-lending functions were then assumed by local and state-chartered banks, eventually giving rise to the free-market, decentralized system that America has today.

Canadian banks have avoided being infected by the Subprime Virus or various other financial diseases that are spreading these days. Some bears claim the Canadian banks are still vulnerable but, so far, they have avoided most of the problems. To give an idea of their success, note that Canadian banks are the few major banks in the world that haven't received government capital injections. The Canadian government has provided some indirect support but no major bailout so far.

Naturally, since the Canadian banks have successfully avoided the serious problems, there is tendency for many to suggest that America should follow the Canadian model. I don't share that view for several reasons.

First of all, as the author of the article alludes to, American banks have developed as de-centralized institutions with literally thousands of banks in the country. It is just not feasible to change than within a few decades. I don't necessarily think the numerous banks is a weakness.

Secondly, everyone seems to be missing the fact that the American banks that have serious issues are precisely the megabanks that resemble the Canadian Big 5 (Five banks dominate Canadian banking.) Although you hear of banks being declared insolvent every Friday, there doesn't seem to be much trouble with the thousands of small banks. Problems may develop for the smaller banks when the economy slows, commercial real estate blows up, and other regional problems. But so far they don't seem to be under duress.

I'm not a banker and too knowledgeable about world financial institutions, but my impression is that most of Europe runs Canadian-style banking. Countries like Ireland, Britain, and Germany have a few megabanks similar to Canada. Yet European banks have been hit hard. To make matters worse, since the banks are so large, it will put a huge strain on the country for a long time. It would not surprise me if British bankers will be considered equivalent to some low-life creatures within a decade, given how it will take many decades for the British to pay off the bank bailouts. If two the Big Five in Canada collapsed, it would be a similar situation with the whole country being threatened. In contrast, America will be fine if a few of their big banks go down.

I would argue that the strength of the Canadian banks come, not from the structure of the banks, but from the tight regulation. Canadian banks are heavily regulated, conservatively run, and weren't permitted to finance consumers and businesses to the same degree. For instance, although Canadians are almost as badly indebted as Americans and there is great demand for low-cost mortgages (Canadians are actually poorer than Americans,) certain subprime mortgages were never introduced in Canada. I think Canadian banks will still take some losses in the future because there were some risky mortgages that they financed, but it is nothing like America.

Moving forward, stronger regulation or at least "better" regulation is the answer. Bankers, investors, and borrowers will always be ahead of the regulators but you don't need to be perfect; you just need to be good enough to prevent a systematic threat.

The problem America is facing right now has little to do with the structure of the banks. America's thousand-plus banks have survived many wars, panics, and crises. The distributed nature also lowers costs for consumers whereas Canadian banks make a killing off anyone they deal with since they are close to an oligopoly (for example, service fees on chequing accounts, debit fees, stock trade commissions, etc, are still quite high.)

The real problem in America, I feel, is the struggle over policy. Part of America is influenced by conservatives, libertarians, and extreme capitalists, who will not permit nationalization of banks. These individuals would prefer to let the failing banks collapse. At the same time, a chunk of the political fabric seems to be liberals, leftists, and moderates, who do not want to let the megabanks collapse and let the system implode. To make matters worse, many of the "best and brightest" who are influencing or executing policy now are culpable in this whole affair. For instance, it is beyond bizarre to have Henry Paulson run the Treasury in the last few years when in fact he had supported policies in the past that are part of the problem now (e.g. allowing higher commercial bank leverage.) So until the government, and hence politicians, decide one way or another, there will be a dark cloud hanging over the banks.

I don't think America needs to change the structure of the system. American banks just need tighter regulation. At a minimum, the shadow banking system needs to be separated from regular banks and insurance companies.


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