Canadian Banking System: Regulating Funding, Finance and Securities

In 2008, the world economic forum ranked Canada as having the best banks in the world. Why does Canada have such good banks? Why would a country that is generally viewed by conservatives as a bastion of socialist thinking in North America offer more stable banking? Since the great depression, only two regional banks have failed in Canada. There have been over 40 banks in the United States that have failed since the year 2000. Is there any merit to having a mixed economic system? Actually having regulations on an economy does in turn have benefits. What are those benefits? How about being the only country in the G8 to have an expected economic growth rate above one percent for this year.

Canadian Bank Breakdown

There are five major banks in Canada along with numerous secondary and regional banks. The five major banks have assets valued at over 2.3 trillion dollars Canadian (roughly $2.1 trillion American). Forbes ranks the top five all within the top 200 banks in the world. The big five are viewed as banking conglomerates since they operate all across the globe most notably the Caribbean and South America. The bank of Nova Scotia was the 11th largest bank in Argentina until 2005 when it pulled out of Argentina triggering massive inflation and economic stagnation (on top of a crap fest that was already happening).

US banks operate via a holding company model. Essentially, US banks can own large shares in various other corporations and collect tax-free dividends from investments. For most major banks in the western hemisphere, personal banking only makes up about ten to twenty percent of their income. That means the majority of the income of a bank in the United States is making is also tax-free. Holding companies are systems that also mean that the main company does not involve itself in the management or the day-to-day activities of the companies it owns. Nor do the individual shareholders have the ability to influence who sits on the board of directors of the main holding company.

Canadian banks operate in a different manner. Canadian banks follow a parent company model of operating. A parent company is a corporation that owns enough stock in other companies to influence the management of their assets. Majority shareholders can elect the board of directors that run the company. This creates a higher level of accountability in the management and operations of the various interests that the company owns.

Subprime Mortgage Fallout

Profits for over 85,000 US banks declined by 89% in the final quarter of 2007. Banks earned 35 billion in the third quarter of 2007, earned about 647 million in the last three months of that year. This was the start of the current crisis we are in. An estimated 100 US banks are expected to shut down because of the subprime crisis.

The only Canadian bank to lose money because of the subprime mortgage crisis was the Canadian Imperial Bank of Commerce (CIBC) which lost about two billion dollars. The CEO of CIBC world markets and the chief risk officer were promptly fired. The CEO of CIBC didn’t face any repercussions though. When Citibank lost 8-11 billion they replaced their CEO. The strangest part is that at this time, Citigroup, the holding company that owns Citibank, does not know the full extent of the loss it has suffered from the subprime fall out.

Regulations in Canada

Banks are regulated by the federal government in Canada and credit unions are regulated by provincial governments. The 1991 Canadian Bank Act is the primary law that regulates the banking system in Canada, allowing federal government involvement. The act divides active banks in Canada into three tiers:

The three tiers of banks, as regulated by the Canadian Bank Act
i. Banks are not allowed to accept deposits from subsidiaries of foreign banks. Domestic banks are the only institutions allowed to hold and enforce security interests (mortgages) under Canadian law. The fact that only domestic banks can issue mortgages means that outside firms cannot purchase up large quantities of debt for profit.

ii. Foreign banks that are allowed to accept deposits but cannot issue mortgages in Canada.

iii. Foreign banks that are allowed to conduct business in Canada (mostly the major cities). These banks operate under the greatest number of restrictions.

These three tiers or “schedules” are regulated by a government institution called the Office of the Superintendent of Financial Institutions - OSFI - (est. 1925 as the Office of the Inspector General of Banks).  In the offices’ mandate is the charge to promote the adoption of policies and procedures designed to control and manage risk. Perhaps the most Canadian statement ever made. Compare this with the English Banking system which has the Monetary Policy Committee  which is a government body which can make recommendations to the Bank of England but are mostly there to regulate prices and deal with inflation. Most of the responsibility of regulating the banking in England fall under the Govenor of the Bank of England (who is technically a civil servant). The govenor guides the national economic policy of Britain. Too many checks and balances set up in Canada to allow single institutions to guide the country’s economic policy. Besides having the OSFI there is also the Department of Finance and the Treasury Board Secretariat as well as numerous provincial agencies. These numerous institutions can compartmentalize economic problems and prevent them from spreading across the board as well as create an environment that prevents bad policy (e.g. subprime lending) from becoming rampant. There are people who keep an eye on the banks, ensuring that when people who are grant writing for businesses or approving mortgages, that there is safety and security to prevent meltdowns.

Effective regulations do not mean that a government tells a business how to function but rather prevents a business from harming itself as well as the consumer. Unfortunately this principle was forgotten by those who saw the banking system of the west as an easy means of funding risky or dangerous business ventures. Hopefully in the future the model currently followed by Canada will be a model emulated by other nations in order to prevent another economic crisis.