Canadian financial stability requires Canadian rules

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Canada's financial system emerged from the global crisis in better shape than in many other countries. Canadian banks avoided the all-out panic that struck some jurisdictions. It's a myth that Canadian banks stood on their own two feet right through the crisis; they received important and timely liquidity assistance from government agencies during the worst months of the meltdown (through a C$200-billion "Extraordinary Financing Framework"). But no bank failed or was taken over by the state. This relative (imperfect) stability has been important to Canada's partial economic recovery since the crisis.

Now the man who oversaw the Canadian system through these turbulent years is crossing the Atlantic. An Oxford-educated former investment banker, Mark Carney took the reins of the Bank of Canada in February 2008 -- just as the world system was sliding into crisis. Now he's been appointed the next Governor of the Bank of England, taking office in June -- the first non-Briton to hold that post in the 318-year history of the institution.

By importing a Canadian central banker, will Britain also import Canadian financial stability? Some Britons clearly hope so. Carney's appointment will surely help the Bank of England navigate the turbulent waters that clearly lie ahead; he is respected for both his credibility and his creativity (a combination rare in the staid world of central banking). However, Canada's relatively positive experience in recent years ultimately owes more to the structure of Canadian banking regulation, than to the traits of its top overseer.

Canada's banking industry is highly concentrated, dominated by five large full-service banks that control over 85 per cent of national bank lending. This market power translates into consistent, above-normal profits. Canadian banks never jumped fully onto the credit-fuelled derivatives bandwagon that brought down so many other banks -- precisely because they weren't so desperate for unconventional trading profit, given the consistent profitability of their traditional asset portfolios.

But this private success owes a great deal to an extensive web of state regulation, protection and support. These stabilizing regulatory forces include:

-  Long-standing limits on asset-to-capital leverage (capping leverage at around 20-to-1) that went well beyond Basel requirements. The proven value of these leverage caps underpins Carney's strong support for similar global limits in debates at the Financial Stability Board (which he now chairs) and other fora.

-  A system of universal public deposit insurance (managed by the publicly-owned Canada Deposit Insurance Corporation) that prevented any measurable outbreak of depositor anxiety, even during the worst months of the crisis.

-  Most mortgages written by Canadian banks are insured by another Crown corporation, the Canadian Mortgage and Housing Corporation. This insurance forestalled any meltdown of investor confidence in Canada's widely collateralized mortgages. Then, during the crisis, the Canadian government instructed CMHC to buy back around C$70 billion of the mortgages it had already insured, injecting crucial liquidity into the banks at that crucial moment.

-  Through the CMHC's insurance system, the state regulates the quality of new mortgages. To qualify for insurance, mortgages must meet minimum standards regarding down payments and amortization. Average mortgage quality is enhanced accordingly. This will help Canada avoid a future freefall in housing prices. Canadian real estate is clearly overvalued (especially in the overheated Vancouver and Toronto markets), after four years of near-zero interest rates and soaring home prices. But the superior quality of most Canadian mortgages means the market, already cooling off, has a better chance of achieving a soft landing, rather than a dramatic downturn.

-  The major banks are even protected against hostile takeover through unique federal government rules requiring dispersed, Canadian ownership of the banks' equity. This further insulated Canadian banks from global pressure during the sub-prime frenzy of the early 2000s -- when acquisition-hungry U.S. banks were rolling in spendable cash.

In short, Canada's banking system demonstrates the virtues of interventionist and flexible government regulation and public ownership. These features long pre-date the election of Canada's current Conservative government in 2006. Conservative officials, ironically, now muse about selling off the very assets (like CMHC) that helped the system weather the storm.

These structural and regulatory strengths also pre-date Carney's tenure at the Bank of Canada.  He was creative and flexible in steering the financial system through the crisis. In his second job as chairman of the FSB, Carney has doggedly pursued the global regulation agenda, overriding sometimes loud objections from self-interested bankers. Carney is a uniquely talented, dedicated, and approachable central banker; Britain's gain is clearly Canada's loss.

However, if Britons are truly interested in emulating the relative stability that Canada's financial system has enjoyed since 2008, they will need to do more than poach our central banker. They will need to copy our successful use of state regulation and public ownership to stabilize a system that, left to its own devices, would likely collapse again.

A version of this commentary was originally published in the Financial Times of London.

Photo: kevin dooley/Flickr

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