Friday, October 17, 2008

The Canadians and Their Resilient Banking System

One of the interesting facts from the Great Depression of the 1930s is that Canadian banking system had zero bank closings. This accomplishment is all the more amazing when one considers that there was no central bank in Canada until 1935. The United States, on the other hand, had a central bank from the outset of the Great Depression but still somehow managed to let thousands of banks to fail. This development caused a massive disruption of financial intermediation in the United States and is believed by some observers to be the main reason for the severity of the the U.S. Great Depression. As I have noted before, many observers believe the resiliency of the Canadian banking system during this time was the result of its extensive branch banking system, something that was absent from the U.S. banking system. Allowing a bank to have branches gives it a more diversified portfolio of assets as well as making it able to draw on reserves across many branches. Branch banking, therefore, makes a banking system more capable of handling economic shocks.

I bring this up, because the Washington Post is reporting that the Canadian banking system is still ahead of the U.S. banking system when it comes to branch banking (ht Tyler Cowen). As a result, the current financial crisis has had less of an impact on Canadian banking system:
TORONTO, Oct. 15 -- While the United States reels from the global financial crisis, with credit markets still frozen and stock prices careening from highs to lows, Canada has remained relatively insulated.

Canadian banks have not gone shaky like their American counterparts, economists and other experts said. There is no subprime mortgage or home foreclosure mess. And while the United States fears a prolonged recession, Canadians have remained relatively sanguine, convinced that they are in a good position to weather the economic tsunami from the south.

[...]

According to the Canadian Banking Association, one reason for the system's solidity is that banks are national in scope. Each of the largest five institutions has branches in all 10 Canadian provinces, meaning they are less susceptible to regional downturns and they can move capital from region to region, as needed. "As far as I am aware, no American bank has branches in all 50 states," banking association spokesman Andrew Addison wrote in an e-mail.
The article also mentions better bank regulations as another factor. Still, what is so striking to me is that 70+ years after the Great Depression we still do not have the level of branch banking found in Canada.

Update: Here is a figure from Mark Perry's discussion on the Canadian vs. U.S. banking system during the Great Depression:

3 comments:

  1. Paul (Not-Krugman)October 17, 2008 at 1:28 PM

    Couple of observations, that you might care to comment on?
    1) I think UK has pretty extensive branching too, but the banking system (espec Royal Bank of Scotland) is one almighty mess.
    2) Some of the smaller US banks are doing just fine - like IBC for instance. They just didnt get involved in the subprime mess. By contrast, the bigger (Too big to fail?!!) banks with more extensive branching like Citibank are in trouble.

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  2. Paul:

    Branch banking may not eliminate all problems. I believe, though, had their been no branch banking at all the banking problems would be even more severe.

    If one follows the diversification justification for branch banking, then what is really needed is a international bank with branches across the globe. This would be the ultimate form of diversification and presumably would eliminate most country and region idiosyncratic risk.

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  3. I think the unit vs branch banking story has validity for the 1930s, but I feel that recent divergence between countries may have more to do with how diligently regulation was pursued. And we are seeing more global diversification of banks. But Nassem Taleb recently argued in the Black Swan that this is actually bad. On PBS last week
    he said:
    NASSIM NICHOLAS TALEB: Let me tell you what is happening in the ecology of the banking system. They're swelling to large banks, OK, because it's vastly more optimal to have one large bank than 10 small banks. It's more efficient.

    PAUL SOLMAN: Well, we've certainly seen the consolidation of the industry.

    NASSIM NICHOLAS TALEB: Exactly. And that consolidation is what's putting us at risk, because we are -- when one bank, large bank makes a mistake, OK, it's 10 times worse than a small bank making a mistake.

    So it can cut both ways.

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