Monday, March 1, 2010

A Question for the James Kwaks and Simon Johnsons of the World

Mark J. Perry has an interesting piece comparing the banking system in Canada with that of the United States. He notes that Canadian banking system has done much better than the U.S. one not only during this crisis but also during the Great Depression. He lists a number of reasons for the better Canadian performance during the recent crisis. Let me suggest another important difference: Canada had a better monetary policy during this time.

Now of the reasons provided by Perry, I believe the most important one is the extensive branch banking in Canada. As Perry notes, the U.S. has been plagued by unit-banking laws for years; it was not until 1994 that interstate branch banking was legal in the United States. Because of this difference Canadian banks had (1) better geographical diversification of their assets and (2) quicker access to reserves in the event of a bank run (i.e. draw on a branch bank's reserves). That is most likely why over 9000 U.S. banks perished during the Great Depression but zero shut down in Canada at that time. It is also a key reason why almost 3000 banks failed during the S&L crisis in the United States and only two shut down in Canada. One issue, however, associated with the extensive branch banking in Canada is the high concentration of asset ownership. Perry says this is a plus since it allows better coordination between policymakers and key players in the banking system during a crisis. Other observers like James Kwak and Simon Johnson are against high concentration of asset ownership. Their argument is that having a few banks control most of a nation's assets makes for a too-big-to-fail moral hazard problem as well as making the banks too influential. So here is a question to the James Kwaks and Simon Johnsons of the world: how do you reconcile your view of banking with the banking experience in Canada?

4 comments:

  1. UK also has concentrated banking system and has suffered a horrendous financial crisis and recession. Australia has a concentrated banking system and has not suffered either. So what do US and UK have that Australia and Canada do not ? Have you thought about doing a monetary policy regression for all 4 (and maybe euro too)?

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  2. Great question ECB. I was thinking of mentioning in my post what one Canadian told me of the difference between them and Americans: Americans are revolutionary and Canadians are evolutionary. This cultural difference may spill over into how we Americans approach risk. However, I am not sure this explanation works more broadly, especially with Australia.

    Kwak and Johnson make some good points, but I genuinely would like to hear how they view the Canadian experience. Maybe it is in their new book.

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  3. I know that 'regulation' is a pejorative amongst those that purport to the pursuit of 'liberty' --I refer specifically to the self styled libertarians that perpetuate political and economic discourse in the American sphere-- but it was indeed a sensible rules based regulatory environment (under "OSFI") in Canada that stood the financial institutions in good stead during the 2008 financial meltdown. In addition to the points outlined, your readers should recognize the strict limitation on leverage and an equally strict definition as to what defined 'Tier 1' capital within the Canadian sphere that ensured that capital was available for its intended purpose: a buffer against unexpected losses. Add to this the monitoring of liquidity and you have an environment that is not burdensome but strict: you are expected to follow the rules. I speak from experience as an employee within a Canadian financial institution who is acquainted with the requirements of capital management.

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  4. Joseph Stiglitz recently made a rather interesting observation about the US banking system,

    http://www.huffingtonpost.com/2010/03/03/stiglitz-nobel-prize-winn_n_484943.html

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