Friday, April 23, 2010
In response to the chorus of experts calling for the mega-banks to be broken up, defenders of our current banking system argue that because Canada's banking system is pretty stable, and Canada has some giant banks, size isn't the issue.
This might be a great argument ... except that Canada's banking system is completely different from America's banking system.
Instead of listing numerous differences, I'll just raise two.
First, as Newsweek points out:
Canadian banks are typically leveraged at 18 to 1—compared with U.S. banks at 26 to 1 and European banks at a frightening 61 to 1.
Of course, Congress or regulators could demand lower leverage ratios.
But the second difference is harder to fix. Specifically, 5 American banks hold virtually all of the world-wide exposure to derivatives, especially credit default swaps. See this, this, this and this.
Unlike the 5 giant derivative dealers in the U.S. who pretend - because they want to keep their derivative sale profits high - that reining in derivatives would be bad for the economy, Canada's banks don't see much need for much exposure.
As the Bank of Canada wrote in 2000:
Anecdotal evidence also suggests that Canadian banks have been slower to embrace credit derivatives than their international counterparts. Reasons citedCan't congress or regulators fix this?
for the slow emergence of credit derivatives in Canada include the Canadian banks’ access to cost-effective funding through their retail deposit base, as well as
their ability to achieve a broad diversification of credit risk internally through their national branch networks.
Derivatives will never be reined in until the too big to fails are broken up. The banks are so big and politically powerful that they have bought the politicians and captured the regulators.
So the American banking giants - which have repeatedly gone bankrupt due to wild speculation - are a totally different animal than the Canadian banks. The former is up to their ears in derivatives while the latter isn't. And the former is preventing any transparency or regulation of derivatives.
Unless the too big to fails are broken up, they will go bust again - and bring the system down with them.
As the Newsweek article also points out, Canada's real estate bubble hasn't popped yet. Even with lower leverage and derivatives holdings, the big Canadian banks might not fare so well when that happens.