PrefBlog

An article in the Globe and Mail by Grant Bishop titled Canadian Banks: Bigger is better highlighted views regarding Canadian banking regulation that differ from my own:

A recently published paper by Columbia University’s Charles Calomiris argues that banking crises have political foundations. He contends that anti-populist political structures guard against the capture of the banking system by voters seeking easy credit. But parts of Mr. Calomiris’ thesis have raised eyebrows: he implies that the British aim of oppressing French Canada is the indirect root of Canada’s long-term banking stability.
…
What policy-makers should take away from Calomiris’ account is the importance of keeping politics away from banking regulation. As Anita Anand and Andrew Green of the University of Toronto also argue in a recent paper, the independence of financial regulation from politics in Canada is a cornerstone of the integrity of our system.

It is, of course, my argument that both OSFI and the Bank of Canada have become intensely politicized in over the recent past, with both Carney and Dickson acting as stalking horses for politically inspired regulatory ideas (mostly to do with contingent capital and the Ban The Bond movement).

In another recent paper, UBC’s Angela Redish and her colleagues ask “Why didn’t Canada have a banking crisis in 2008 (or in 1930, or 1907, or…)?” They conclude that, in contrast with the fragmented U.S. system, Canadian banking stability owed to the single overarching regulator and the high concentration of the sector.

A cross-country study by World Bank researchers reaches a similar conclusion: more concentrated banking systems appear to be more stable.

The paper by Anita Anand & Andrew Green titled REGULATING FINANCIAL INSTITUTIONS: THE VALUE OF OPACITY has the abstract:

In this article, we explore a question of institutional design: What characteristics make a regulatory agency effective? We build on the growing body of administrative law literature that rigorously examines the impacts of transparency, insulation, and related administrative processes. We argue that there are certain benefits associated with an opaque and insulated structure, including the ability to regulate unfettered by partisan politics and majoritarian preferences. We examine Canada’s financial institution regulator, the Office of the Superintendent of Financial Institutions (OSFI), whose efficacy in part explains the resilience of Canada’s banking sector throughout the financial crisis of 2008. In particular, OSFI operates in a “black box”, keeping information about the formation of policy and its enforcement of this policy confidential. With its informational advantage, it is able to undermine the possibility that banks will collude or rent-seek. Our conclusions regarding the value of opacity cut against generally held views about the benefits of transparency in regulatory bodies.

Huh. I wonder if they’re also in favour of re-establishing the Star Chamber, which worked very well until it didn’t.

The body of this paper commences with the startling claim:

Canada’s financial institutions weathered the crisis well relative to their international peers, an outcome that has been attributed at least in part to the presence of an effective regulator.[Footnote]

Footnote reads: See Canadian Securities Institute, Canadian Best Practices Take Centre Stage at Financial Conference in China (25 February 2009), online: Focus Communications Inc ; Financial Services Authority, Bank of England & Treasury, Financial Stability and Depositor Protection: Further Consultation (London: HM Treasury, 2008), online: HM Treasury

The Canadian Securities Institute is not something I consider an authoritative, or even credible, source, so I looked for the paper HM Treasury: Financial stability and depositor protection: further consultation, July 2008 which contains four instances of the word Canada (in each case, grouped with other countries as a participant or example), no instances of “OSFI”, one instance of “Superintendent” (the “Superintendents’ Association of Northern Ireland”, which responded to an earlier consultation), and two instances of “effective regulat”, both of which referred to the UK bodies aspirations.

Ratnovski and Huang, for example, examine the performance of the seventy-two largest commercial banks in OECD countries during the financial crisis, analyzing the factors behind Canadian banks’ relative resilience at this time.[Footnote 4] They identify two main causes, one of which is regulatory factors that reduced banks’ incentives to take excessive risks.[Footnote 5]

Footnote 4 reads: Lev Ratnovski & Rocco Huang, “Why Are Canadian Banks More Resilient?” (2009) IMF Working Paper No 152, online: Social Science Research Network .

Footnote 5 reads: Ibid. Other factors included a higher degree of retail depository funding, and to a lesser extent, sufficient capital and liquidity.

The Ratnovski & Huang paper was reviewed in my post Why Have Canadian Banks Been More Resilient?. The paper is available from the IMF

Specifically, Ratnovski & Huang say:

The second part of this paper (Section 3) reviews regulatory and structural factors that may have reduced Canadian banks’ incentives to take risks and contributed to their relative resilience during the turmoil. We identify a number of them: stringent capital regulation with higher-than-Basel minimal requirements, limited involvement of Canadian banks in foreign and wholesale activities, valuable franchises, and a conservative mortgage product market.

Returning to the Anand & Green paper, the guts of the argument is:

OSFI’s efficacy may at first be surprising. It is the primary regulator of Canada’s five big banks (which account for approximately 85 percent of Canada’s banking sector).10 Its power to overcome the possibility for rent seeking or capture by these institutions depends on its rule making and enforcement processes, and forms of accountability for its actions. That is, if not sufficiently independent, regulated institutions might seek rules that favour their profitability at the expense of consumers. Yet on many important issues, including capital adequacy requirements, OSFI relies on guidelines rather than regulations. OSFI creates these guidelines through a largely opaque process in which the regulated parties have early input. Other parties (such as consumers) not only face considerable collective action problems but are limited to a stunted notice and comment process. The comment process thereby potentially privileges the views of regulated institutions. Further, in addressing compliance with regulations or guidelines, OSFI attempts to work informally with regulated parties, ultimately rendering it unnecessary for it to take formal enforcement action. This structure seems to point more towards capture by the large (albeit regulated) players. To aid in the discussion of the appropriate institutional structure for banks, we examine whether Canada’s financial institutions—and banks in particular—have been successful because of, or despite, the presence of OSFI.

Later comes a real howler:

Despite its insulation and opacity, however, OSFI is almost universally viewed to be an effective regulator.[Footnote 17]

[Footnote 17 reads] The Strategic Counsel, Qualitative Research: Deposit-Taking Institutions Sector Consultation,
(Toronto: 2010) at 2-6, online: OSFI < http://www.osfi-bsif.gc.ca/app/DocRepository/ 1/eng/reports/osfi/DTISC_e.pdf >

So lets have a look at the OSFI document that says OSFI is doing a great job. It’s a survey. Who is surveyed, you may ask. So I will tell you:

A total of 49 one-on-one interviews were conducted among Chief Executive Officers (CEOs), Chief Financial Officers (CFOs), Chief Risk Officers (CROs), Chief Compliance Officers (CCOs), other senior executives, auditors and lawyers of deposit-taking institutions regulated by OSFI.

The use of the phrase “almost universally” seems … a little strained.

The paper’s arguments are founded upon the premise that OSFI is doing a great job, therefore the way it does it must also be great. Unfortunately, the premises do not support the conclusions.

This entry was posted on Friday, April 12th, 2013 at 2:32 pm and is filed under Interesting External Papers. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.