Good Governance is the Key to Canada's Financial Stability

In late 2008, a World Economic Forum survey rated Canada's banks the soundest in the world, with U.S. banks ranking 40th. In the United States, twice as many banks already have failed in 2009 as in 2008. In the last 18 months, we also have witnessed the failure of such institutions as Lehman Brothers and Merrill Lynch, and the implosion of the housing sector. But not in Canada. Why?

As the Canada Institute convened two Washington sessions on the Canadian banking and financial industry, we also gathered a group of bankers in Toronto to look at the Canadian and American banking industries.

The Canada Institute's Advisory Board Chairman Gerry McCaughey, president and CEO of the Canadian Imperial Bank of Commerce, invited Rick Waugh, president and CEO of Canada's Scotiabank, and Bob Kelly, chairman and CEO of the Bank of New York Mellon, to discuss what worked in Canada. Former Deputy Prime Minister John Manley, who moderated the June 24 session, asked the panel if the performance of the Canadian financial sector resulted from good management, wise regulation, or just plain luck.

Waugh argued that good governance in the public and private sectors provided a good balance and backup system that continues to work. He admitted the Canadian financial system is not perfect, but that it does have good risk, capital, and overall management.

Chided by Wall Street that Canadian banks had too much capital, Waugh said the excess capital not only created opportunities for the banks, but also provided a substantial buffer when times got tough. Waugh lambasted the unregulated shadow-banking system in the United States, saying the issue wasn't the level of banker compensation, but how compensation was delivered.

He and Kelly noted that Canadian banks chose to refrain from sub-prime lending, and instead kept mortgages on their balance sheets; these good assets gave banks reasonable and predictable earnings that served as a safeguard in bad times.

Kelly noted the United States has the longest dated product, mortgage interest rate deductibility, the smallest spread over government paper, free prepayment options, and non-recourse lending. Even with all these advantages, he said, the United States has the lowest home ownership rate compared with the United Kingdom, Canada, and Australia. Clearly these advantages have failed and necessitate a fundamental rethinking of the still-struggling U.S. mortgage industry.

Kelly said the out-of-control U.S. securitization market had been bigger than total bank assets and was unlikely to rebound. He expounded on this, saying the U.S. securitization market must revive with instruments that are simpler, transparent, and easier to understand because U.S. banks cannot alone fund the credit needs of the nation.

The two bankers agreed our economies will move into positive GDP territory later this year. The savings rate will have to go up. But the flip side is that a 1 percent addition to the savings rate in the United States translates to about 700,000 lost jobs. We will likely see stubbornly high unemployment rates and very low GDP growth.

Will Canada be the global solution to the financial meltdown? That is unlikely, but financial centers like Toronto will do well because good regulation and good management offer greater predictability. While Canada may go up less, it also goes down less.