As a financial consultant, I spent more than 15 years in the U.S. banking sector. For the last six years I’ve worked in Canada, and the past two years I have worked exclusively for one of the largest Canadian Banks. Because of my experience across the two North American systems, I’m often asked to explain the differences between Canadian and U.S. banks.
It’s a fair question, made particularly relevant because the Canadian banking system did not suffer the same negative impact experienced by the U.S. financial system during the economic downturn from 2008 to 2010. Canadian banks, which are generally regarded as some of the safest and most stable in the world, avoided taxpayer-funded bailouts, and Canada’s economy enjoyed a faster recovery than its neighbor to the south. Here are several reasons why.
Canada Has Fewer Banks
While there are only 28 domestic banks in Canada, in the U.S. that number exceeds 7,000. Even when considering differences in population size, the U.S. is a more crowded space, and its banking environment is more competitive. As a result of this competition, in the last few years U.S. banks took more chances and subsequently created a less stable financial system — e.g. the Savings & Loan crisis.
Because there are fewer banks in Canada, its financial system is more concentrated. And the “Big 6” in Canada (Toronto Dominion, Royal Bank of Canada, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce, and National Bank of Canada) control more than 85 percent of $3.955 trillion in domestic assets. Although highly concentrated, Canadian banks are generally more diversified, with expansion into wealth management, insurance, deposit and loans, and brokerage services.
Also, because of the fewer number of Canadian banks, Canadian regulators are more involved in everything the banks do. This includes everything from capital requirements to underwriting standards. This level of scrutiny has helped the Canadian banks be more conservative in terms of risk taking.
By comparison, the “Big 5” in the U.S. (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs) control 44 percent of the $15.3 trillion in assets held by U.S. banks, according to data compiled by SNL Financial.
According to Canadian payments expert Sue Whitney, “In Canada, the small number of major players has resulted in a very coordinated market. Banks move in lock step on pricing, watching each other carefully for changes. A case in point was this year’s account package plan pricing changes, where they all made similar pricing moves within a few weeks of each other.”
Thus, Whitney explained, the smaller number of major players also allows regulators to form closer relationships with banks. Given this concentration, regulators get to know the banks, their risk policies and procedures, and their sources of revenue very well. Politicians also know the bank CEOs very well,
and don’t mind calling them to account, using moral persuasion if they don’t behave in a way that is conducive to the government’s agenda. When a major bank cut interest rates on mortgages a few years ago — creating the possibility that Canadians might take on risky levels of mortgage debt — lawmakers expressed dismay and the bank reversed its mortgage rate cut.
Canadian regulators take the position that having a banking license is a privilege and not a right, and that permeates the relationship. For this reason, major banks invest heavily in government relations, and actively manage their relationships and images in the market.
It’s also worth noting that Canada has around 650 credit unions, while the United States has nearly ten times as many.
During the past 20 years, the U.S. Congress has mandated that the majority of Americans must have access to banking. This has resulted in a change from banking for the wealthy to a retail banking model, where all but the under- or un-banked have bank accounts. Unfortunately, the old banking system in the U.S., which relied heavily on fees from those using banking services, moved to a model where a relatively small percentage of customers support the rest. This penalizes disadvantaged populations that don’t have other banking options, and draws the ire of regulators like the Consumer Financial Protection Bureau (CFPB).
Additionally, U.S. banking regulation is more intrusive than the Canadian system. While Canadian regulations tend to focus on safety and soundness, U.S. regulations place additional focus on privacy, anti-money laundering, banking access, and most recently, consumer protection. For example, U.S. banks must comply with the U.S. Federal Community Reinvestment Act, which forces banks to lend to low-income customers, and lends itself to higher fees and pricing to support additional risk.
There are also significant differences in mortgage lending. While homeownership between the two countries is similar, interest on mortgages in Canada is not tax deductible, terms are typically shorter than 30 years, down payments are larger, and pre-payment penalties are significant. Thus, Canadians are less likely to take on speculative real estate propositions.
In addition, the U.S. indirectly subsidized mortgage lending through Government Sponsored Entities (GSEs) Freddie Mac and Fannie Mae, which provided not only mortgages and mortgage insurance, but also purchased mortgages from U.S. banks. Canada’s equivalent, the Canada Mortgage and Housing Corporation (CMHC), primarily provided mortgage insurance. Historically, this re-selling of U.S. mortgages allowed U.S. banks to take higher risks than their Canadian counterparts. In Canada, if a bank makes a mortgage, it typically keeps that mortgage rather than securitizing that asset.
Not only is the regulatory environment different, the relationships between banks and the regulators are more collegial. In Canada, the big banks cooperate on standards setting, which results in reduced market entry risks and costs.
For example, nearly a decade ago, Canadian market participants, banks, acquirers and the networks all worked collaboratively to develop common business requirements for EMV. This led to Canadian banks pursuing offline PIN as the right approach, rather than requiring more expensive security protocols like Triple DES on PIN transmissions.
The recent 2015 Canadian Bankers Association (CBA) Payments Security White Paper is another great example of industry collaboration. In this example, the top six banks coordinated an expressed concern about losing control over customer authentication during the migration to mobile. This has no doubt influenced recent regulations, and provided for a more level playing field between the banks and new market entries like PayPal, Google, and the telecoms.
Despite the differences, Canada and the U.S. regulation do have some similarities. Bank regulation in both countries is more fragmented than in other G10 countries, where most countries have only one bank regulator.
In the U.S., banking is regulated at both the federal and state level. In Canada, banking is regulated at the federal and provincial level. Both scenarios have resulted in a patchwork of standards. And in Canada, provinces like Quebec guard their jurisdictions carefully. In a recent legal case, the Supreme Court of Canada reaffirmed provinces’ rights to assert consumer protection jurisdiction on federally regulated banks and has resulted in a major legal/constitutional effort to sort out federal banking obligations, province by province.
It’s hard to highlight just the banking differences because the financial system is very much a reflection of the customers served.
Canadians pay more in taxes, but receive more universal benefits such as paid maternity leave, healthcare, and low university tuition rates. However, the cost of living in Canada is generally higher.
According to a report published recently by New York Times that leveraged the Luxembourg Income Study Database, Canada has a large — and the world’s richest — middle class. By comparison, the U.S. has experienced an ever-widening income gap. While average salaries between the U.S. and Canada are similar, in Canada salaries are more centralized around the average, resulting in less income inequality. This also translates into a healthier banking system, which is better equipped to absorb economic stresses.
While Canadian household debt-to-disposable income levels are at historically high limits, when considering Canada’s social program benefits like universal healthcare, Canadian debt to income levels are still well below the U.S. This is partly due to Canadians paying off their mortgages faster than their U.S. counterparts. Statistics Canada says 43 percent of Canada’s homeowner households are mortgage-free.
Additionally, most Canadians are cautious about using credit, and this is reflected in Canadians being among the world’s heaviest debit card users. Similar to U.S. households, Canadians have recently begun paring down their debts and deleveraging across the board.
Canada’s big 6 have traditionally been strong international competitors. Because the Canadian banking system is so small, these banks have been forced to look internationally for continued growth.
Canadian banking has also benefited from international trade deals like the Canada-European Union trade agreement that created new markets for Canada’s domestic banking sector.
Additionally, during the first round of WTO negotiations in the 1990’s and even as part of the North American Free Trade Agreement (NAFTA), Canadian regulators refused to allow foreign banks to set up in Canada as branches. Instead, these banks were required to set up subsidiaries because the government determined those entities would be easier to regulate. Eventually branches were allowed, but the government held firm in its initial stance far longer than in any other sophisticated market.
U.S. and Canadian banking systems are very different, due to factors including regulation, mindset, and customer base. Both systems have their advantages, and both have contributed to the prosperity and growth of their respective country’s economies.
Because of their differences — and the positive attributes found in each system – Canadian and U.S. Banks could learn from each other and gain insights on how to improve banking.