Canada’s banks are fundamentally different from American banks and less likely to suffer from the malaise that has consumed the U.S. financial system for most of March, says a U.S.-based economist and former senior fellow with the Montreal Economic Institute. He nevertheless adds that banking reform, as it relates to protection for depositors, is needed writ large and must avoid creating moral hazard.
“The Canadian banks are of course much more diversified,” Peter St Onge, research fellow with The Heritage Foundation in Washington, D.C., told The Epoch Times.
“You tend not to have sort of systemic-level banks, like Silicon Valley, where tech withdrawals are going to cause a chain reaction,” added St Onge.
The issue with those U.S. regional banks is their exposure to a particular region or industry. And when business goes south, depositors fear their bank may not be good for all their money and therefore all at once try to get their money out.
“I would expect that Canadian banks are probably sitting on similar magnitude losses, but because they’re larger, they’re more diversified. I don’t think that we'd expect to see the kind of issue like in Silicon Valley Bank,” St Onge said.
Oxford Economics (OE) said in a March 16 note that Canadian financial regulators are instead watchful given Canada’s worsening housing downturn and high household debt levels.
“Canada is one of five advanced economies with a 7 percent probability of suffering a banking crisis in the next year due largely to elevated household debt, rapidly falling house prices, and aggregate bank balance sheet vulnerabilities. The odds are much higher at 18 percent–20 percent in the next three-five years.”
The Canadian Deposit Insurance Corp. (CDIC) protects eligible deposits at over 80 financial institutions in Canada up to $100,000. While the United States has seen hundreds of banks go belly-up since 2008, according to CDIC, “The last time a Canadian bank went under, however, the Spice Girls had a number one hit on the radio.”
That would be sometime in the late 1990s.
Banking Reform
U.S. Treasury Secretary Janet Yellen said on March 21 that the government could take more steps if necessary to backstop more bank deposits in order to avoid contagion in the financial system.
But St Onge sees this as introducing a significant moral hazard.
“The banks, they will occupy every last nook and cranny of that moral hazard,” he said, adding that if banks aren’t taking the maximum risk allowed, they’d be leaving money on the table.
St Onge says that banks should be treated just like any other company.
“So if Ford has immediate liabilities, then they have to have immediate cash. If they don’t, if they owe money right now and they don’t have cash right now, there’s a word for that—bankruptcy.”
His focus is on the distinction between demand deposits and certificates of deposit (CDs) or time deposits, where banks should be required to have enough cash to cover the former. Then people would not make runs on banks for fear they might not get their money back, because the banks are backing their deposits with cash, St Onge said.
However, St Onge also puts forth the idea of private deposit insurance for additional protection.
“That would also mean that any bank that was reckless, their deposit insurer would have an unfriendly conversation with them about straightening out their lending,” he said.
Economic Impacts
A hawkish U.S. Federal Reserve and pressure from the labour market had been inserting doubt into how long the Bank of Canada could maintain its pause on hiking rates. But now with the banking turmoil engulfing the United States, rate hike expectations for the BoC have turned into rate cut expectations.
BMO chief economist Doug Porter said in a March 17 note that markets are pricing in at least two BoC rate cuts by the end of 2023 and that the Bay Street bank’s call for a shallow recession in North America “now looks all too realistic.”
The U.S. banking crisis is a sign that the rate-hiking cycle is really starting to take effect.
U.S. president Joe Biden promised stiffer bank regulation after the bank failures, the largest since 2008. The most notable was Silicon Valley Bank (SVB), which became insolvent after its portfolio of long-term bonds lost considerable value due to the rapid rise in interest rates.
“The inevitable tightening in credit conditions that will emerge from the turmoil will dampen economic growth,” Porter said.
In an analysis of past banking crises, OE cites research saying that they are “frequently associated with big short-term hits to GDP [gross domestic product].”
A study of banking crises in the United Kingdom shows that the effects can last a long time.
“Academic studies of large samples of banking crises estimate that on average they cut the long-term level of GDP by 5 percent–10 percent,” according to a March 17 OE note.
OE notes that among the G7, Canada has the third-highest share of financial services as a proportion of total output.
Tech Crunch
SVB’s demise has left Canada’s tech ecosystem concerned about funding. Betakit reported on March 15 that a group of nearly 30 tech leaders asked the government to inject $700 million of capital into the ecosystem via existing programs.
About 60 percent of direct funding for Canadian tech companies comes from the United States, and the tech leaders say that impact on U.S. capital markets will disproportionately put Canadian companies at greater risk of failure.
The implications startups face are lower valuations, intensifying layoffs, and higher mortality.
