December 7, 2023 – Canada and the US are highly similar economies from a global perspective. However, the US has a unique history of major banking crises over the years, while Canada has been remarkably stable. A new C.D. Howe Institute report asks why these two systems differ, and what the US and Canada can take away from this divergent experience?
In “Let it Fail? Reflections on the SVB Collapse and the US and Canadian Approaches to Bank Crises," C.D. Howe Institute Fellow-In-Residence Dan Ciuriak contrasts the outcomes between these two countries over the course of more than a century of financial crises, and asks whether there is a unifying explanation for this difference and, if so, what this implies for Canadian and US financial sector policy going forward.
“Where Canada has implicitly prioritized avoiding systemic risk in handling troubled financial institutions and has a remarkable history of stability, the US has implicitly prioritized market discipline to contain moral hazard and has an unparalleled history of financial crises,” says Ciuriak, former Chief, Financial Institutions Section and Project Director, Financial Institutions Reform Project with Finance Canada.
Notably, the Canadian and the US banking sector stability experience diverged in 1900 when Canada had a decennial revision of its Bank Act, which saw the Canadian Bankers Association given a prime role in resolving bank problems, says Ciuriak. Bankers are strongly averse to instability because of the negative spillovers of such failures on their own banks and on the value of their bank charters. As the author explains, while Canada thus opted to pre-empt destabilizing bank failures and to control the moral hazard this policy course generated through “social networks,” the US has prioritized the role of market disciplines in controlling moral hazard.
“This, along with the historical accident of decennial revisions that prompted regular reform between crises rather than driven by crises, allowed the system to address the externalities generated by bank failures directly rather than indirectly through market discipline, while adapting to changing societal needs and technological conditions on a timely basis,” says Ciuriak. “Importantly, the system ensured enough competition to be efficient.”
Examining the US’s most recent banking crisis, the collapse of Silicon Valley Bank (SVB) in March 2023 – the US’s 16th largest bank of assets and an iconic institution for technology firms – Ciuriak writes that markets generally appear to have drawn a line under the institution’s failure. “However, the US banking system remains fragile on a structural basis, and all the ingredients for a crisis remain in place,” says Ciuriak.
SVB’s failure has led to consideration of regulatory reforms in the US – however, this does not appear to have led to a fundamental reappraisal from US authorities of their overall approach to bank supervision, explains Ciuriak. In particular, although the relatively limited fallout of the SVB failure reflects the invocation of the system-risk exception, the US is looking for ways “to improve the likelihood of an orderly resolution of large regional banks under the Federal Deposit Insurance Act, without the expectation of invoking the system risk exception,” says the author. “This exception is what helped the US with SVB.”
In conclusion, Ciuriak says instability is a choice made by prioritizing moral hazard concerns over controlling negative externalities from bank failures. “Moral-hazard issues are addressed far more effectively through regulatory design formulated in quiet periods rather than in the heat of a crisis,” he explains. “As Canada’s historic experience attests, economic efficiency can be pursued by fine-tuning the scope of risk taking through competition and regulatory design.”
For more information contact: Dan Ciuriak, Fellow-In-Residence, C.D. Howe Institute, and Director and Principal, Ciuriak Consulting Inc.; Lauren Malyk, Communications Officer, C.D. Howe Institute, 416-865-1904 Ext. 0247, lmalyk@cdhowe.org
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