– The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies through research that is nonpartisan, evidence-based and subject to definitive expert review.
CANADA – Ottawa should consider new regulatory approaches to bolster the role of smaller financial institutions if it is to achieve its goals of enhancing quality, price and innovation in that sector, according to a new report from the C.D. Howe Institute. In “Swimming with Whales: How to Encourage Competition from Small Banks,” author John Jason suggests that if the government continues to believe in these goals, then it is time to reconsider the regulatory model for smaller banks and perhaps across the industry.
“Since 2007, the share of all financial institution assets controlled by the largest six banks grew from 90 percent to 93 percent,” states Jason. “Further the share of all banking assets controlled by the largest three banks grew from 54 percent in 2002 to 65 percent in 2015,” he adds. As a group, small and medium-sized domestic financial institutions control just 2 percent of the banking assets in Canada.
Since 1999, the number of domestic banks in Canada has increased from eight to 30. However, despite the growth in the number of domestic financial institutions, new entrants continue to face challenges to thrive and survive in the sector.
The report highlights three areas that remain a challenge for start-up financial institutions:
- Overburden from the regulatory framework: New institutions are by their nature often more risky than large, long-established competitors. Prudential regulators are, therefore, more cautious with start-up banks. Asking them to abandon their carefully crafted prudential guidance to accommodate a new entrant that is unproven and untested may simply be asking too much. It is time to rethink our approach to the calibration of regulatory expectations for smaller banks.
- Capital Requirements: The rules respecting regulatory capital are another aspect of the prudential regulatory framework that has important implications for new entrants. While there is plenty of rationale for strengthening the capital rules for banks, they were designed for large internationally active banks. Applying them for even the smallest start-up seems unduly conservative and is discouraging new entrants into the market.
- Creating Flexibility: The emergence of Fintech industry is another concern for new entrants. Although many of these Fintech companies offer products that compete with the regulated sector, not only are they free from the regulatory burden, they are also unconstrained by the confines of the regulatory framework. The question is whether the regulatory framework is too narrow, thereby limiting the ability of new entrants (and transitioning credit unions) to provide the services that today’s consumer demand and inhibiting their ability to become economically viable.
“If the government continues to believe that a level playing field is required, then it may be time to reconsider the regulatory model across the industry. At a time when the industry is under pressure from the developing Fintech sector, taking a harder look at the confines of financial institutions and banking is warranted,” concludes Jason.
