Unleash Financial Sector to Drive Economic Performance

May 12, 2021

JEREMY KRONICK

CANADA – Rules and regulations holding back innovation and productivity in Canada’s financial sector should be updated to drive wider economic performance, says a new report from the C.D. Howe Institute.

In “Upping our Game: How Canada’s Financial Sector Can Spur Economic Performance,” authors Jeremy M. Kronick and Farah Omran look at financial sector regulations and policies that hinder productivity growth through their impact on competition, the ability to attract foreign investment and the allocation of capital, and offer a way forward.

FARAH OMRAN

Over the past 18 years, Canada has lagged behind many OECD countries – including Australia and the UK – in terms of productivity. And with the pandemic’s impact exacerbating pre-existing weaknesses and damaging productive capacity, enhancing productivity growth will be vital to drive Canada’s economic recovery.

Enter the financial services sector. In Canada, the sector employs relatively more Canadians with postsecondary and postgraduate education than do other sectors, and promotes growth and productivity within the other complementary sectors that serve it.

“The financial services sector has the unique ability to boost both its own productivity and that of other sectors, says Kronick. “That’s why it’s for the benefit of the Canadian economy to remove restrictive rules that hinder financial services productivity.”

Fintech: The current environment of under- or overregulation of fintechs creates a fragmented and complex regulatory system. As recommended by the Competition Bureau, regulations should focus on the function performed and be proportional to the risk this function poses. For example, unlike large interbank settlement payments, small retail payments such as buying a daily coffee do not risk putting the entire system in jeopardy in case of failure – and oversight should reflect this divergence in risk.

Small and medium-sized enterprises: Canada has the largest spread between interest rates on loans to small and medium-sized enterprises (SMEs) and those to large firms among OECD peers. These barriers in accessing financing become more consequential in a post-COVID world, where SMEs were hurt disproportionally by shutdowns, adding to their riskiness in the eyes of lenders. Policymakers could improve SMEs’ access to capital by deepening Canada’s capital markets beyond domestic bank debt financing.

Open banking: Open banking gives customers of financial institutions control over when and how to share their financial data. Implementing open banking would help spur the development of the types of tailored products and services that would create a more innovative and competitive market.

More broadly, the authors recommend:

  • A flexible regulatory approach ensuring regulations focus on the function and the function’s impact on the financial system;
  • More explicit competitiveness mandates for Canada’s financial services regulators to spur innovation;
  • Improving coordination, cooperation and the sharing of financial market data between federal and provincial regulators; and
  • Ensuring that the share of mortgage and business lending in the economy reflects the true underlying risk of both types of lending through modifying how mortgage insurance premiums are priced.

Read Full Report

For more information contact: Jeremy M. Kronick, Associate Director, Research, C.D. Howe Institute; Farah Omran, former Policy Analyst, C.D. Howe Institute; or Nancy Schlömer, Communications Officer, C.D. Howe Institute, email: nschlomer@cdhowe.org.

 

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