The financial system of a country is comprised of banks, central bank, securities markets, insurers, pension and mutual funds, market infrastructures in addition to the supervisory and regulatory authorities. The markets and institutions provide a unique framework for conducting economic transactions and monetary policy while also assisting in channeling savings into investment to spur economic growth. Any problems in the financial system not only undermine the effectiveness of the monetary policies, but they disrupt financial intermediation, trigger exchange rate pressure and capital flight, create unbearable fiscal costs due to the need to rescue troubled financial institutions, and exacerbate economic downturns (Illing & Liu, 2006). Moreover, the ever increasing connectivity among the various countries` financial institutions and tighter trade and financial linkages between Canada and other countries can quickly spill over across national borders and the financial sectors at large. Consequently, a robust financial system that is well-regulated and supervised is essential for both domestic and international financial and economic stability.
Canada`s financial system, according to the World Economic Forum and the International Monetary fund, during the latest financial crisis has appeared to be more resistant to financial shocks compared to the United States. A section of experts assessed the characteristics of the country`s financial supervisory framework to obtain an approach that may be important to consider in the US (Ratnovski & Huang, 2009). Indeed, the system is designed through a strong prudential supervisions and regulation, a uniquely designed of insurance deposits, stringent capital requirements and low risk tolerance, and prior arrangement for crisis management and resolutions for failed banks. Canada`s financial system supervisory responsibility is characterized by the federal and provincial governments and a group of agencies within the country`s federal government.
Unlike the United States` which was the focal points of the 2008 financial turmoil, Canada`s financial bodies were properly capitalized, managed and regulated. They have remained so to this day and no Canadian financial institution has been in danger of failing or is need of government bailout. The limited exposure to the United States market and other world markets and government management liability, that has facilitated access to both medium and long term credit, the Canadian financial system has been able to deter any effects of financial shock that have affected the United States. In recent assessment of Canada`s financial system, it has been concluded that its systems is extremely mature, well-managed and sophisticated.
There exists several critical participants such as regulatory officials and Canadian policy makers that have played an important role in shaping and adapting regulatory frameworks of the country`s financial system. In Canada, the financial supervisory management is categorized into various agencies each with its responsibility. For instance, the federal government is tasked with the supervising of all banks, trust and loan companies, cooperative credit associations, federal pension plans and federally incorporated insurance companies. The provincial governments are tasked with supervising mutual funds, security dealers, credit unions, provincially incorporated loan, trust and insurance companies, and investment advisors. This system creates 13 provincial regulatory bodies with each administering securities laws and regulations throughout the country.
The incorporation of Canadian banks is overseen by the Minister of Finance while also permitting foreign bank branches and reviewing large bank mergers. The minister has discretion authority to disapprove any mergers. Additionally, Canada`s regulatory model assigns the central bank the role of carrying out monetary policy while also maintaining price stability. It is responsible for regulating and supervising some aspects of the financial system to separate federal agency while also providing the provincial governments with the authority over other sections of the financial system. Canada`s regulatory approach is shared responsibilities among the Department of Finance and the other federal regulatory authorities such as the Bank of Canada, the Canada Deposit Insurance Corporation, the Office of the Superintended of Financial Institutions. In the end, it is the Finance Minister who is tasked with the sound stewardship of the Canadian financial system. The country`s shared financial regulation and supervision criteria has proved important during the recent financial crisis.
The Canadian banks have had stronger balance sheet position as compared to the US during the recent financial crisis. Despite the numerous challenges in the world economy, Canadian banks never needed public guarantees and public capital injections. This high level of liquidity and capital implies that Canada is properly positioned to attain the higher liquidity and capital standards adopted within the Basel III framework. According to the IMF, Canadian banks have been able to be resilient due to Canada`s financial supervisory and regulatory systems (Ratnovski & Huang, 2009). In addition, the regulatory structures discourage Canadian banks from taking huge risks. Banks in Canada are supposed to hold capital at rates higher than the once set by the Basel Accords. This has helped the country`s financial system to be stable and ready to handle financial shocks.
In comparison to the US banking industry that is dominated by several banks spread across the states, Canada`s financial system is maintained by five large banks that account for more than 65% of the country`s total financial sector assets. Foreign banks account for roughly 4% of the country`s total financial sector assets. Low representation by the foreign banks is attributed to the rule which puts limits on the concentration of the bank share ownership which in consequence reduces the extent of mergers and foreign direct entry through mergers and acquisitions. Canada`s financial legal framework, combined with lack of competition, allows the Canadian banks to pay close attention to their low-risk and profitable domestic retail banking services. The authorities hold that expansion abroad could principally help the Canadian banks in the diversification of risks, but would also need monitoring on potential changes in the banks` appetite for risks. These regulations have seen the Canadian banks report phenomenal profits due to improved income from wealth management, fees, and costs that have offset narrow interest rate margin due to slow growth of household loans. However, the Canadian central bank does not hide its worries as a result of high indebtedness of the Canadian households which is so high when compared to the United States.
In comparison, the United States` big 5 control more than 44 percent of the assets held in US banks. However, there are several other small banks that have made it challenging to devise a coordinated financial market in the US. This makes it difficult for regulators to establish close relationships with the banks and thus regulators have low chances of getting to know the banks` risk appetite and procedures in addition to their source of revenue. Unlike the US where having a bank license is a right; the opposite is true in Canada where it is considered a privilege to have a license. Therefore, the major banks in Canada invest hugely in government relations while actively managing their image and relationship with the market.
During the last two decades, the US Congress mandated that Americans should have access to banking services. This has changed to a retail banking model instead of the previous banking for the wealthy model that has been in existence for a very long time. In consequence, under or un-banked Americans have obtained access to banking and financial services. Unfortunately, the US`s old banking system that relied heavily on fees the once using banking services moved to models where a small section of customers support the rest (Shachmurove, 2011). Disadvantaged populations have been penalized by this banking system due to their lack of other financial options. In addition, the US banking regulations are quite intrusive as compared to Canada`s. While the United States` regulations place more focus on anti-money laundering, privacy, access to banking, and consumer protection, Canadian financial regulations focus on safety and financial soundness. For instance, the United States banks should comply with the US Federal Community Reinvestment Act that forces banks to lend to the low-income customers while lending itself to higher pricing and fees to support any additional risks.
Significant differences abound in the sector of mortgage lending in both countries. While homeownership in the United States and Canada is almost similar, the interests on Canadian mortgages are not tax deductible; terms are shorter than 30 years with large down payments significant pre-payment penalties. This makes it less likely for Canadians to take speculative real estate prepositions. Comparatively, the United States indirectly subsidized lending of mortgages through Fannie Mae and Freddie Mac government sponsored entities that provided not only mortgage insurance and mortgages, but also made mortgage purchases from the US government. The Canada`s equivalent is the Canada Mortgage and Housing Corporation that provided mortgage insurance (Reinhart & Rogoff, 2009). Ideally, the re-selling of United States Mortgages provided a leeway for banks to take high risks as compared to the Canadians. If banks make mortgages in Canada, it keeps the mortgage instead of securitizing the asset.
Not only is the financial system regulatory environment different, relationship between regulators and banks is more collegial. The big banks in Canada cooperate on the setting of standards which leads to a reduction in market entry costs and risks. For instance, more than a decade ago, the Canadian financial market participants, acquirers and banks collectively developed common business requirements for EMV that led to the Canadian banks pursuing alternative approaches for security protocols. Despite the differences in regulation, the US and Canada do have similarities with financial systems regulation in both countries being more fragmented when compared to other large economies where majority of the countries have one regulator. In the US system, financial systems are regulated at both the state and federal level while in Canada; the financial systems are regulated at federal and provincial levels. Both regulators have led to a patchwork of standards.
It is imperative that an analysis of the differences in customers is made so that a true reflection of the two countries` financial system can be understood. As compared to the US counterparts, Canadians pay considerably higher taxes but in return receive benefits such as healthcare, low university tuition, and maternity leave. However, there is a high cost of living in Canada. However, in terms of income comparison, Canada prides itself with the world`s largest middle class which contrasts the US that has experienced widening income gaps. While the salaries between Canada and the US are similar, Canadian salaries are centralized around the average which results in minimal inequality which equally translates to a health financial system that is better equipped to absorb any economic stress. While the household debt-to-disposable income levels are high in Canada when taking into consideration of the social program benefits such as universal healthcare, the country`s debt levels are below the US. This results from the Canadians repaying off their mortgages quickly as compared to the US counterparts with research indicating that more than 43 percent of the Canadian homeowners are mortgage free. In addition, majority of the Canadians are credit cautious since they are mostly debit card users.
Canada`s 5 largest banks have been strong international competitors. As a result of a small Canadian banking system, the banks have resorted to seeking for international growth. The banks have hugely benefited from international trade agreements such as the Canada-European Union trade pact aimed at establishing new markets for Canada`s financial systems sector. In addition, during WTO negotiations in the 1990s, Canada regulators denied foreign banks the opportunity to set up banks in the country. Instead, the banks were supposed to set up subsidiaries since they were deemed easier to regulate. The branches were allowed eventually but the Canadian government firmly held in its prior stance for far much long than other sophisticated financial markets system.
Though the Canadian financial system has historically remained robust due its banks being well capitalized, well-functioning financial markets, and its financial market tools effectively supporting its core activities, the system has some potential vulnerability as compared to the United States financial system. The financial system has imbalances in the Canadian housing market that have been demonstrated by high house prices coupled with buildup of supply in other housing segments. The housing prices are ideally growing faster than the people`s disposable income (Acharya & Richardson, 2009). Also, there have been elevated levels of the Canadian household indebtedness which has been evidenced by a high ratio of aggregate household debts that is higher than the disposable income. In addition, the Canadian financial system is vulnerable to potential external shocks due to significant exposures from the market system. Canada has an open economy which implies that the country`s market for financial services and goods are globally integrated. While the country`s access to global markets gives its citizens important benefits, cross-border linkages have high chances of transmitting shocks and vulnerabilities to Canada.
In conclusion, the United States and Canada`s financial system are quite different as a result of factors such as regulation, mindset, customer base. Both systems are coupled with their unique differences which each contributing to the growth and prosperity of their economies. The two countries` systems have been devised in a way that they can maintain confidence in the financial system frameworks, maintaining financial stability through protecting and enhancing stability of their systems, ensuring consumer protection through securing commendable levels of consumer protection and reducing financial crimes in the finance sector. Therefore, a highly innovative and liquid financial system that can absorb shocks is important for the growth of the present day economies. The Canadian financial system is well positioned to offer such a robust system when compared to the United States system that is less regulated and highly vulnerable to market shocks.
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