The era of blind pursuit of stability over growth in Canadian banking is finally ending

John Turley-Ewart is a contributing columnist for The Globe and Mail, a regulatory compliance consultant and a Canadian banking historian.

Peter Routledge is breaking from Canada’s banking past. Missed amidst the excitement around Prime Minister Mark Carney’s Canada Investment Summit was Mr. Routledge’s recent speech announcing a new era for our financial system.

Mr. Routledge is Canada’s banking supervisor, leading the Office of the Superintendent of Financial Institutions, or OSFI. In the days before the summit, he delivered to the Economic Club of Canada what in the bank supervisory world was a barn burner of a keynote.

His remarks are arguably the most important words to come from a Canadian bank supervisor in living memory. While the stability of the Canadian banking system remains OSFI’s primary responsibility, Mr. Routledge announced that OSFI would now balance that against two additional deliverables.

The first is ensuring that bank supervision rules do not impair the ability of our chartered banks to finance “sustainable economic adaptation and growth.” The other is “promoting a greater degree of competitive intensity” within the banking system.

In short, OSFI’s blind pursuit of stability regardless of the cost to the economy is ending.

Pro-active, federal oversight of Canada’s chartered banks did not come easy to Ottawa.

It had resisted inspecting banks from the days of Sir John A. Macdonald, when the country’s first government after Confederation in 1867 laid down a clear policy – Ottawa wasn’t in the business of bailing out bad banks.

The objection wasn’t ideological but practical. Canada didn’t have the money to do it. And given the number of bank failures in Canada (about 40 per cent of banks failed between 1867 and 1925) the policy turned out to be fiscally prudent, yet politically dangerous.

While Ottawa decided it would not bail out banks, it also offered the illusion of safety through the country’s Bank Act, which first appeared in 1871, and was updated roughly every 10 years.

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The Bank Act pointed to high capital requirements to secure a bank charter, reserves banks were to maintain and use when booms went bust to guard against insolvency, protection for depositors by imposing obligations on bank shareholders to help make them whole in the case of failures, and monthly returns published in the Canada Gazette reporting on the financial well-being of each chartered bank in the country.

The Bank Act was so full of loopholes it hardly mattered. Too many banks failed by hook and crook and the officials who ran them into the ground, be it through fraud, incompetence or just bad luck, were hardly ever held to account.

But rather than change the Bank Act and pro-actively supervise chartered banks – the U.S. began supervising national banks in 1863 – Canadian governments concluded that the problem behind the instability in Canada’s emerging national banking system was competition.

That notion has had long-lasting negative consequences for the Canadian financial system.

Ottawa subsequently tried to smother competition, first by encouraging the country’s bankers to form a cartel in 1891, the Canadian Bankers Association, to regulate competition. When that failed (banks proved far more competitive than Ottawa first thought), the federal government encouraged consolidation.

When 1867 drew to a close there were 35 chartered banks operating in Canada, serving a national population of about 3.4-million. By 1925, that number had grown by roughly 170 per cent to 9.3-million. At the same time the number of banks fell by 68 per cent, to just 11.

When Ottawa couldn’t avoid pro-active supervision of the banking system any longer after several failures following the First World War, it was forced to launch bank supervision in 1925, with a mandate to continue limiting competition and maintaining a small number of banks for safety’s sake.

The measure of success was zero bank failures, not supporting economic growth or competition. This culture survived into the present, was reinforced by the Great Financial Crisis of 2008-2009, and has been fully embedded in OSFI’s operating model.

The result, as Mr. Routledge noted to the Economic Club of Canada, was an approach to bank supervision that “endeavoured to prevent institutional failure without much consideration of the cost of the approach, particularly with respect to sustainable economic growth and competition.”

Such is an admission that the culture that has driven bank supervision in Canada for a century hasn’t served the interests of the economy nor consumers as well as it should have.

That Mr. Routledge wants to change that deserves praise. It also deserves continuing scrutiny, to ensure that what he says is what he does.