THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 244

212

PA R T I I I

Why Canada s
Banking
System Is the
Envy of the
World

Financial Institutions
Canadian banks also had their problems during the recent turbulent financial conditions. Their shares fell by almost 50% and some of them experienced huge losses
in derivatives trading; for example, CIBC lost $2.1 billion in derivatives trading in
2008. However, while governments in the United States and Europe have been
working on full scale banking bailouts and rescue packages (in the trillions of dollars), the Canadian government did not have to bail out any banks.
One reason that Canada s banks have fared better than banks in other countries is the structure of the Canadian mortgage market. Unlike banks in the United
States that sold the bulk of their mortgages, banks in Canada held a large proportion of their mortgages on their balance sheets. This practice gave Canadian banks
an incentive to make sure that their mortgage loans were good loans. In addition,
law in Canada allows banks to go after other assets when a consumer walks away
from a mortgage, thereby making it difficult for consumers to do so.
Another reason is that Canada s big banks have been more conservative in their
lending and acquisition practices in comparison with major banks around the
world. Also, Canada s top banking regulator, the Office of the Superintendent of
Financial Institutions (OSFI), has been more conservative than banking regulators
in the United States and Europe. For example, at the beginning of the financial crisis, Canada s banks had higher capital requirements than their global peers. As a
result, they had stronger reserves to cushion potential losses. Although this conservative regulatory regime enabled Canadian banks to withstand the financial crisis better than banks in other countries, it has been argued that it makes the
Canadian banking sector less competitive because of the lower leverage and a
lower rate of return on capital than in other jurisdictions.
Moreover, the activities of Canada s banks are well diversified and are not limited to traditional retail banking. In particular, the federal government s decision in
the late 1980s to allow banks to acquire investment brokers on Bay Street and to
engage in the mutual fund and insurance businesses created a more diversified

financial services marketplace for Canada s banks. In addition, these arm s-length
institutions are subject to the same strict rules and regulations as the banks, unlike
investment dealers in the United States that had been subject to very relaxed and
minimal regulation from the Securities and Exchange Commission.
Overall, in the aftermath of the global economic meltdown, Canada s banking
system has been viewed as the soundest in the world. In fact, many countries
around the world are now considering Canadian-style reforms of their financial
markets.

DYN AMI CS O F FI N AN CIA L CRIS ES
IN EM ERG IN G - MAR KET E CO N OM IE S
Before the subprime crisis in the United States, economists looked in other countries
for recent examples of financial crises. Emerging-market economies, economies in
an earlier stage of market development that have recently opened up to the flow
of goods, services, and capital from the rest of the world, are particularly vulnerable. With the opening up of their economies to markets, emerging-market
economies have been no stranger to devastating financial crises in recent years.
The dynamics of financial crises in emerging-market economies have many of the
same elements as those found in Canada and the United States, but with some
important differences. Figure 9-3 outlines the key stages and sequence of events
in financial crises in these economies that we will address in this section.