A Bay Street sign is seen at the financial district in Toronto, October 10, 2008.MARK BLINCH/Reuters
Rarely does Canada's banking system stand out for the wrong reasons.
So it is noteworthy when it does. At a time when the world's leading financial centres are reducing the influence of their biggest lenders, Canada's banking giants are becoming more dominant.
A team of International Monetary Fund economists led by Frederic Lambert and Kenichi Ueda has just completed a study on the implicit subsidy banking behemoths receive for being "too big to fail."
In the course of their research, Mr. Lambert, Mr. Kenichi and their team observed that Canada is one of the few major economies in which the three largest lenders' share of overall banking assets has increased since 2006. (Yes, we're talking about you Royal Bank of Canada, Toronto-Dominion Bank, and Bank of Nova Scotia.)
RBC, TD and Scotiabank command about 65 per cent of all banking assets in Canada, compared with about 55 per cent before the financial crisis. France and Spain exhibit a similar level of concentration and the two countries' Big Three also are becoming more important rather than less so. In the United States, Germany and Italy, the figure is closer to 45 per cent, which is a smaller percentage than before the financial crisis.
"The high degree of concentration carries with it a high degree of potential systemic risk," Mr. Lambert and Mr. Ueda write in their report, which will be published officially as a chapter in the IMF's next Global Financial Stability Report. "The distress or failure of one of the top three banks in a country, for example, could destabilize that country's entire financial system, in part because its activities may not easily be replaced by other institutions, because it is likely to be highly interconnected with other banks, and because of the potential effect of the failure on confidence in the whole financial system."
The IMF economists performed the calculations as part of an effort to determine whether the world's too-big-to-fail banks still pay a lower cost of capital than smaller financial institutions that, in the face of bankruptcy, are less likely to be saved by the government. Their conclusion: Oh, yes they do.
"The estimated subsides are large," the report's authors say, with typical IMF understatement. Using prices of credit default swaps on bank bonds and the scores of credit-rating agencies, the IMF team estimate that America's biggest banks enjoyed a funding advantage of "at least" 15 basis points in 2013. In other international banking centres the subsidy was even bigger: 25 to 60 basis points in Japan; 20 to 60 basis points in Britain; and 60 to 90 basis points in the euro area.
Those spreads translate into savings worth hundreds of billions of dollars for the world's biggest banks. In the U.S., the IMF researchers say the implicit subsidies received by the 25 lenders on the Financial Stability Board's list of global systemically important banks was as much as $70-billion (U.S.). In Japan it was $25-billion to $110-billion; in Britain, $20-billion to $110-billion; and in the euro area, $90-billion to $300-billion.
There are no specific estimates for Canada and other secondary banking centres, but there is little reason to doubt that the subsidy exists outside the U.S., Japan and Europe. The too-big-to-fail subsidy "appears to be widespread: other large banks that are not classified as [systemically important, or SIBs] are not much different from SIBs in terms of the subsidies they receive," the report says. "The presence of an implicit subsidy for the other banks suggests that they may also be considered TITF," or "too important to fail," a term the authors prefer to "too big to fail," arguing that size isn't everything.
These are important findings. The U.S. bank lobby pushed back hard against a New York Fed study that attempted to measure the "too-big-to-fail" subsidy, noting the Fed researchers only used data up until 2009, and therefore missing changes in the market brought about by stricter, post-crisis regulations.
The Lambert-Ueda team at the IMF conclude that the implicit subsidy generally is less now than it was before the crisis, but that it remains significant. That suggests the Group of 20 and the Financial Stability Board still have not convinced markets that the biggest financial institutions won't be saved if crisis strikes.
And since the authorities have failed to do so, the biggest banks still have an incentive to get bigger – or at least stay big – because they retain a competitive advantage over smaller rivals and new entrants. That's particularly relevant in Canada. The federal government's latest budget subtly acknowledges that winning market share from the Big Six is a daunting challenge, by proposing some administrative changes aimed at helping smaller banks.
"The Government will study and consult on other measures to encourage competitive financial services," the 2014 budget reads. One way to level the playing field would be to minimize the built-in advantage legacy lenders have from being too big to fail. Canadian authorities have managed to shield RBC, TD and Scotia from some of the strictest financial regulations and surcharges that have been imposed on the world's biggest lenders. The Big Three appear to have returned the favour by becoming even more "important" and further tipping the scales to their advantage.