Canada's five largest banks would pass the U.S. government stress test brilliantly. They were profitable in the last quarter of 2008, are well capitalized now, and have had no problems raising additional private capital. On average only 7% of their mortgage portfolios consisted of subprime loans (versus 20% in the U.S.). And no major Canadian bank has required direct government infusions of capital.
Advocates of increased regulation of U.S. financial markets have concluded that more stringent rules governing leverage and capital ratios account for Canada's impressive performance. They champion such measures here. In a Toronto speech earlier this year about reforming the U.S. banking system, former Fed chairman and Obama administration adviser Paul Volcker said the model he is considering "looks more like the Canadian system than it does the American system."
Nevertheless, Canadian banks operate in a very different context. Copying the Canadian banking system in this country, without understanding how its banking and housing sectors operate, would be a mistake.
Start with the housing sector. Canadian banks are not compelled by laws such as our Community Reinvestment Act to lend to less creditworthy borrowers. Nor does Canada have agencies like Fannie Mae and Freddie Mac promoting "affordable housing" through guarantees or purchases of high-risk and securitized loans. With fewer incentives to sell off their mortgage loans, Canadian banks held a larger share of them on their balance sheets. Bank-held mortgages tend to perform more soundly than securitized ones.
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