Lecture 3: The US and Canada — Contrasting Banking Systems
Key Themes
- Comparison of banking system stability in the US vs. Canada.
- Structural choices: unit banking (US) vs. nationwide branching (Canada).
- The role of political institutions in shaping financial stability.
- The puzzle of similar economies with drastically different banking crisis histories.
Main Concepts
1. Banking Fragility
- Banks face maturity/liquidity mismatch:
- Assets: illiquid loans with fixed maturities.
- Liabilities: demand deposits withdrawable anytime.
- Inherent fragility: depositors can “run” to withdraw funds first (first-come, first-served).
- BUT: fragility doesn’t always lead to crises. Banks can manage risk with:
- Higher equity capital (lower leverage).
- More cash reserves.
2. US vs. Canadian Banking Histories
- US:
- Prone to crises: 17 major crises since 1790.
- Adopted unit banking: most banks restricted to a single branch.
- Result: lack of diversification, highly localized risks, and poor coordination.
- Canada:
- Zero crises in 200 years.
- Banks allowed to branch nationwide, creating diversification across sectors and geography.
- Small number of large banks could coordinate during shocks.
3. Diversification & Coordination
- Ex ante diversification:
- US banks small and local → exposed to regional shocks (e.g., crop prices).
- Canadian banks large and national → risks spread across regions and industries.
- Ex post coordination:
- US: 20,000 small banks → no coordination possible.
- Canada: a dozen or fewer large banks → could meet, cooperate, or rescue troubled banks.
4. Political Determinants
- US: agrarian populism favored unit banking.
- Farmers preferred local banks tied to their communities → credit “insurance.”
- Opposition to branch banking viewed as opposition to Wall Street domination.
- Canada: same populist impulses, but constitutional structure centralized banking regulation, preventing local populists from shaping national banking rules.
5. Crises and Political Choices
- Scotland vs. England parallel:
- England: monopoly Bank of England, weak regional banks, unstable.
- Scotland: free entry and innovation, stable.
- US vs. Canada parallel:
- US: populist-driven restrictions → unstable.
- Canada: centralized structure → stable, innovative, diversified.
Important Data & Facts
- US had 17 major crises; Canada had 0 (1790–present).
- US banks held more cash & capital (0.45 cash/asset, 0.20 equity/asset) vs. Canada (0.27 cash/asset, 0.19 equity/asset), showing US banks knew they were riskier.
- GDP paths of both countries are almost identical → instability difference not due to economic fundamentals.
- National Monetary Commission (1910) studied Canadian banking, recognized advantages, but ignored unit banking in recommendations (politically untouchable).
Examples
- Panic of 1907: led to the National Monetary Commission. Despite knowing unit banking was the problem, Congress avoided addressing it due to political backlash.
- Canadian coordination: Bank of Montreal and peers cooperated to stabilize troubled banks, sometimes absorbing failing institutions preemptively.
- Real estate risk: US historically subsidized mortgage risk → higher volatility. Canada avoided subsidies → fewer mortgage defaults, even in 2008.
Summary
- Banking crises are not mechanically inevitable; they are shaped by political and regulatory choices.
- US: unit banking + agrarian populism = high fragility and frequent crises.
- Canada: nationwide branching + constitutional design = stability and zero crises.
- The persistence of bad banking policy in the US illustrates how politics often outweighs economics in shaping financial systems.
Questions for Review
- What structural differences explain why the US had frequent crises and Canada had none?
- How does unit banking increase fragility in the US system?
- Why did agrarian populists oppose branch banking despite its stability benefits?
- How does the Scotland–England comparison mirror the US–Canada comparison?
- What does the National Monetary Commission’s failure to address unit banking reveal about the role of politics in financial reform?
DANTE SISOFO · · dantesisofo.com/the-us-and-canada/
