Canadian and US Financial Sector Stability Differences over Long History: Is There a Unifying Explanation?

Abstract

Canada and the United States are highly similar economies, as would be expected given the many common historical influences on economic policy and regulation, the shared geography and the high degree of economic interaction, amplified powerfully in recent decades by the 1989 Canada-US Free Trade Agreement. However, in the financial sector, and particularly in banking, the experience of the crisis-prone United States contrasts starkly with Canada’s stability. For each major US crisis – the Great Depression, the S&L crisis and the sub-prime mortgage debacle as well as others – different sets of micro reasons have been put forward to explain Canada’s comparative stability in the face of broadly similar shocks. This paper examines whether there is a unifying explanation for these contrasting outcomes. It identifies the tipping points early in Canada’s history that led Canada to manage banking sector problems in a cooperative arrangement between the banks and the Canadian authorities directly addressing the externalities generated by bank failures while controlling the resultant moral hazard through social networks rather than market disciplines. Importantly, the system ensured enough competition to be efficient.