Is an oligopolistic banking system more resilient and at what cost? A study of the competitiveness of the Canadian banking structure

Abstract

The Canadian banking system, like its Australian counterpart, is often credited for weathering the 2007/8 financial crisis effectively. The oligopolistic rent is overlooked, as a necessary price for the resiliency of the system. In this paper, the authors discuss that the resilience was due to the banks’ ability to pass on the cost of the crisis and the following regulations to the end users of their products and services, and their ability to alter products and services to maximise profitability. In a competitive market, positive economic profit is supposed to erode over time, especially following major events such as the 2007/8 crisis. This did not happen for Canadian banks; therefore, arguably, there was an ‘implicit bailout’ in Canada whose cost was not borne by the taxpayers (as in the case of an explicit bailout) but by the end users of the banking services and products (the payers of the oligopolistic rent). This may reoccur in the aftermath of the COVID crisis, and the perceived resilience may win out over competition. The authors also theorise the diversification benefit vs the systemic risk trade-off with an increasing bank size. The diversification benefit can increase, but at a decreasing rate as a bank grows, whereas systemic risk increases at an increasing rate. Therefore, there exists a point where the systemic risk outweighs the diversification benefit as a bank continues to grow. The authors find that the standardised capital regime not only diminishes the banks’ competiveness against their internal ratings-based (IRB) counterparts but also forces them into the riskier segments of the market and diminishes their ability to diversify. The authors make a case that a banking environment that promotes competition is desirable to increase the utility of the system without sacrificing safety and soundness. As a matter of fact, increased competition can increase stability while reducing the undesired implicit public subsidy of private enterprise.