Regulations put smaller banks at disadvantage, report finds

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Canadian banking regulations have stifled competition and innovation, leaving smaller players at a competitive disadvantage to the Big Six banks, according to a report from the C.D. Howe Institute.

"If the government continues to believe that a level playing field is required, then it may be time to reconsider the regulatory model across the industry," said John Jason, a Toronto lawyer and author of the report.

His arguments come at an interesting time for the sector, given that nimble financial technology companies, or fintech, are vying to grab market share from incumbent banks with online services that are fast and efficient.

As well, new banks are sprouting up, often with the goal of servicing specific niches within the Canadian landscape. Over the past few months, three new banks have arrived on the scene, and a fourth is expected this month.

But as Mr. Jason notes, the players have not succeeded in wrestling market share from the bigger banks. Since 1999, the number of domestic banks has risen from eight to 30, yet over the same period the share of assets controlled by the Big Six banks has risen from 90 per cent to 93 per cent.

It is possible, Mr. Jason believes, that consumers are fond of the biggest banks because they are happy with the service they get. Also, the 2008 financial crisis may have made larger institutions appear more attractive because of their size and diversification.

But he has another theory: Even though the Department of Finance has stated that its policies try to balance the needs of stability, efficiency and utility in the financial system, he believes that there is too much emphasis on stability.

"Regulatory tightening has imposed significant expectations for the resources that are dedicated to risk management, adding a commensurate financial burden," Mr. Jason said in his report.

He added: "While the resource demands posed by the vast number of regulatory requirements can be difficult for a large bank to accommodate, for smaller banks, they can mean the difference between profitability and loss leading to non-viability."

Mr. Jason has some solutions, though. He argued that regulators could allow smaller financial players to petition for some sort of regulatory relief, given that they pose substantially less systemic risk to the financial system.

Another approach would be to modify regulations that pertain to a small bank's capital requirements. Although the federal government has lowered the minimum amount of capital required to establish a bank to $5-million from $10-million, the key banking regulator insists that all banks must have sufficient capital at all times and meet severe stress tests.

The result, Mr. Jason believes, is a financial system that discourages innovation.

"Instead of acting as an innovator, a new bank is incented to offer the same products and services in the same manner as every other bank," he said.

Applying the capital rules – designed for large, international banks that threatened the global economy during the financial crisis – to even the smallest startup, Mr. Jason said, is discouraging new players from entering the market or holding them back from offering anything more than limited services.

"The fundamental question is whether our regulatory framework is too narrow, thereby limiting the ability of new entrants … to provide the services that today's consumers demand and inhibiting their ability to become economically viable," he said.

"If the answer is yes, the government will have to consider whether to continue with transitional relief to assist new entrants or, more fundamentally, review the framework for the entire sector."