Canadian Banking System Could Provide Insight Into Future Regulatory Planning

As the industry looks toward 2009 and tries to put the not-so-sweet memories of 2008 behind it, everyone is debating how a regulatory framework should be set up to avoid another crash like this in the future.

But no matter how well we prepare for the next subprime mortgage crisis, credit crisis, or savings and loan scandal, regulations are always designed to protect against the last crisis. And, no doubt, we will have a new type of crisis 10 or 20 years from now, and everyone will act surprised and ask, "How could this happen?"

The answer is actually pretty simple. Our memories of painful things -- negative events such as market crashes, personal loss or even being rejected by a high-school crush -- are suppressed, and time seems to soften our memories of how bad things actually were. It's human nature to forget the bad and remember the good.

Right now everyone is risk-averse: Risk is bad, and poor risk management is causing a lot of pain. But as 2008 memories fade, banks will begin to take more risks again. At first a little risk will be acceptable. When it doesn't blow up in the bankers' faces, then a little more risk will be OK. Before the bankers know it, a whole lot of risk will be rationalized as being tolerable, until "something completely unforeseen" happens, such as thousands of people who have no income defaulting en masse on mortgages that never should have been offered in the first place. Who'd have thought?

Right now everyone is waiting to see the new regulatory framework that will monitor the financial markets. But we needn't look far or come up with radical new regulations. Our neighbors to the north seem to have found a good balance.

Canada's banking model has weathered the storm. Canadian banks are more tightly regulated, more liquid and less highly leveraged. There is no subprime mess in Canada, as lending rules are stricter. No banks are on shaky ground. In fact the World Economic Forum rated Canadian banks as the soundest in the world. As such, Canadian banks are eyeing weakened U.S. banks as possible acquisition targets. And while IT spending growth globally will be slightly negative -- double-digit negative in the U.S. -- financial services IT spending in Canada is the only market projected to experience IT growth in 2009, according to Financial Insights.

Is Canada's banking structure the answer? Some say it's too restrictive, which is probably true. But since every other country got it wrong when it comes to regulating financial services over the past decade, maybe we should look to the sole survivors of the credit crisis and learn something from them.