Why Canada does not need or deserve Basel III regulation

Canadian banks performed well during the financial crisis and have continued to generate healthy profits in the first quarter of 2011. It is only understandable then that, like many other lenders in the world, they worry about the proposed stringent Basel III rules.

Unlike many banks around the world, Canadian banks did not go into the red or have to be nationalised, so many complain about the risk of having their activities curtailed. Gord Nixon, chief executive of the Royal Bank of Canada, has strong views about international regulation that could go too far. His country’s banking system has been working well with a principle-based approach and the need to tame systemic risk, necessary in other markets, is not mirrored in Canada.

In the US, the collapse of structured products that were based on subprime residential mortgages – at the epicentre of the financial crisis – was a consequence of the lax regulation of the mortgage market, says Mr Nixon. This does not correspond to the Canadian market, where mortgages are highly regulated and excessive capital requirements – which can supplement permissive regulation in other non-banking sectors – would be meaningless.

Different mortgage market

“Capital is important but the biggest differentiator for the Canadian system is the mortgage market. At the heart of the problem in the US was its mortgage market, [while] a huge source of strength for the Canadian [banking] system is our mortgage market. That has been a huge differentiator in comparison to the US in particular, but also the UK and others such as Spain.” Mr Nixon also points out that it is only now that some of the US mortgage market policies are being reviewed.

As a whole, however, the international banking community does need a stronger capital base, and Mr Nixon acknowledges this. “There is no question that the [international banking] sector was undercapitalised and over levered and you want rules that put countries on a stronger footing," he says.

"But the complexity of the [Basel III] regulation, the ability for jurisdictional interpretation and the phase-in period are all excessive. [The new proposed rules] are an attempt to very quickly bring a lot in. [But] when you have this incredibly challenging set of rules and when you actually go to implement them, the market, and politicians and regulators too, recognise that they can’t be [enforced] and therefore the rules get either changed or get diluted or phased in over excessive periods.”

Too far ahead

Mr Nixon's complaints seem justified. Cumbersome rules that will only be implemented over almost a decade still leave a degree of uncertainty on the final shape of the regulatory system. A more balanced, less extreme approach is deemed more desirable. “My view is that it is absurd to have a rule that is phased in by 2019 – most people in the industry will not be around then," Mr Nixon says.

"We can go through two or three cycles from here to 2019. I’d much prefer more reasonable requirements that do not push too far [but] with much shorter implementation periods, where you end up with a level playing field and far less jurisdictional interpretation.”

Mr Nixon also has firm views on the issue of whether firewalls between banks’ operations would be beneficial to containing systemic risk. “It would be a major mistake to suggest that banks should be broken up, separate wholesale from retail, for example. By reducing diversification, they would increase risk. It will not necessarily lead to better products and better performance across the industry," he says.

“Financial services by nature are a big diverse, complex area where if you try to eliminate too much you’ll end up taking innovation out of the system or you’ll end up pushing it outside the regulated [framework] and into the shadow system. From a systemic perspective, that does not accomplish anything," he concludes.