Are our banks really number one?

- November 13th, 2008

Just about any time these days that Finance Minister Jim Flaherty or Prime Minister Stephen Harper talk about the global fiscal and economic crisis, you will almost certainly hear them assert that Canada’s banks are “the soundest in the world.” Indeed, that was the first thing Flaherty said Wednesday morning just as he was announcing a suite of measures to help the banks do their job better.

It’s a claim Canada’s politicians have been making ever since the Geneva-based World Economic Forum published a report Oct. 8 that ranked Canada’s banking system the “soundest” among 134 countries surveyed.

But is Canada’s banking system really that sound? Should Canadians and politicians be putting much stock in the World Economic Forum’s report?

“If you look at . . . all these rankings, they’re meaningless,” Reuven Brenner, a professor in the Desautels faculty of management at McGill University told me.

And here’s the danger of such a meaningless stat: Canadians and politicians may be lulled into into a false sense of security about our banks and may not have the incentive to make changes or introduced more regulatory reforms.

Our banks aren’t perfect,” Queen’s University professor and former Bay Street banking executive Louis Gagnon said. ”They do venture sometimes, at a cost, into markets where they don’t belong. There’s no question that a review in processes would be useful. There’s a measure of transparency that hasn’t existed. We’d like to know more about our banks.

The WEF report  ranked 134 countries on a broad array of issues that affect a country’s ability to attract and retain new business investment.

So, for example, Canada ranked 19th in the world on intellectual property protection, 34th when it comes to co-operation in labour-employer relations, and 10th on the quality of overall infrastructure. Canada ranked first on “soundness of banks.

But no one from the World Economic Forum objectively researched all these variables. All the WEF did was to circulate surveys to small groups of business executives in each country.

In Canada, just 75 business executives were asked their opinion about each of these factors.

As it turns out, those 75 Canadians essentially thought Canada’s banks were more sound than any group of another country’s executives thought about their country’s banking system.

It’s important that people who are using these statistics recognize that one question by itself doesn’t give you the full answer,” said James Milway, executive director of the Institute for Competitiveness and Prosperity at the University of Toronto.

Milway’s institute was the World Economic Forum’s Canadian partner. It found the Canadian executives and administered the survey.

The survey “is really speaking to the perceptions of business executives in Canada to similar business executives around the world talking about their own country. The ranking is not the result of a thorough and deep analysis done by analysts who are looking at various ratios and measures of banking systems,” Milway said.

So what do our banks need to do to become more sound?

Brenner says it’s very difficult to get a sense of what exposure Canadian banks have to credit default swaps, a sophisticated kind of hedging investment that, if it works correctly, should balance out some of the risk associated with lending money. But credit default swaps were at the centre of the banking failures in the United States and many other countries.

The market for these types of investments is unregulated and there is no “clearinghouse” so that investors can understand who’s standing behind which investment.

 

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