/Canada’s lagging productivity could get a jumpstart from financial services reform: C.D. Howe

Canada’s lagging productivity could get a jumpstart from financial services reform: C.D. Howe

Canada’s strong financial services sector is an “underwhelming” contributor to the country’s productivity, according to a report from the C.D. Howe Institute, which places some of the blame on what it views as restrictive rules that hold back competition and innovation.

The report, written by policy analyst Farah Omran and Jeremy Kronick, associate director of research at the think tank, suggests Canada’s lagging productivity could be given an “outsized” boost from the financial services sector if rules were updated to encourage more competition from non-traditional, innovative financial technology (fintech) services.

It also recommends changing the incentive structure of financial institutions to shift the focus from government-backstopped mortgage lending to making loans to small and medium-sized businesses — which would also benefit from increased competition in the lending segment of capital markets.

According to the authors, it has been established by earlier research that “robust” productivity growth occurs when regulations and policies foster competition and spur innovation in the delivery of financial services, and create conditions to attract and efficiently allocate capital.

Over the past 15 years, Canada has lagged behind many OECD countries in terms of productivity — including countries it is often compared to such as Australia, Norway and Sweden, according to the C.D. Howe report.

The authors, who zeroed in on business lending and compared Canada with a sample of other countries that are part of the Organisation for Economic Co-operation and Development, concluded that credit for small and medium-sized businesses (SMEs) is “both less available and less affordable in Canada — a critical gap to be addressed given the strong link between SMEs and productivity growth.”

Omran and Kronick found that Canada “ranks last” in small business lending as a share of total business lending among the sample OECD countries, and “near the bottom in overall business and small businesses lending as a percentage of GDP.”

The report concluded that there is also a lag in fintech development in Canada, with investments totalling $263 million in the first half of 2018, compared with $16 billion in the United States and $14.2 billion in the United Kingdom.

The fintech market of New York state alone is valued at $9 billion, a figure that dwarfs Canada’s $1 billion in investment since 2010, the authors note.

Stephen D.A. Clark, co-chair of the Financial Institutions Group at law firm Fasken Martineau DuMoulin LLP in Toronto, said he agrees with several of the report’s conclusions.

“The authors are correct about fintech,” he said, adding payment systems and open banking could be put in the same category because Canada “lags” other countries there as well.

“The problem is not the banks or their willingness — it is the underlying statutory regime that needs to be updated.”

Clark said completing such an overhaul would be a complex task because there are a number of laws to review and consider. In addition, there are jurisdictional considerations highlighted by legal and political wrangling over who controls aspects of financial services regulation governing consumer protection.

The problem is not the banks or their willingness — it is the underlying statutory regime that needs to be updated

“This same refrain (calling for updated rules) has been out there for years, (but) it does not seem to be a priority for the federal government,” he said.

Both Clark and the report’s authors pointed to a federal government pledge to relax rules for banks investing in fintechs that also do business outside the financial services sector as an example of the long road to reform.

“Supporting regulations have not yet been released, let alone enacted,” Clark said of the pledge to relax the investment rules.

Omran and Kronick suggested that removing such obstacles is key to promoting investment and productivity and scaling up fintechs.

The arrival of new fintech players has heralded both under-regulation and overregulation in the banking sector, according to the C.D. Howe report, which suggests the problem has been noted but not fully addressed.

Fintechs that are in the lending business, in particular, face stiff regulations similar to traditional bricks-and-mortar banks, even though the risks they pose to the system could be much lower, the authors say.

The report notes the success of structures and policies put in place to support innovative firms — such as the Canadian Securities Administrators’ regulatory “sandbox,” the Ontario Securities Commission’s LaunchPad, and the FinTech Group at Quebec’s Autorité des marchés financiers — but says “evidence suggests that Canada is not reaching its potential” compared to other jurisdictions.

“In the United Kingdom, for example, and unlike many of Canada’s financial sector regulators, the Financial Conduct Authority (FCA) has an explicit mandate to promote competition, and has established a clear link between competition and productivity,” the authors wrote.

Financial Post

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