On a Saturday morning in 1923 in Toronto’s financial district, an employee appeared behind the locked doors of a bank headquarters with a sign that read: “Bank Closed. Payment Suspended.” It was nailed to the stately building’s mahogany doors, and with that, a Canadian financial institution was dead.
The collapse of the Home Bank of Canada 100 years ago triggered a homegrown banking crisis, the highlights of which are uncannily familiar today.
Tens of thousands of depositors faced the loss of their savings, sparking a debate over how much bank deposits should be guaranteed at the federal level. Speculative lending, poor management and lack of oversight soon came to light. Canadians panicked, their faith in the financial system shaken. Other banks were shored up to stave off a run on deposits.
Even after a century of financial evolution, episodes of instability in the banking system unfold pretty much as they did back then. As the financial fallout of the Silicon Valley Bank bankruptcy continues to spread, with U.S. Treasury Secretary Janet Yellen pledging on Tuesday to protect smaller banks if needed, U.S. regulators are confronted with the same old questions. How could this happen again? And most importantly, how to stop the domino effect of bank failures from threatening the stability of the entire system?
This is where the Canadian and U.S. systems diverge. Canada more or less answered those questions decades ago. Home Bank’s demise inspired key features of Canada’s modern banking system, including deposit insurance, federal regulatory oversight and a more concentrated sector built around a handful of big banks. It has proven to be a durable structure. Home Bank’s failure was the last of any major chartered bank in Canada.
Up to that point, banking was pretty lightly regulated in Canada and failures were common. Between Confederation and 1914, federally chartered banks in Canada had a rate of failure of 36 per cent. Home Bank proved to be a turning point. So disastrous was its collapse that the federal government was compelled to act.
There was no such thing as deposit insurance in 1923. The closure of Home Bank’s network of branches – more than 70 of them spanning from Quebec to British Columbia – wiped out the savings of 60,000 depositors. A parliamentary committee struck to study the failure recommended a government backstop for account holders at chartered banks of up to $3,000. This was rejected. The feds felt like the business of regulating the banks was best left to the banks themselves.
Instead, the government enhanced supervision with the establishment of the Office of Inspector General of Banks, the predecessor to the Office of the Superintendent of Financial Institutions, which is responsible for ensuring the banking system functions smoothly today. Last week, OSFI made headlines when it took control of Silicon Valley Bank’s Canadian operations. And it has also begun daily monitoring of bank liquidity for early signs of stress, according to a Globe and Mail report.
It wasn’t until the 1960s that deposit insurance came into force in Canada. A string of scandals involving mortgage and loan companies led to a push for the federal government to assume authority over all levels of banking. The provinces, however, would surely resist ceding any control. “Deposit insurance allowed them to offer a kind of a carrot,” said Trevor Tombe, an economics professor at the University of Calgary. “In order to get that insurance, you need to subject yourself to a bit of supervision.”
Deposit insurance is like a fire extinguisher – people tend to forget about it until they see smoke. At that point, fewer things are more important. When Silicon Valley Bank went into a death spiral two weeks ago, the U.S. government quickly moved to insure all the bank’s deposits, even those above the US$250,000 cap. There are now discussions over doing away with the limit altogether and guaranteeing all of the country’s deposits. After all, it was Silicon Valley Bank having uninsured deposits that made it vulnerable to a bank run in the first place.
In Canada, deposits are protected up to $100,000, but that too could be revisited if trouble continues to spread. “Unlimited deposit insurance makes sense to reassure the public,” said Cristian Bravo Roman, Canada Research Chair in Banking and Insurance Analytics at Western University. “Especially now that we are digital and cash usage is declining, people need to know their money is safe.”
The downside is that removing any default risk to depositors may remove the incentive for banks to guard against those risks. This is the debate taking place in U.S. Congress.
When the psychology of a bank run takes hold, deposit insurance is clearly a crucial tool in preventing the spread of financial contagion. But it alone cannot explain a century of stability in Canadian banking, especially compared with the U.S., where a banking crisis every decade or so seems to be an inescapable reality. Since 2001, a total of 563 U.S. banks have failed, representing more than US$1-trillion in assets, according to the U.S. Federal Deposit Insurance Corp. No Canadian banks have failed over that time.
The U.S. financial system is a vast patchwork of thousands of unit banks, operating under competing regulatory bodies, and governed by federal and state regulations to varying degrees of stringency – or lack thereof.
Canada started down a very different path in the early 20th century. An oligopoly of large, national banks with branch networks spread across the country, and governed by a single regulator, has proven to be far less crisis prone. The sector even coasted through the 2007-08 global financial crisis with relative ease. In fact, aside from two small Alberta-based regional banks shutting down in 1985, Canada hasn’t had any bank failures since Home Bank 100 years ago – a scandal that laid the foundation for the banking system we have today.
Editor’s note: An earlier headline on this story stated no chartered banks have failed in Canada in a century. While this is accurate for major chartered banks, there have been some smaller banks that failed.