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Economy Lab: Are Canada’s banks getting too big to fail?

People walk by an ING Direct cafe in Toronto following the announcement on Wedneday that ING Bank of Canada will be acquired by Bank of Nova Scotia.


Bank of Nova Scotia chief executive Rick Waugh was waving the flag Wednesday as he unveiled his plan to purchase the Canadian assets of ING Groep NV for $3.13-billion, the bank's largest-ever acquisition.

ING Bank of Canada "will benefit from the backing of a strong, stable Canadian shareholder with the additional resources to enable it to expand and grow," Mr. Waugh said in a statement.

At the risk of being unpatriotic, let's unpack what Mr. Waugh is saying. Is it really such a great thing that ING's Canadian clients have been gobbled up by a "strong, stable Canadian" owner?

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The benefits are clear enough.

Amsterdam-based ING, which sits among the world's 20 biggest banks, got into trouble during the financial crisis and needed a government rescue to survive. It's now selling assets and the bank's Canadian clients clearly were deemed unessential. Now those clients have an owner that cares – and that is comfortably solvent.

If you believe diversification reduces the threat of default, then Mr. Waugh's bank is poised to become a safer one. The ING assets would bolster Scotiabank's Canadian business, offsetting whatever risk the company runs by operating in more than 50 countries. "Many past banking failures were linked to over-concentration in particular products or markets," said Ann DeRabbie, Scotiabank's communications director.

And the costs?

Let's begin with the reason ING attracted 1.8 million Canadian customers over 15 years. The bank shook up the market by offering no-frills, Internet-based banking that used the money saved by shunning bricks and mortar to offer higher interest rates on personal savings accounts. That's an innovation of the Dutch owner, which does battle with other financial behemoths all over the world. ING spotted an opening in Canada, where an oligopolistic banking system tends to churn out roughly the same offerings from bank to bank. For those who grumble about a lack of real competition in Canada's retail banking market, ING was an argument to support their misgivings. Those people now can go back to grumbling freely.

There's a second cost; one that is too often dismissed in Canada.

If the purchase is accepted by regulators, Scotia's 1.8 million new clients also will represent almost two million new reasons why the federal government would have to bail out the lender if it ever hit the rocks.

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Finance Minister Jim Flaherty, Julie Dickson, head of the Office of the Superintendent of Financial Institutions, and Mr. Waugh will recoil at this suggestion. Canadian authorities and the country's banks insist that "too big to fail" doesn't apply in Canada. They insist no bank will ever be rescued by taxpayers.

The thing is no one believes them.

"The largest Canadian banks create a major 'too-big-to-fail' risk," Malcolm Knight, a former No. 2 at the Bank of Canada, told an audience in Washington earlier this year. Canada's banks might be "less likely to fail," but "it is difficult to believe that the Canadian authorities would be able to stand by and let one of them succumb to stress – the impact on customers, on competition in financial services and on reputation would be too great," Dr. Knight said.

The "strength and stability" of Canada's banks is rooted in prudent management and excellent supervision. But Mr. Waugh and his counterparts also benefit from the market's belief that none of Canada's biggest five or six financial institutions would be left to go bankrupt. Moody's Investors Service scores Canada's biggest lenders two notches higher than it otherwise would because it assumes the government would prevent default. (Scotiabank's credit score is Aa1, Moody's second highest rating. Without "systemic support," Scotia's rating from Moody's would be Aa3.) All things equal, a higher credit score equates to lower borrowing costs. Canada's banks protest the notion that they are too big to fail, but they profit from the assumption.

So, do the benefits of Scotiabank's purchase of ING's Canadian business outweigh the costs? Analysts and investors seem to think Mr. Waugh has made his bank stronger, and ING's Canadian clients would be in the care of a well-resourced owner. On the other hand, a bank that probably is too big to fail would become even bigger, and a concentrated industry would be left even more so.

The Scotia purchase is being reported as a fait accompli. That could be, but Ottawa still has the final say.

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The Harper government talks about the soundness of Canada's financial system as competitive advantage. It also expresses concern about the country's lacklustre record of productivity and innovation. Given those two priorities, a proposed transaction that makes one of the country's big banks bigger and eliminates a rare source of competitive pressure might warrant more than rubber stamp.

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About the Author
Senior fellow at the Centre for International Governance Innovation

Kevin Carmichael is a senior fellow at the Centre for International Governance Innovation, based in Mumbai.Previously, he was Report on Business's correspondent in Washington. He has covered finance and economics for a decade, mostly as a reporter with Bloomberg News in Ottawa and Washington. A native of New Brunswick's Upper St. More


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