Canada is being dragged into "overzealous" financial regulation by a global campaign to root out risky bank lending practices, former Bank of Canada governor David Dodge argues in a new report.
Meeting tighter new capital, liquidity and leverage rules could cut bank pretax profits by as much as 20 per cent, Mr. Dodge warned in a report being released Thursday by the C.D. Howe Institute.
Regulators are losing sight of efficiency in their drive to promote stability in the banking system, he said.
"Little effort has been directed at ascertaining the least-cost way of achieving stability goals," he writes in the report, Financial Regulation and Efficiency: Tradeoffs in the-Post Financial Crisis Era. "Governments around the world have demanded stability at any price."
Inefficient and overly precise "American-style" regulation will "cabin, crib and confine" Canadian financial institutions, according to Mr. Dodge.
The new rules have been pushed on Canada by the international Financial Stability Board, an association of regulators that advises G-20 countries, and have been gradually tightened since the financial crisis, with more changes to come by 2019. The FSB is chaired by Bank of England Governor Mark Carney, Mr. Dodge's successor at the Bank of Canada.
For example, the FSB issued a proposal in November that would require banks to hold equity and bonds equivalent to 16 to 20 per cent of their assets to shield taxpayers in a collapse.
"There was tremendous pressure on the Canadian authorities to fall in line with that … because we didn't want to be offside with the world," Mr. Dodge said in an interview.
"Our folks were dragged along by this international pressure."
Mr. Dodge acknowledged that tighter rules were needed. But he lamented that Canada has acted as the "good boy scout," going "above and beyond" other countries in imposing stricter capital ratios for banks.
"We've gone faster in implementing the capital rules than the Europeans, which has made it tougher for our banks competing against the Europeans in global markets," he said. "We could have been less aggressive."
In the report, Mr. Dodge pointed out that financial regulation held up well in Canada during the 2008 financial crisis – a regime that relies more on principles than strict rules.
The Canadian system relies on a "continuing dialogue" between large banks and insurers and key federal regulators – the federal Office of the Superintendent of Financial Institutions, the Finance department, the Bank of Canada and Canada Deposit Insurance Corp.
"We in Canada would be well advised to stick with our pre-2008 principles approach to prudential regulation," Mr. Dodge said.
Canadian financial consumers benefit when there is a "co-operative relationship" between financial institutions and regulators, he added.