Why Were Canadian Banks More Resilient?

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Why Were Canadian Banks More Resilient?

• Lev Ratnovski and Rocco Huang
• IMF WP 09/152

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Canada

• Six nation-wide, universal banks
• Domestic, Carib/LA, US operations
• No failures, no public capital
• Banks able to raise capital early in the crisis

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The paper

• Policy-oriented study
• Large OECD banks (assets gt100B)
• Which key pre-crisis fundamentals
• Capital ratio, Balance sheet liquidity, Funding
• best predict performance during the crisis?
• Equity returns, Jan 2007 - Jan 2009
• Qualitative public intervention, degree of
  stress
• Canada
• Bank fundamentals Specific regulations
• Wider implications for recent debates

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Capital Ratios

• Equity / Total assets
• Equity is balance sheet equity Assets Debt

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Balance Sheet Liquidity

• Liquid assets / Total assets
• Liquid assets claims on government, other
  banks, parts of trading book

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Funding Structure

• Deposits / Total liabilities
• Deposits retail, interbank, transaction accounts

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Regressions
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Dependent Variable Extreme Stress Extreme Stress Extreme Stress Price Decline gt85 Price Decline gt85 Price Decline gt85
(1) (2) (3) (4) (5) (6)

Equity Ratio -0.182 0.259 -3.042 1.240 3.580 -31.80
(0.454) (0.187) (3.419) (2.025) (1.221) (10.02)

Equity Ratiolt4 0.0802 0.361
(0.0988) (0.183)

Balance Sheet Liquidity -0.541 -0.425 -0.382 -1.527 -1.694 -1.187
Balance Sheet Liquidity (0.431) (0.377) (0.336) (0.576) (0.631) (0.538)
Balance Sheet Liquidity
Depository Funding -0.326 -0.281 -0.479 -1.133 0.536 -3.836
(0.224) (0.204) (0.447) (0.401) (0.629) (1.029)

Depository Fundinglt50 -0.0148 0.473
Depository Fundinglt50 (0.0224) (0.228)
Depository Fundinglt50
Equity Ratio Depository Funding 5.208 58.15
Equity Ratio Depository Funding (5.480) (17.33)
Equity Ratio Depository Funding
Log (Asset) 0.0629 0.0517 0.0529 0.142 0.142 0.168
(0.0574) (0.0526) (0.0516) (0.0938) (0.106) (0.105)

N 72 72 72 62 62 62
R-squared 0.393 0.435 0.450 0.139 0.240 0.233
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Dependent Variable Price declinegt70 Price declinegt70 Price declinegt70 Price decline () Price decline () Price decline ()
(7) (8) (9) (10) (11) (12)

Equity Ratio -0.907 3.685 -51.03 11.88 190.6 -1448
(3.692) (3.053) (18.96) (122.8) (85.48) (366.1)

Equity Ratiolt4 0.558 22.20
(0.125) (4.511)

Balance Sheet Liquidity -0.890 -1.151 -0.402 -33.20 -25.77 -17.73
Balance Sheet Liquidity (0.611) (0.835) (0.601) (24.64) (21.94) (22.43)
Balance Sheet Liquidity
Depository Funding -1.156 1.776 -5.543 -51.68 17.66 -167.9
(0.492) (0.600) (2.152) (17.59) (17.91) (36.38)

Depository Fundinglt50 0.576 13.07
Depository Fundinglt50 (0.116) (4.775)
Depository Fundinglt50
Equity Ratio Depository Funding 87.43 2545
Equity Ratio Depository Funding (33.46) (597.0)
Equity Ratio Depository Funding
Log (Asset) 0.123 0.0937 0.135 4.025 2.353 4.988
(0.0916) (0.124) (0.0953) (2.664) (2.707) (2.785)

N 62 62 62 62 62 62
R-squared 0.084 0.282 0.170 0.147 0.323 0.269
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Summary

• Capital
• Important to have above critical minimum
• Important in wholesale banks
• Balance Sheet Liquidity
• Important in explaining imminent failure
• Depository Funding
• Important in explaining failure
• Canadian banks outliers, ample retail deposits
• Fundamentals matter

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Canadian Regulation

• Above-Basel risk weighted capital targets
• 7 tier 1 (instead of 4 banks hold 10-12)
• 10 tier 2 (instead of 8)
• Quality of capital 75 of tier 1 in common
  equity
• Leverage ratio (assets-to-capital multiple)
• 5, based on tier 12
• IB and off-balance sheet consolidated
• Direct effect (buffers) and incentive effect
  (focus on core business) ? contained asset growth
• Quality ? transparency

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Canadian mortgage markets

• Limits
• 80 LTV
• 32 mortgage service-to-income
• 40 total debt service-to-income
• Simplicity
• 5 year max Plain vanilla (e.g. no teaser rates)
• Incentives to repay
• Interest payments not income-deductible

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Summary

• Capital
• Important to have above critical minimum
• Important in wholesale banks
• Balance Sheet Liquidity
• Important in explaining imminent failure
• Depository Funding
• Important in explaining failure
• Canadian banks outliers, ample retail deposits
• Fundamentals, policies, incentives matter