‘Underwhelming’ financial services sector contributes to lagging productivity: report

Investment Executive | Maddie Johnson | Oct 16, 2019

productivity and the financial services sector - ‘Underwhelming’ financial services sector contributes to lagging productivity: reportC.D. Howe calls for more regulatory barriers to be removed

For years, Canada’s productivity growth has lagged many of its international peers, according to an upcoming report from the C.D. Howe Institute. And the financial services sector could play a vital role in reversing the trend.

The report, to be released Thursday, examines the financial services sector and its overall contribution to productivity in Canada.

Authors Farah Omran and Jeremy Kronick link long-term sustainable economic growth with an improvement in productivity, saying advanced economies need to do more than just increase their traditional inputs, such as labour and capital.

The financial services sector has the ability to improve its productivity, which would in turn enhance Canada’s overall productivity growth, the report says.

Despite its potential, the sector falls short, and its overall contribution to Canada’s productivity growth is “underwhelming.”

The report discusses how three main channels — competition, attracting capital and the allocation of capital — are hindered by restrictive regulation, hurting Canada’s overall productivity growth.

“Canada’s current regulatory framework has improved over the past decade; however, more could be done to remove regulatory barriers that hamper competition, the progress of innovative firms, and better reflect international best practices,” the report says.

See:  Nov 20, 2017: NCFA Canada Welcomes Competition Bureau’s recommendations to encourage competition and innovation in Canada’s financial services sector


Remove barriers to financial sector productivity: C.D. Howe Institute

C.D. Howe Institute | Oct 17, 2019

The authors examine the contribution of the financial services sector to Canada’s productivity growth and find it has been underwhelming, considering its potential. The financial services sector employs relatively more Canadians with postsecondary and postgraduate education than do other sectors, and promotes growth and productivity within the other complementary sectors that serve it. As a result, any increase of productivity in the financial sector has an outsized effect on Canada’s productivity at large.

The report lays out how regulatory changes could improve the contribution of the financial sector to productivity by increasing competition through the development of fintechs (financial technology), and by bolstering lending to small and medium sized businesses (SMEs), through measures including a switch from a focus on mortgage lending to business lending.

Fintech: The report notes only $263 million in investments were made in Canada’s fintech market in the first half of 2018, compared with $14.2 billion in the United States and over $16 billion in the United Kingdom.

One obstacle to investment, productivity and scaling up of fintechs in Canada is legislation that until recently restricted the extent to which banks could invest and participate in fintechs and other technology-related activities. Although recent amendments to the Bank Act and the Insurance Companies Act raised the investment limits based on the value of the entity being acquired, the government has yet to provide sufficient clarity regarding these changes and set a date for enforcing them.

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Lending to SMEs: Canada ranks dead last among OECD peers in small business lending as a share of total business lending, and near the bottom in overall business and small businesses lending as a percentage of GDP. This indicates a need to investigate whether it is necessary to deepen Canada’s capital markets beyond domestic bank debt financing, which according to OECD data was 60 percent of all SME financing in 2017 (approximately 80 percent if we include foreign banks, credit unions and caisses populaires).

One reason for this is that the alternative to business lending – residential mortgage lending – is risk free, and SME operational costs might be too binding and crowd out SME credit. This risk-free mortgage lending is a result of the 100 percent insurance that Canada Mortgage and Housing Corporation (CMHC) provides lenders of insured mortgages. As a start, the authors recommend that CMHC begin scaling insurance premiums to the credit-worthiness of mortgage borrowers instead of the present one-size-fits all approach.

“Although regulations are necessary to protect consumers and maintain the stability of the financial system,” says Omran, “They should be balanced between protecting against potential risks and ensuring appropriate competition – often from new entrants – which is crucial for the generation of innovative ideas and, in turn, productivity growth.”

More broadly, the authors recommend:

  • the continued removal of barriers to the development of fintech through a flexible regulatory approach that is both based on the specific function of individual fintechs, and proportional to the risk involved in the services provided;
  • more explicit competitiveness mandates for Canada’s financial services regulators to spur innovation;
  • continued strengthening of the links between regulatory bodies both across provinces and different regulatory areas;
  • changes to the incentive structure so that financial institutions move away from a focus on mortgage lending to one on business lending.

 


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