Getting Financial Regulations Right

After the 2008 financial crisis, Canada was recognized as having developed a strong framework for financial regulation that enabled it to avoid the mortgage crisis that wreaked havoc in the United States and Europe. While Canada weathered the 2008 financial crisis better than most other wealthy, industrialized democracies, the reform process in the aftermath of the crisis revealed a number of flaws that could stand significant improvement.

A better approach would improve regulatory impact analysis in Canada based on lessons learned from Europe and United States. Since 2008 a spate of new financial regulations have been introduced in Canada improving the process for policy formation and consultations between government authorities and the private sector. While this approach is much less complex than the Regulatory Impact Analysis (RIA) process used in Europe, its simplicity and lack of full transparency results in outcomes that can lead to unnecessary compliance costs and unintended effects, including a non-level playing field that may disadvantage both consumers and relatively small financial firms.

No doubt many regulations further strengthen the goal of financial stability. However, financial regulations should not only improve financial stability, critical to performance, but also market efficiency and investor protection, which are two other important goals pursued for a strong financial market regulatory system. Despite their benefits, the regulations can also result in unintended effects whereby unnecessary costs could be avoided by smarter regulatory policy.

Overall, participants at a Roundtable meeting on the topic of financial sector RIA in Canada earlier this year (including representatives of the financial sector industry, public sector regulators, and independent researchers) felt that lengthy and costly regulatory reviews as are usually required in Europe and the United States might be counter-productive compared to the more “principles based” approach preferred in Canada.

Specific concerns in Canada include insufficient time available for the private sector to provide feedback to proposed changes in regulations, resulting in a lack of thoroughness in the review of the proposals and thus potential unintended effects such as unnecessarily high compliance costs for the new regulations.

The consultation process here tends to focus more on large institutions without due regard to the compliance costs imposed on smaller institutions, which could lead to less competition in the financial sector.

Insufficient ex post evaluation of regulations is undertaken to determine their impacts and if they should be improved.

Few automatic “sunset provisions” are used that would require particular regulations to be reviewed and either re-authorized, revised, or eliminated by a specific date.

And then there is the typical Canadian problem whereby financial regulation involves federal banking powers but also provincial control over property rights and contracts under the Constitution Act. The Canadian RIA approach involves little public input at the provincial level in most provinces.

Nor is the approach fully transparent even at the federal level (with the risk of regulatory capture).

The current lack of regulatory harmonization in certain areas leads to internal barriers to trade for financial services. Harmonization of federal and provincial regulations would help reduce compliance costs for the financial sector as well as improve the efficiency of markets. It would also be useful if the federal and provincial levels work towards common regulatory assessment regimes especially in areas where regulatory powers overlap.

Many of the other shortcomings can be avoided by establishing a new review process that enables full consultation and ex post review with stakeholders to minimize their adverse effects. One could argue that the European approach to regulatory approval is perhaps too cumbersome but some important attributes are worth considering in Canada to ensure that regulations are developed to minimize administrative and compliance costs as well as unintended effects. These include the following:

Minimum requirements to assess whether a regulation is beneficial.
Consultation with parties to estimate costs, unintended effects and to help understand the benefits of regulation.
Transparency so all can see the entire RIA process, and regulators can hear from all interested stakeholders.
Post-evaluation that is made public.
A joint federal-provincial approach to regulatory impact analysis to encourage harmonization and improved RIA processes at the provincial level.
A requirement for regular “sunsetting” provisions requiring that all regulations be subject to periodic review before being either re-authorized, revised, or eliminated.

Canada should look to make whatever improvements it can to its RIA framework at federal and provincial levels to ensure that its stellar reputation will be maintained in future years.

Jacqueline Coolidge is a consultant to the World Bank and Jack Mintz is the President’s Fellow, School of Public Policy, University of Calgary. Their paper, Getting Financial Regulations Right: Avoiding Unintended Effects, can be found at www.policyschool.ca.