Financial Regulation and Small Banks in the U.S.: Learning from the Canadian Case


Zhen Wang, University of Toronto

After the 2008 financial crisis, the U.S. legislated new banking regulations such as the Dodd-Frank Act to reshape the financial system to be safer for consumers and taxpayers. However, these legislations were not without criticism, and the fiercest among them is the argument that tighter regulations erode the competitiveness of smaller banks and force them to merge with larger institutions, diminishing the diversity of the banking industry. Years later came the rollback of Dodd-Frank with several clauses loosening restrictions for smaller actors in the financial sector. To investigate these claims about the antagonistic relationship between financial regulation and smaller financial institutions, I turn to the case of the Canadian banking sector. Canada has the type of financial system that many on the American right oppose – it is highly concentrated with more than ninety percent of the financial assets controlled by the five biggest banks, and there are fewer than forty domestic banks currently operating in Canada. At the same time, Canada levies much more stringent federal regulations on the banking industry compared to the U.S., which many argue shielded Canada from the worst outcomes of 2008. A combination of big players dominating the market and a high level of federal oversight should create a hostile environment for smaller banks, as opponents of Dodd-Frank often assert. By examining the 2019 financial data of domestic banks in Canada from OSFI, my paper finds more nuance in the claim that financial regulations hurt smaller banks and reduce the diversity of the banking industry. A concentrated market indeed resulted in several bank mergers since the 1990s, reducing the total number of financial institutions in Canada. Nevertheless, most existing smaller banks remain highly profitable and safe, and medium and small banks are much less leveraged than the Big Five banks. Smaller banks also employ very different strategies than larger players. They engage in more traditional banking activities such as loans and deposits, specifically in mortgage loans. Smaller banks also have minimum to no exposure to risky financial innovations like derivatives and security products whereas large banks routinely engage in these activities. The results of my study indicate that a concentrated financial sector inevitably brings on certain difficulties for smaller actors, but tight financial regulations do not necessarily equal doomsday for smaller banks. As we see in the Canadian case, even within a challenging ecosystem, existing small and regional banks can still carve out a competitive business profile to counter larger institutions and remain profitable thanks to the stable banking environment that comprehensive financial regulations have engendered. With its much more vibrant and robust regional bank network, I argue that the relationship between regulations and the diversity of the financial sector in the U.S. can also be a net positive one. My study contributes to the discourse on financialization and regulation, as well as organizational studies, specifically population ecology theory on how smaller players react to macroeconomic shifts and create organizational niches to survive in an unfriendly environment.

This paper will be presented at the following session: