Chris Gay, a contributing columnist for The Globe and Mail and former Wall Street Journal staffer who writes the newsletter Figure at Center, argues that Canadian financial institutions should closely monitor recent regulatory shifts occurring in the United States. South of the border, U.S. regulators have initiated a significant loosening of rules governing the capital reserves banks must hold as a protective buffer against economic shocks. This development is viewed by many analysts as a potential slippery slope toward the next financial crisis, and it may create pressure for Canada to enact similar deregulatory measures, initiating a concerning race to the bottom in financial oversight.
Fed Approves Capital Requirement Reductions
On March 19, the U.S. Federal Reserve provisionally approved a measure to ease capital-adequacy regulations that were originally tightened in the aftermath of the 2008 financial crisis. The proposed rules, now open for a standard 90-day public comment period, would lower capital requirements for the nation's largest banks. In practical terms, this could reduce average capital requirements by up to 4.8 percent in dollar value, thereby freeing approximately $40 billion in core capital. This liberated capital could then be redirected toward increased lending, shareholder dividends, and corporate share buybacks. These changes represent some of the most substantial regulatory liberalizations since the financial crisis era.
A Dangerous Change in Direction
While the specific percentages are noteworthy, the broader shift in regulatory philosophy is even more significant. It is crucial to recall that stricter capital rules were implemented precisely because undercapitalized American financial institutions collapsed during the 2007-09 crisis, forcing taxpayers to fund massive bailouts when their risky investments failed. The legislative response was the Dodd-Frank Act, which, among other provisions, mandated higher capital-to-asset ratios to create a stronger buffer against future economic turmoil.
Many observers interpret the current move toward lower capital ratios as the initial phase in a cyclical American pattern of manufacturing financial crises. This historical cycle typically follows a predictable sequence: 1) periods of easy credit, lax regulation, and asset inflation; 2) a subsequent market crash and recession; 3) government-funded bailouts of failing institutions; and 4) the implementation of new prudential regulations. Once the painful memories of steps 2 through 4 fade from public consciousness, Wall Street often successfully lobbies for deregulation, thereby completing the circle and returning the system to step 1.
Pressure Mounts on Canadian Regulators
The American banking lobby, which has long opposed the constraints of Dodd-Frank and resisted tighter requirements proposed by the Biden administration, has unsurprisingly applauded the Fed's new proposal. However, critics remain vocal, including lone dissenting Fed board member Michael Barr, who warns that the new rules "would harm the resilience of banks and the U.S. financial system."
Canada maintains comparatively tight capital rules, which have contributed to making its banking sector one of the most stable globally. The landscape is also more concentrated, with approximately 80 banks operating in Canada compared to over 4,000 in the United States. Nevertheless, some industry voices argue that this stability comes at the cost of suppressed lending activity. They caution that Canadian banks could face a competitive disadvantage against less-restrained American counterparts unless domestic regulations are similarly eased.
Laurent Ferreira, Chief Executive Officer of National Bank of Canada, has publicly called for looser capital constraints to facilitate increased lending to small businesses. Canada's primary financial regulator, the Office of the Superintendent of Financial Institutions, appears to be leaning in a similar direction. However, proponents of deregulation might want to exercise caution regarding their wishes.
The Slippery Slope of Deregulation
Even a moderate loosening of rules in Canada would remain far from the current levels of permissiveness seen in the U.S. proposal. Yet, the slope remains dangerously slippery. The narrative arc of boom-and-bust cycles, particularly evident in American financial history, persists despite a well-documented chronicle of past crises and their deregulatory antecedents. Many economists attribute the 2008 crash directly to a series of deregulations that left American banks dangerously overleveraged and undercapitalized.
Conversely, many on the political right dispute that deregulation played a significant role in the 2008 collapse, instead arguing that poorly conceived regulation itself was the primary culprit. These arguments—often advanced by commentators paid to criticize government intervention and extol unfettered markets—frequently discount the relentless logic that drives unrestrained financial institutions toward ever-higher risks in pursuit of ever-greater returns, thereby jeopardizing innocent bystanders in the broader economy.
This dynamic is what former Citigroup CEO Chuck Prince famously alluded to in 2007 when he stated, "as long as the music is playing, you've got to get up and dance." A core function of financial regulation is to protect banks from their own potentially self-destructive impulses.
The Preparedness Paradox and Prudent Policy
American banks frequently complain that excessive capital requirements raise operational costs and constrain profit margins. While there may be some truth to this, the vast majority of U.S. banks currently exceed existing requirements, and net profit margins across the sector remain robust. The Federal Reserve may ultimately prove correct in its assessment that looser rules do not automatically guarantee a financial crisis. Indeed, one hopes that a decade from now, critics like Michael Barr will be viewed merely as alarmists.
However, it remains prudent to consider that financial regulation is inherently vulnerable to criticism due to the "preparedness paradox." This concept renders the successes of regulation invisible: society never witnesses the crises that were prevented precisely because effective regulations stopped them from occurring. This absence of visible catastrophe allows critics to argue that the rules were unnecessary in the first place.
It is true that regulations can sometimes create perverse incentives and moral hazards. Yet, given the lamentable history of financial crises and the widespread economic hardship they inevitably cause, prudent policy should privilege public safety and systemic stability over the pursuit of maximal corporate profits. Society does not typically erect complex regulatory institutions and elaborate rules without reason.
Therefore, those eager to weaken the existing regulatory framework would be wise to heed an aphorism often attributed to the early 20th-century British critic G. K. Chesterton: "Do not remove a fence until you know why it was put up in the first place." The fences of financial regulation were constructed for very specific and historically validated reasons, and dismantling them requires extreme caution.
