A World Class Banking Industry:
The Canadian Experience,
the Canadian Opportunity
An address by Richard E. Waugh
Chief Executive Officer
the Canadian Club
November 2, 2009
Check Against Delivery
Thank you very much, John (Capobianco). It's a pleasure to have the opportunity to speak to the Canadian Club. I'm also pleased to see so many friends and colleagues here – thank you all for coming today.
The last time I delivered a keynote speech to the Canadian Club was in Montreal in 2005 – and boy, what a change in four years! Thinking about how quickly things change and unexpected outcomes, I've labelled my speech "A World Class Banking Industry: The Canadian Experience, The Canadian Opportunity". I'll speak more on this and the changes caused by the past two and a half years of financial turmoil in a moment – I'm reminded of a uniquely Canadian observation I heard a while ago.
Here in Canada – many years ago – we had the opportunity to invent ourselves. Sir Wilfrid Laurier, while addressing the Canadian Club in 1904, said that while the 19th Century was when America leapt forward, the 20th century was Canada's to lead.
But really, we've proven that we're so much stronger than the sum of our parts, our geography and our heritage. We have something of our own to bring to the world – the Canadian model. So, even better than trying to copy others, we have the potential, in our own unique Canadian way, to make this century ours to leap forward.
Importantly, others are starting to look at Canada as a role model for the future.
I know we as Canadians like to poke fun at ourselves, we are humble and we often doubt ourselves, but we do have a lot to be proud of. We've proven ourselves to be leaders in many areas, certainly, in our strong economy and our values of fairness and democracy. In particular, and what I'll focus on today, in the strength and performance of our financial system.
As I'm sure you've heard, during the crisis the World Economic Forum ranked our banking system No. 1 in the world for its stability. It was also similarly ranked by the IMF, Standard and Poor's and now, most recently, Moody's.
Beyond this recognition, we should realize that the Canadian banks have not cost the Canadian taxpayer anything. In fact, banks have actually continued to pay tax and high government fees throughout the crisis.
And I couldn't help but notice that it took a global crisis for the Canadian media to finally print a good story about our banks!
Seriously, Canada has earned the recognition we received on several levels. To have our financial system hold up so well during a crisis of such magnitude is quite an achievement and one we should all feel proud of and one we should take advantage of.
I'd like to take the first part of my time with you this afternoon to discuss some of the reasons why Canada is succeeding and why our banks, our financial system and indeed our country remain in a strong position.
Then, with these successes in mind, I'd like to make a few recommendations aimed at re-building of a better global financial framework: things that I see as critical not only for the success of the recovery, but also for our long-term Canadian and global prosperity.
Let me begin by looking at the Canadian financial system, a system based on good governance.
Canada's system is strong top to bottom. We have good public governance, strong fiscal, monetary and regulatory oversight, and good, prudent management of our financial institutions.
Looking at our governance, Canada has had a solid macro-economic policy framework that has produced excellent results. Our debt levels have remained manageable and they not only compare favourably to the G-7, but by most measures, they are the best.
We've also benefited from consistent and effective monetary policy that has shown a firm grasp of the issues and has kept inflation low and stable.
Canada also has, beyond a doubt, a strong financial sector structure and regulatory approach.
We have a national, federally-regulated banking system. The legislation that governs the financial sector – The Bank Act – is strong and comprehensive, but it also allows for change and evolution, a necessary component in today's world.
Canada's banking system has benefited from strong oversight through our national regulatory body, the Office of the Superintendent of Financial Institutions (OSFI). OSFI works independently, but is open to dialogue with our banks. This has been augmented by formal and informal dialogue with the Bank of Canada and the Ministry of Finance
Canada was one of the first jurisdictions to implement Basel II, a more demanding regulatory standard, but only after a long, rigorous and expensive process to ensure the integrity of our system and the new Basel regulations. In addition, as a precaution, OSFI also retained proven safeguards, such as leverage ratios and additional capital buffers, intensive onsite inspections and its own self and peer evaluations on performance. As well, the Government and the Bank of Canada have also ensured a unique, conservatively-structured mortgage market through CMHC and other safeguards.
The strength of Canada's regulatory leadership has led the G-20 to name Canada co-chair of a group responsible for improving regulation and transparency. OSFI is also actively involved as a member of both the Financial Stability Board and the Senior Supervisor's Group.
Another important part of our system is that, unlike the United States, all of Canada's major investment dealers are owned by banks, and have been managed and regulated on a consolidated basis for nearly 25 years. The result is an integrated banking model under a single regulatory and management framework that has worked and survived one of the worst financial crises in history, without government bailouts or subsidies.
The foundation, structure and oversight of our financial system all have a great deal of influence on its strength, but what happens on the ground level, in the management of the financial institutions themselves, is extremely important, and in fact, equally as important to our success.
Canadian banks have an undisputable record of good, prudent management that has been built over a period of many decades. If you'll forgive me, I'll use Scotiabank as an example.
Scotiabank has been in business for 177 years. Our Bank has survived the ups and downs of many, many business cycles, and more than a few crises. Our revenue is earned from retail, commercial and corporate customers, as well as investment banking and client trading. The latter is important, but not a large part of our total revenue.
The point is, that our business model, along with the other Canadian banks, is fundamentally different than several of the U.S. and European banks which were driven and dominated by investment banking and trading, which, in many respects, was at the core of their financial problems. They took risks that were too large in order to drive short-term profitability.
As I said, we are more of a traditional banking model, with ensured accountability and good risk underwriting. We have a strategy of originating good assets, primarily loans, with known risks and we generally hold these loans rather than securitizing and moving them off our books.
It's important to note that no government regulation or policy prohibited us from using securitization for the sale of assets, or investing in toxic assets, like U.S. sub-prime mortgages, CDOs and so on. We just chose not to do it because of our unease with the risks. And while OSFI prudently regulated us to higher capital ratios, Canadian banks voluntarily chose to hold much higher capital than our international peers and in fact higher than OSFI requirements.
Our approach to risk is that we think of it in holistic terms, which encompass credit and market risks, operational risks and accountability.
Scotiabank's success is based on diversification of several sustainable revenue streams internal checks and balances, and a strong embedded risk culture of accountability and caution. Revenue and profitability take into account the cost of risks in our pricing, products and compensation.
We are diversified in several ways: across our three business lines, all of which produce sustainable revenue; across the many products and services that we offer our customers; and across the many geographies in which we operate, encompassing some 50 countries.
We have strong internal and external audit, underpinning our belief in checks and balances. Our risk management responsibility reaches across the entire organization and right to the top, including myself and the entire Board of Directors.
We also have an independent Board and Chair which we've had since 2003 when I took over and we separated the Chairman and CEO functions. All Canadian banks now have non-executive Chairs and, in our case, I'm the only management representative on our Board.
Scotiabank's past three CEOs, going back to 1972 – myself included – have headed the Risk Committee, which reviews all large exposures and transactions. We meet at least twice a week. Business line heads as well as senior risk managers are expected to attend regularly.
And, as my colleagues will confirm, these are not just meetings held at 10,000 feet. We deal with risk by transaction, applying appropriate strategies, policies and most importantly judgment. As well, we have several other risk committees that permeate the Bank both in Canada and around the globe where we do business.
I'll end here because I don't want to disclose too many details on how we manage risk and give away our competitive advantage!
The point I'm trying to illustrate is that Canada and our banks have demonstrated it's possible to have a strong, sound financial system that supports the economy, that can withstand crises, and that sustains healthy, profitable banks. It is a combination of sound government policy and regulation, and good management and judgment by banks themselves.
Canada's system does all of the things I mentioned based on values, broad principles and the exercise of judgment and accountability, not with overly stringent rules-based requirements.
It comes down to prudent and balanced governance and management at all levels, by all parties, public and private.
Right now there are some disturbing suggestions that include overly prescriptive rules being put forward in a number of international jurisdictions on how to structure and regulate the global financial sector to prevent further crises and strengthen the system for the future.
Changes must certainly be made and mistakes were made by all of us, but the risks of over-reaction and damaging our return to economic growth are not to be treated lightly.
These proposals must be thought through very carefully because impacts can be significant. We must not try to fix things too quickly, or go too far and risk the probability of unintended consequences in restoring growth to our economies. And certainly for us in Canada, we want to make it clear that while our system can always be improved, it is not broken. The remedies to fix those systems that are broken may not all be appropriate for us.
Going forward, as we rebuild the global financial system and the new regulatory framework, international regulators and policy setters could learn a lot from Canada's example of a system that survived the crisis in good shape. We need to continue to work together to build a strong, stable system and we can and should make improvements in Canada, while being careful not to fix the parts that are not broken.
With this in mind, I'd like to make two broad recommendations.
My first recommendation is that we must ensure collaboration on issues of systemic and idiosyncratic risk among regulators, policy setters and the private sector – and we must allow for big and small financial institutions to fail, but in an orderly and controlled fashion.
Most banks have initiated better risk management, liquidity and compensation policies, however, these are complicated changes and take significant resources, such as senior management talent and extensive systems changes. For example, it requires at least several months to plan, design, communicate and execute complex compensation changes, and because of their complexity, they have not yet been fully implemented by all participants. We implemented changes early this year in our compensation practices in Scotia Capital, but started work on them in early 2008.
Markets, however, have responded much more quickly and in certain markets, indeed, this has created windfall profits for several banks where changes have yet to be implemented. Ultimately, the policies will be implemented and monitored and the result will be a stronger financial framework.
This is especially important in a world of globalization and inter-connectedness, and in a time of uncertainty. The crisis showed the degree to which the global financial system is interconnected. It is critical that all parties involved work together to build a new financial framework that addresses this complex interdependence.
We must address moral hazard in the system. It is an unfair and unsustainable model to privatize profits and socialize losses. Taxpayers should not pay, management should be held accountable and shareholders should bear the risks.
To do this among the other changes, we need the equivalent of a bankruptcy code on an international scale – for inter-connected financial institutions – endorsed and hard-wired into the international legal and prudential framework. This would include large institutions, but also smaller ones with a large degree of interconnectivity.
Size is not the only issue. It is how interconnected they are, as we've seen with the small Icelandic banks.
The mistake made with the collapse of Lehman Brothers is not necessarily the fact that it went under, but that there was no way of ensuring that failure would be orderly and controlled, and there was no legal or multi-jurisdictional framework in place. This has to be improved.
There must now be renewed global co-ordination to ensure that solutions are being applied in a way that creates a level playing field. Regulators, central banks and political leaders all must be conscious of how the rules are being interpreted in all jurisdictions, and beware of quick solutions which can lead to unintended consequences.
In Canada, we can improve by quickly adopting a national securities regulator, ensuring they are part of this collaboration process.
As part of a greater collaboration, the private sector and the accounting profession must also be involved. Regulatory rules have never prevented a crisis and changes should take into account measures already underway by private sector banks, to address problems identified by this crisis.
I've had the honour of leading significant work being done by the Institute of International Finance (IIF), an association representing the world's largest financial institutions, to address private sector best practices in response to the crisis. The financial industry has firmly recognized the need for wide-ranging improvements in business practices, and there has been tangible progress on implementing our recommendations. We will be releasing a report on the progress of these improvements on December 9, 2009 in New York.
Throughout the world, we are seeing a movement towards less leverage, better pricing of risk and liquidity and better governance by global financial institutions.
My second recommendation is that our financial institutions, regardless of any regulatory changes, must ensure a risk culture that includes accountability by all participants, beginning at the top, including checks and balances both externally and internally, and based on sound principles and values.
I've said this before: risk management counts. It's what we as financial institutions should be doing well. And those who do it well are successful, and that's what will define success, and separate the winners from the losers.
At Scotiabank, we've done this well, not perfectly, but well. Canadian banks in general have done it well, and certainly better than most.
At our Bank, we don't think of risk management as a separate division, but rather as a critical part of our entire organization, embedded at all levels, in all business lines, and in all countries. This is how it must be viewed.
We don't think of managing risk as a necessary evil. We think of it as a competitive advantage for our Bank. The better we are at it, the more it benefits us and our customers, employees, shareholders and ultimately the community at large.
We're very proud that consulting firm Oliver Wyman ranked Scotiabank among the Top 10 best performing banks in the world during the worst period of the financial crisis. It doesn't mean that period wasn't a challenging time for us, it's one I don't ever want to go through again, but I think our success speaks to the strong emphasis we've placed on building our risk culture and risk management over many years.
I suggest that it would benefit everyone if others would do the same.
These two broad recommendations I have made are focused on one thing: building a stronger, more resilient financial framework for the future and contributing to the well-being of individuals and to our collective standards of living.
Bankers are not evil, despite what you may have heard, but, mistakes were made. I suggest that when we look at fixing the mistakes and closing gaps which were exposed, we should also look at successes: what worked, why it worked and what we can learn from it.
The world can learn from Canada's example. A good, sound and profitable system like ours is the best defence against further crises, which undoubtedly will come again.
Strong fiscal and monetary policy, balanced regulatory oversight and prudent management policies and judgment by the banks have all played an important role.
Moving ahead, in Canada, we must build upon our strong fundamentals and proven principles and not succumb to using solutions being put forward to fix other systems which were severely broken and which are not appropriate for us.
For our part, at Scotiabank, we will keep working, using our stability and success to improve our practices, to build a better bank, and contribute to strengthening our financial system and our economy. And we look forward to taking on new opportunities here in Canada and around the world.
We understand that we have a role to play in the greater economy. We will continue to work with our customers during this difficult time, especially those in hard-hit sectors. We must continue to provide access to credit at competitive rates and we must work with our customers to grow and seek out the opportunities that exist in the "new norm".
And our regulators and political leaders must continue to work together to do so as well.
Scotiabank is an international company proudly based in Canada, and we have tremendous faith, faith in the people, government and businesses of Canada, and faith in the people and economies in the 50 countries where we operate. As I travel the world, I see that the Canadian brand, the awareness of a true Canadian identity, has never been stronger.
I have every confidence that Canada will continue to set an example for the world and to be an important part of the future success of the global economy in building better lives for all of us. But we – business and government – must seize this unique opportunity.
So yes, Canada, we do have the opportunity to take our place in the world – in banking, in other industries – and as a uniquely Canadian model that has led to a well-managed country based on sound principles and values. This can be our century. Sir Wilfrid was right. His timing was just a little off!