Hot! Canadian banking can still learn from the U.S. – Business
Published On Fri Apr 30 2010.   Jordan Eizenga, Special to the Star

It’s clear: Canada has supremely well-run and well-regulated depository institutions. So much so that the World Economic Forum has identified the Canadian banking system as the best in the world.

The Big Five Canadian banks have emerged from this financial crisis in much better shape than their American counterparts, which is one reason for Canada’s comparatively quick return to economic growth. Sound, intelligently regulated banks allow for efficient allocation of capital.

That being said, there’s a small, mission-driven sector within America’s vast banking and financial system that remains in under-supply in Canada: Community Development Financial Institutions, or CDFIs for short.

Broadly speaking, CDFIs are U.S. Treasury-certified, specialized financial institutions that serve low income households and economically distressed regions. They range from institutions with as little as a few hundred thousand dollars in assets to those such as Chicago based Shore Bank, which has an asset base in the billions. To be classified as a CDFI, a financial institution must meet several criteria that demonstrate a commitment to community and economic development, as well as a genuine desire to expand affordable financial products and services to low-income, underserved populations.

The social bent of CDFIs means that, when compared to more mainstream financial institutions, they are more likely to work with their delinquent, low-income borrowers, rather than call the borrower into default. Doing so can often save a borrower from cancelling the construction of a charter school or an affordable housing project in a poor neighborhood.

The fact that CDFIs lend locally and often know their borrowers personally helps explain why they are able to lend in small increments to high-risk borrowers without generating decreasing returns to scale (a fancy way of saying that the incremental cost of underwriting a given loan exceeds the likely return on that loan).

Since the creation of the U.S. Treasury’s CDFI Fund program in 1994, a large, well-coordinated network of more than 800 like-minded institutions has developed, each aiming to expand the number of people able to participate in the ownership society. The benefit of this network is that the government is able to stimulate hard-to-reach parts of the market by providing equity capital to these financial intermediaries, who in turn originate affordable loans to low-income borrowers.

It would take a substantial and costly effort for any government to be able to underwrite the number and kind of loans CDFIs are able to. Over the past 15 years, $1.13 billion in equity capital have been disbursed to these institutions. This may not seem like much, but when one considers that most of these funds are leveraged with private money, the impact of such efforts is substantial.

This leads me back to Canada, whose financial system primarily consists of five big, supermarket banks. With a small number of large financial institutions dominating lending activity, the need for alternative lending streams for those at the margins is evident. If you are poor and you cannot get a loan from one of the Big Five, chances are you are out of luck.

The major government-led initiative that does exist, Business Development Canada, is primarily aimed at providing favorable financing to tech-heavy and export-oriented businesses, neither of which is likely to serve or be owned by low-income individuals. The philanthropic and non-profit organizations, such as the Canadian Community Investment Network and the National Aboriginal Capital Corporation, that actually serve low-income clientele, lack the requisite ongoing public subsidization to sustainably reduce their cost of capital.

The point is that there are no public-private initiatives in Canada that adequately aim to provide affordable credit to the poor and help the unbanked open deposit accounts. A Canada-made, government-backed CDFI network would have a serious impact in aboriginal communities and low-income urban centres such as Toronto’s Regent Park and parts of the east side of downtown Vancouver where economic development (and not merely philanthropic activity) is needed.

Such a network would not only tap into an under-served market, but would provide resources to enhance the capacity of existing institutions and create the incentive for social entrepreneurs to create new ones. At least in this respect, the American banking system is one up on Canada’s.

Jordan Eizenga, a native of Ontario, is a Hamilton Fellow in the Department of the Treasury in Washington, D.C. A dual citizen of Canada and the United States, he holds a master’s degree in public administration from Cornell University.

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