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The relative health of the Canadian banking system has been getting a lot of attention these days. Yves Smith notes with approval the "decidedly retro" nature of the system while referencing a NYT op-ed that praises "The Great Solvent North." On a bigger scale, the Europeans seem to have latched on to the success of Canadian banking system as a guide for banking reform - they may very well use it as a stick with which to beat the Americans over the head while promoting their new joint economic agenda for the G20. Finally, with the World Economic Forum recently ranking it the soundest in the world, the boys of Bay Street have become the envy of the global financial system.

It's easy to understand why. After witnessing the fallout from what happens when the world's largest banks leverage their assets 30-, 40-, or 70-1, some policymakers are positively drooling at Canada's cautious reserve requirements. And if it weren't enough that their levels of market capitalization now rival their major American counterparts, some of these cheeky Canuck banks are still making profit! In a recession!

So why have Canadian banks so far remained (relatively) insulated? From the NYT article:

The five major chartered banks, the few regional banks and handful of large insurance companies are all regulated by the federal government. Canadian banks are relatively constrained in the amounts they can lend. Canadian banks are required to have a bigger cushion to absorb losses than American banks. In addition, Canadian government regulations protect the domestic banks by limiting foreign competition. They also keep banks broadly owned by public shareholders....

The... horror. I think Italy is the only other major industrialized country with such heavy protective measures over its financial community - a factor which also seems to have insulated them from the crisis somewhat. But it's important not to overstate things. The op-ed continues:

Canadian banks are known to be risk-averse, and this has served them well. While their American counterparts were loading up their books with risky mortgages, Canadian banks maintained their lending requirements, largely avoiding subprime mortgages.... The big five Canadian banks... [have] survived the recent turmoil relatively unscathed.

I think those points deserve a few qualifications. First, I don't think the full impact of the US economic collapse has filtered across the border yet: several of Canada's top 5 expanded their operations into the US and so remain exposed to the fallout. Secondly, anecdotal evidence suggests that some of the banks were decidedly less cautious when it came to investing in the subprime market - and their clients are feeling the pain. Finally, it's not clear where future profits are going to come from given the nasty global environment - there are worrying signs already.

So maybe this model has a few blemishes after all. It's also worth noting that many banking execs had been lobbying very hard for Canada to alter its regulatory structure to allow its domestic banks to compete with their international rivals. Their relative failure to achieve this has proved to be their saving grace. But before the Europeans and Americans rush headlong into imposing Canadian-style banking regulations, they should take a good hard look at the social, political and institutional reasons for why those lobbying efforts had limited success - it wont be easy to re-create that environment at home.

But one thing does seem clear: Canada's financial regulators have the eyes of the world upon them. It will be interesting to see how they choose to deal with the new-found attention.

(photos: Mike Manalang's & Mister V's photostream)