Significant flaws in the organization of the U.S. banking system are responsible for the financial crisis, University of Toronto professor of finance Laurence Booth said on Friday.

Speaking at the Accounting Standards Board Oversight Council’s meeting, Booth explained that the Canadian banking system is inherently healthier than its U.S. counterpart for numerous reasons.

“At the core of all this is the banking sector,” Booth said.

Key problems with the U.S. banking system include the branching system, which has historically restricted branching beyond one state.

“They’ve had too much concentrated geographic exposure,” he said, explaining that Canadian banks are much healthier as a result of their geographic diversification across the country.

More flaws exist in the American regulatory system. While Canadian bank regulations are reviewed every 10 years, U.S. regulations have no such review process, according to Booth. Furthermore, the existence of both the Controller of Currency and the Office of Thrift Supervision creates competing legislation in the United States, he said.

“There are essentially two regulators,” Booth said. “Banks can almost choose between which of the U.S. organizations they want to be regulated under.”

Lastly, Booth said interest rate controls are lacking in the United States. While nearly all money in Canada flows through the banking system, the American system has seen the major investment banks play a much more significant role.

“The investment banks controlled the capital markets, they controlled the money markets—this intermediation of funds should have gone through the banking system,” he said.

The structure of the American banking system is abnormal compared to Canada’s system and others around the world, and does not operate in a way that would naturally arise under normal controls and a competitive marketplace, Booth said.

Efforts by both the Bank of Canada and the Federal Reserve have played an important role in easing the financial crisis, but more must be done by the U.S. government, Booth said. He believes the U.S. government must inject more money into the banking system.

“That’s the only thing that’s going to restore confidence in capital markets,” he said.

The Troubled Asset Relief Plan, Booth noted, is crucial to shore up bank capital and keep the banks solvent.

“It’s an investment package designed to make sure the U.S. banks don’t fail,” he said. “You cannot allow the financial system to collapse. The big banks are too critical to fail, they’re too critical in terms of the functioning of the economy.”

Booth noted that the lack of details released regarding the second part of the TARP package was disappointing to capital markets, sending stock markets down sharply this week.

In terms of accounting-related issues at play in the financial crisis, University of Toronto accounting professor Gordon Richardson said fair value accounting is not working effectively.

“Fair value accounting isn’t working, and I don’t think disclosure is working,” Richardson said. He added that banks have hid their losses through the use of fair value accounting.

In order to achieve a more effective system, Richardson argues that standards must be rewritten. “The writedowns aren’t timely enough, and there’s a lack of transparency.”

Booth added that the use of mark-to-market accounting has been problematic for financial institutions in recent months.

“I believe in mark-to-market accounting, except in crisis,” he said. “We’re in a crisis.”

IE