Policymakers need to focus on improving productivity in the Canadian financial industry by enhancing competition and streamlining regulation, according to a brief from the C.D. Howe Institute.

It calls for clarity on bank mergers, the possibility of banks selling insurance, and more efficient securities regulation.

The brief notes that the federal Department of Finance is finalizing its long awaited white paper on plans for financial services legislative renewal, and it expresses the hope that it will address the fact of declining labour productivity in the financial sector.

“Could the white paper set the stage for action on productivity in Finance Minister Jim Flaherty’s own bailiwick? It should, because smartly delivered financial intermediation is extraordinarily important to our economy and a vital policy goal,” it says.

The paper points out that the broad financial services sector is experiencing “surprisingly weak” labour productivity, with five consecutive quarters of declining productivity. “A smartly performing financial services sector is vital to the economy: effective financial intermediation is central to managing the commercial transactions that steer the flow of today’s savings into current investment in houses, plant and equipment, and converting that physical investment into future income,” it says.

One problem, the report suggests, is that Canada’s financial marketplace is not as efficient and effective as it could be. “Unlike manufacturing, much of the sector operates behind protective barriers that dampen competitive forces and may sustain uncompetitive cost structures,” it says. “Laws limit foreign ownership in banking and require large banks’ shares to be widely held, preventing cross-border or cross-pillar acquisitions of domestic firms; they inhibit scale-building domestic mergers; and they limit competition among the sectors’ parts. Federal and provincial financial regulations impose stiff compliance costs within business subsectors. These are serious issues, some portending a future wherein stasis is the prettiest prospect — and stasis is not the same thing as effectiveness or stability.”

The brief points out that Canada’s balkanized securities regulation is all but unique in the developed world, “and perhaps uniquely expensive to sustain and comply with.

“Provinces must explain why they cannot agree on a better plan. Securities issuers, for their part, with Sarbanes-Oxley and Enron Corp. still in the daily headlines, must demonstrate how partial self-regulation will in future guard against what it previously did not,” it adds. “Neither regulatory stasis nor uncertainty over the quality of corporate disclosure helps to steer workers’ savings to their most productive opportunities — which is what efficient financial intermediation is all about.

“Ideally, the white paper would clarify the government’s plans for handling bank merger proposals; reducing political influence within the process will make proposals for productivity-enhancing realignments a brighter prospect,” it says. “The federal plan would also leave the door open to regulatory change regarding insurance distribution; closing out competition before it began would make little sense. While securities regulation is not an issue the white paper will address directly, the federal government could use the occasion to offer provinces tangible rewards for partially ceding their oversight role in securities issuance, as part of a program intended to produce a better functioning economic union.

“Given a minority Parliament — and the fact that this not a field on which any party wants to go down fighting — the white paper is likely to be a tepid, timid, and tentative document,” it warns. “Yet Canadians should have high expectations of their public and private institutions. The Department of Finance could signal its willingness to turn words about productivity into legislative action in its own back yard. A focus on building the financial sector’s competitiveness and efficiency in serving the public marketplace will keep the reform process on track — and help the economy at large better its performance.”