Productivity and the Financial Services Sector – How to Achieve New Heights

Advanced economies must focus on improving productivity in order to achieve long-term sustainable economic growth. Increases in traditional inputs – labour and capital – can only go so far before generating diminishing returns. These economies, such as Canada’s, must then look beyond traditional inputs and seek to increase their productivity through competition and innovation. Financial services have a vital role to play in these efforts. Unfortunately, Canada’s productivity growth has lagged behind that of its international peers for the past 15 years. The financial services sector, with its unique ability to improve its own productivity and the overall economy’s, has also fallen short in contributing to Canada’s overall productivity growth over that period. Improving the financial services sector’s productivity would not only boost its performance, but also that of Canada’s economy as a whole. In this Commentary, we focus on Canada’s financial services’ regulatory framework and its impact on productivity growth through three different channels: competition, attracting capital, and the allocation of capital. Canada’s current regulatory framework has improved over the past decade; however, more could be done to remove regulatory barriers that hamper competition, the progress of innovative firms, and better reflect international best practices. Restrictive regulation and policy hinder productivity growth through their effects on competition, the environment they create for attracting foreign capital, and potential distortions in the allocation of capital. To address these challenges, this Commentary recommends the following: • a flexible regulatory approach that is both function based and proportional to functional risk; • regulatory mandates that include more explicit references to competition as a way of spurring innovation; • monitoring the new rules around the flexibility of banks to participate and invest in fintechs and other innovative technology-led institutions; • improving the collection and sharing of financial market data between federal and provincial regulators; • improving access for small and medium-sized businesses to affordable capital; and • changing the incentive structure so that financial institutions move away from a focus on mortgage lending to one on business lending.