Brian Milner, a Toronto Globe and Mail Report on Business columnist, reported today on Boston University Professor Williams’ positive comments on Canadian banks and regulatory system. According to Williams: “What I find so fascinating about Canada is the fact that throughout the whole system, not just the oversight system, not just the bank executives themselves, but also the customers, there is risk aversion.”

Perhaps, risk aversion is one of the main reasons Canada continues to lag behind the U.S. in productivity growth and competitiveness.

Williams did add that the banks have “a propensity to get themselves in trouble” and the financial crisis was “basically caused by very low credit standards and cheap capital laced with lots of toxic derivatives.”

Canadian banks, while they may have avoided the worst of the recent crisis, more by luck than design (they did not invest much in EU country sovereign debt, and a sub-prime mortgage market did not develop to the same degree as in the U.S. – but remember the Asset Based Commercial Paper debacle), have had their share of getting themselves into trouble over the years. They have not been immune to setting low credit standards, especially for large corporate customers, and losing billions as a result. Furthermore, they have been willing to bet part of their balance sheets to get underwriting and advisory assignments. Indeed, Canadian banks probably showed their U.S. counterparts the advantages of merging investment banking and retail banking to strengthen their investment banking presence.

Central banks were responsible for cheap credit. In hindsight, it appears that they kept rates too low for too long between 2003 and 2006. They face a similar conundrum today: when should they begin to raise rates and how quickly? There is no easy answer.

But cheap credit by itself should not have precipitated the financial crisis. Low credit standards combined with the blind pursuit of extra yield and more fees were the toxic ingredients.

Williams strongly believes in the need for a strong risk overseer for the banks. Indeed, he advocates an international risk overseer for the entire global financial system. “The crisis showed that when field examiners fail in their duty of early detection, banks quickly can overdose on risk.”

An interesting proposition, but it falls flat for two main reasons. First, why would a regulator be better able to assess credit risks (consider the experiences of the credit rating agencies during the financial crisis) than banks? And why would a regulator be better able to spot problems than banks?

Second, what about the failings of corporate governance? Where were the boards of directors, and why do they allow their banks to get into trouble?

The people who run banks are as prone to the herd instinct as anyone else. So when one bank appears to have found a new elixir to make money, the others are bound to follow. Further, these same people also have the hubris to believe that they are smarter than everyone else, and thus they will be able to steer their banks away from trouble and get out before the bubble bursts.

A risk overseer is not going to be able to spot the problems early enough to force the banks to correct them with minimal damage. Once the problems materialize en masse, and given the interconnectedness of the banks, the correction becomes very painful and threatens the financial system as a whole.

Diligent boards (an oxymoron) can play a more useful role in acting early. Unfortunately, they seem to be lacking. As I have said before, CEOs do not like to be second-guessed by their directors.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.