Canada’s banks are Stumbling Giants.
Book excerpt, Page A11
Canadian banks continue to deliver strong returns. But as Patricia Meredith and James L. Darroch write in their book Stumbling Giants, the status quo can’t last. This is the fourth in a series of excerpts from this year’s nominees for the Donner Prize, a $50,000 award for the best public policy book in Canada. The winner will be announced May 15.
Canadians take justifiable pride in having one of the world’s most stable banking systems. But they are tired of high fees, poor service and products that fall short of their needs. According to a recent study, 75 per cent of Canadians are unhappy with their bank.
The banks have also exhausted most of the growth opportunities from their traditional lending business. Consumers are heavily in debt and cannot afford to borrow more, especially given that interest rates may start rising again. With the introduction of computerized credit scoring in the 1990s, Canadian banks’ skill in pricing riskier loans has atrophied to the point where they no longer show much interest in providing small and mid-sized companies with the capital they need. In any case, the tighter capital requirements introduced since the financial crisis have lessened the attraction of this type of lending.
Growth in the banks’ wealth-management business will also remain anemic. Their customers are unlikely to save much in future years without innovative new investment products and services that deliver the 3.5 per cent real returns that Canadians need to afford a comfortable retirement and educate their children. If American money managers can deliver such returns, why can’t their Canadian counterparts?
New regulations that force banks to disclose their sky-high fees will provide another incentive for their customers to look elsewhere for portfolio management and advice. The banks’ wealth-management business is vulnerable to low-cost disruptors, such as Blackrock and other ETF distributors and tactical asset allocation funds, not to mention robo-advisers.
As for the lucrative payments business, technology companies are sure to keep chipping away at the banks’ private networks, in the process eroding their huge profit margins. As Brett King observed in the subtitle of his book Bank 3.0, “Banking is no longer somewhere you go, but something you do.” It is far more convenient, faster, and usually cheaper these days to use a mobile device to make a payment, transfer money, apply for a loan, or trade securities than to trek to a bank branch.
Retail banking in Canada, with its 40 per cent return on equity, is far too attractive a business for an ambitious financial services entrepreneur to ignore. In this sense, the banks have set themselves up to become the victims of their own success.
Canadians still need banks, at a minimum to protect their savings, provide home mortgages, fund loans to small and mid-sized businesses, and support the capital markets for investors and large corporate and government issuers.
The banks will always play a key role in helping the Bank of Canada execute its monetary policies. Nonetheless, this book’s central theme is that change is long overdue for the banks and the rules that govern them.
Boards of directors and long-term investors must force banks to invest in innovation. Government policy needs to find a better balance between stability and innovation. Marketbased lending and bank financing for businesses must be encouraged, perhaps with government inducements. The burgeoning array of fintechs, large and small, must have easier access to a modern payments system to spur competition and innovation. Tighter regulation in other areas, such as fuller disclosure of investment management fees, an expanded Canada Pension Plan, and a much stronger Financial Consumer Agency of Canada, will help Canadian consumers take advantage of cheaper alternatives to grow their retirement savings and manage their transactions.
Finding the common ground necessary to ensure that Canadians continue to benefit from a safe and secure banking system is good for us all.
The trouble is, the chances that the Canadian banks will carry out such a farreaching transformation without a push from their stakeholders are not much higher than zero. Regulators are focused on protecting the status quo. Investors and analysts expect the banks to churn out quarterly earnings growth to justify their share prices. Senior managers — and many other employees — receive bonuses based on meeting those earnings targets. Most employees also own shares in their bank, either directly through stock options and deferred share units or indirectly through pension and mutual funds. It is clearly in their selfinterest to work as hard as they can to meet those short-term targets, and — to paraphrase Chuck Prince, the former Citibank CEO — “to keep dancing until the music stops.”