Canadian banking results haven’t just been good, they’ve been spectacular. Can the trend continue or are banks being too greedy?
By Don Pittis
Mar 01, 2017
The profits announced by Canada’s banks over the last week have been nothing less than astounding.
Whether the banks can keep on doing well matters to all Canadians, but are they being greedy?
Yesterday the Bank of Montreal said it had made about $1.5 billion in three months.
That may be hard to put in context until you hear that it is an increase in profit of nearly 40 per cent from the same period last year and dramatically higher than stock watchers had been expecting.
The big banks tend to take turns being the biggest winner in any given year, and some take brief stumbles, but year after year Canadian banks have been persistent money machines.
After such a long period of success, it is reasonable to ask how long the banking boom can last.
What’s good for the banks …
There are a number of reasons why it matters.
RBC is the largest component in nearly every Canadian retirement fund and mutual fund portfolio.
A glance at the Canadian stocks in the Canada Pension Plan portfolio show the banks as the biggest holdings.
If personal greed isn’t enough to convince you, there are at least two more reasons to wish the banks well. One is that like mining, banking is one of Canada’s globally acknowledged successes.
Our banks have stakes in other countries around the world, from RBC’s banker to the stars serving the international one per cent, to Scotia’s presence in the Caribbean and Latin America. Rather than softwood or oil or copper, they export services.
The other reason to be happy about the success of banks is that they are an indicator of Canada’s economic health. If banking is sick, watch out for your job.
There are some good reasons why Canadian banking is ready to keep booming, including an expected rise in interest rates. In general, retail banks do well when rates go up.
“Absolutely, because banks’ business model is to have the interest rate difference between the deposit rate and the lending rate, and when the overall interest rate is higher there is just more room to make a profit,” says Kai Li, finance professor at UBC’s Sauder School of business.
Selling banks short
Li says recent reports that international investors were shorting Canadian banks — the financial equivalent of betting the shares would fall — were mostly based on fears of non-performing loans in Canada’s oil and gas industry as oil prices crashed from $100 US in 2014 to less than $30 a barrel last year.
Now that oil prices are back above $50, the danger of wholesale defaults on huge portfolios of energy loans no longer hangs over the banks, says Li.
A remaining hazard for banks’ finances, says Li, is “the risk on their mortgage portfolio,” something the banks seem to be taking seriously.
This month BMO issued a stern warning of a bubble in Toronto area real estate. In an interview with the Financial Post, Royal Bank CEO Dave McKay added his own warning, calling the market unsustainable and in need of regulation.
Because of CMHC mortgage insurance, the banks are sheltered by the taxpayers from the brunt of any property decline, but as we saw in the U.S., when a property bubble pops, the entire economy goes sour.
Sofia Johan sold her property in the United States just before the 2007 bubble popped and bought here in Canada. Now a banking regulation expert at York University’s Schulich School of Business, Johan says such a meltdown would hit the Canadian economy hard.
However, she thinks Canadian banks have the depth and diversity to withstand a property crash better than the U.S. banks did.
Risk and greed
In the near term, Johan says, Canadian banks stand to benefit financially as the Trump administration cuts banking regulation, “if they act in the correct manner, i.e., not taking on too much risk.”
She worries cuts to regulation could start a new financial frenzy that could end badly. That would be a risk for Canadian banks even if they don’t participate in the worst excesses.
Contrarian market watcher Benj Gallander, president of Contra the Heard, says we have returned to “a pretty greedy time” in banking right now.
“They should be … loyal to their employees,” he said.
“When they are making so much money, I think what they should be looking to do is pay down some of their debt so that when the hard times really hit, things will be more stable.”
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