Canada's 'old-fashioned' banking conservatism now envy of the world

VISITS BY US presidents to Canada have traditionally been pro forma affairs. But before setting off on his first foreign trip as US president this week, Barack Obama said the performance of Canadian banks – alone among those of the Group of Seven (G7) nations in not receiving a government bailout – was “striking”.

“Canada has shown itself to be a pretty good manager of the financial system in the economy in ways that we haven’t always been here in the United States,” Mr Obama said.

Mr Obama spent Thursday in Ottawa meeting Canadian prime minister Stephen Harper to discuss the economy, trade and the environment, in addition to any talk surrounding the strength of Canada’s banks.

In large part because of their conservative banking culture, one that depends heavily on a vast and stable retail branch network, Canada’s banks have remained the strongest in the G7 and, according to an October report by the World Economic Forum, the soundest in the world. “In Canada they do it the old-fashioned way, where when you need money you go to the bank and they review your file and they will lend you no more than 75 per cent of the value of your house,” says Laurence Booth, a finance professor at the University of Toronto.

“Canada is a more conservative place and, as much as it limits growth in good times, that approach pays off when others begin a race to the bottom.”

In Canada, five banks – the Royal Bank of Canada (RBC), Toronto-Dominion Bank, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, and the Bank of Montreal – largely control the market through thousands of branches across the country, forcing geographic diversification on a scale generally not found in the US. Canadian investment banks, as part of commercial banks, are more tightly regulated and kept in check by the main banks, which would pay a price for unwise investing.

In the US recently, investment banks such as Merrill Lynch have been brought under the wing of commercial banks. With moves such as this, the US is moving towards a Canadian model.

The Canadian government reregulates its banks every eight to 12 years, compared with the US system of decentralised regulation.

Canadian banks have not been immune from the turmoil, but their value has fallen less than that of their US counterparts.

Among North American banks, all five big Canadian banks rank in the top 15 in market value. One, Toronto-Dominion, has risen from 30th two years ago to sixth.

Toronto-Dominion and RBC are among only seven banks worldwide that still carry a Moody’s triple-A credit rating.

Since October, Canada’s five biggest banks have bolstered their balance sheets by raising nine billion Canadian dollars (€5.7 billion) in common equity and preferred shares.

These distinctions have cast growing attention on Canada’s system, especially from the US.

Paul Volcker, former US Federal Reserve board chairman and a close adviser to Mr Obama, is pushing for a regulatory regime similar to Canada’s model.

“It’s interesting that what I’m arguing for looks more like the Canadian system than the American system,” Mr Volcker said in a speech in Toronto.

Canada’s banks have not escaped the downturn entirely. A debate has erupted on whether the banks might be forced to cut dividends – something not done since the 1930s. Dividend yields are about 7 per cent, their highest in 24 years, suggesting investors are bracing themselves for cuts.

The banks paid out 76 per cent of their earnings in dividends last year, compared with an average of 42 per cent over the previous decade. The picture may become clearer next week when the banks begin reporting earnings for the quarter to January 31st.

Government support has so far consisted mainly of providing liquidity through regular auctions for high-quality mortgages held by the banks and other mortgage lenders. The authorities have also raised the limit for preferred shares qualifying as tier-one capital. But the government is amending legislation to allow it to inject capital into troubled institutions, if necessary.

The banks have so far resisted help. – ( Financial Timesservice)