Canada: Canadian Banks 2011 - Perspectives on the Canadian Banking Industry

Capitalizing on Opportunities

In a time of accelerating change, Canadian banks have done far more than what's necessary to survive over the past year. As many global banks struggled to regain their pre-crisis position, Canada's Big Six banks leveraged their well managed, well regulated and well capitalized standing to actively pursue their growth strategies. And the effort paid off: the 2010 combined net income of the Big Six was $20.4 billion, exceeding 2009 net income by more than $6 billion and eclipsing the previous record of $19.5 billion set in 2007.

With the events of the past year in mind, we spoke with a number of Canadian analysts and portfolio managers to understand their opinion on what the future holds for Canadian banks. Overall, managing complexity, pursuing growth strategies and transforming through innovation were the overriding considerations to stay competitive. As is often the case, the real challenge going forward is how to execute while many pervasive risks remain.

A clearer path ahead

In last year's edition of this publication, we reported that increased regulation, tighter controls and government intervention in many countries dominated the agendas of the financial services sector. This sentiment continued in 2010: according to PwC's 14th Annual Global CEO Survey, over 80% of global banking CEOs were concerned that overregulation would threaten their business growth prospects. In Canada, despite their strong earnings, banks were also faced with significant obstacles related to economic and regulatory uncertainty. Out of necessity, 2010 ushered in a new era of regulation through global regulatory reform designed to increase both capital and transparency for financial institutions—and provide much needed clarity for the industry.

The recently endorsed Basel III reforms will require banks to retain greater levels of capital and liquidity, as well as higher capital quality. Currently, all of Canada's major banks comply with the attributes of the new rules and meet the initial 2013 targets. But the changes will likely have implications for each bank— potentially impacting profitability and decisions around the mix of business.

At the same time, increased US regulation, such as The Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), will change the way financial institutions conduct business, requiring banks to assess how they operate and manage risks as the rules are defined.

Execution in managing the different and growing regulatory requirements will be critical over the coming years; and management and boards will need to pay significant time and attention to the implications of the changing regulations. As clarity emerges around the way regulations will be devolved, the banks will be able to operate with greater certainty and confidence in those growth strategies that have propelled them into the global spotlight over the past year.

Looking back, how have Canada's banks generated growth? According to one portfolio manager, "Five to six years ago, the Big Six banks looked similar, now they have really differentiated themselves." Looking ahead, where do they go from here?

Last year's events have shown that a number of the Big Six banks are looking internationally to expand their presence and gain precious share in important strategic markets. Announcements of foreign acquisitions dominated the news in late 2010, with banks snapping up smaller players around the world and deepening their presence in countries where they have existing operations. According to one portfolio manager, "the easiest way to play catch-up is to acquire".

Interestingly, Canadian banks' strategies are now starting to diverge, in terms of both geographic and line of business focus. For example, we have seen varying focus on growth opportunities in the US, Latin America, the Caribbean, Europe and Asia For some institutions, capital markets and asset management is the priority, while others are investing more in personal and commercial banking.

In 2010, Bank of Montreal (BMO) and Toronto- Dominion Bank (TD) focused on consolidation in the US by acquiring a number of US banks, including both FDIC transactions and non-bank financial companies in niche markets. With the Canadian dollar holding its strength, we will likely see more expansion into the US, an area that was previously seen as more challenging to penetrate with the weaker dollar and historically prohibitive bank valuations. One leading banking analyst comments: "now is a good a time as any to leverage that into growth opportunities". Overall, the Big Six banks' assets invested outside of Canada and the US ranged from 2% to 26%, with Scotiabank holding the most assets invested beyond North America, largely focusing on Latin America and increasingly Asia.

But, with greater geographic expansion, comes greater global regulations and risks. Navigating political, cultural, economic and regulatory hurdles in international markets is critical for banks to successfully expand in chosen geographies. One analyst says the key to getting it right is "You need to have decent local roots. Local commitment is important, whether it be from a political, economical, [or] social perspective." For many banks, a baseline is a stable political and economic view. Yet, there's also the question of a broad range of macro-economic threats, such as rising public sector deficits and the ability to refinance debt, which could impact both the Canadian economy—and with it, Canadian banks— down the line.

Undeniably, the concern of a double dip recession impacting an already battered US housing market has some analysts and portfolio managers anxious about the impact on Canadian banks with US operations. Decreasing home prices will send more homeowners into negative equity and constrain consumption growth, bringing with it difficulties for banks and their government guarantors.

Domestically, Canada's largest banks continued to focus on their existing profitable operations and product offerings at home to grow their revenues. Many of our interviews pointed to the re-emergence of the wealth management segment as a key area to boost profitability, particularly given the banks' strong control over distribution channels and changing demographics. The importance of savings and retirement planning will become more significant as baby boomers near retirement and life expectancies increase. Not surprisingly, 2010 saw a number of acquisitions in the wealth management space; however, the number of independent players left in Canada are few, which could drive the banks to explore opportunities outside the country, particularly to those regions where similar demographics and opportunities prevail.

When it comes to domestic personal and commercial banking, undoubtedly an interesting year is before us. While a significant amount of the banks' earnings growth in 2010 was driven by consumer spending and increased borrowing, debt levels are currently at all-time highs in Canada. According to Statistics Canada, household debt in Canada surpassed the US for the first time in 12 years, with a debt-to-income ratio of 148.1% compared to 147.2% in the US. At the same time, with recent government announcements around clampdowns on the insurable mortgage market, changes are afoot that will dampen consumer enthusiasm for debt.

According to PwC's Consumer Lending Survey, out of over 600 Canadians, 67% are comfortable with their debt level, yet most (64%) intend to decrease this debt over the next 12 months, primarily by cutting back on, or deferring large-ticket items such as autos, home electronics and housing upgrades. As customers' willingness to spend and borrow decreases, by necessity, so too will the banking sector's earnings growth in these areas.

Some banks are focusing on strengthening their core consumer offerings, while others are expanding their product lines into other areas, such as integrated lending products. The fallout from the financial crisis is giving cause for banks to steer back into debates with regulators to re-enter the auto leasing space, an area that was previously off limits, yet could expand the banks' product offerings and be generally favourable to the market.

Several analysts also believe that increased foreign interest for Canadian companies, particularly in Alberta and the resources sectors, will boost banks' revenues from mergers and acquisitions (M&A) activity. "Our economy has done well to attract foreign investment. When you think of the pace and the role Canadian banks will play in M&A activity, it's a positive catalyst," says one banking analyst. The recent proposed merger of the TMX Group (which operates the Toronto Stock Exchange) and the London Stock Exchange Group would create the largest venue for global listings for natural resources, mining, energy and clean technology. This is a testament to the attractiveness of the resource sector and the place it plays within the Canadian capital markets.

With this heightened focus on business, analysts and portfolio managers see the commercial and small business segment growing at a faster rate than personal banking. PwC's Global CEO Survey indicates that half of Canadian CEOs and 48% of global CEOs surveyed said they were "very confident" for growth in the next 12 months. Longer term, 95% of Canadian CEOs are confident for growth three years from now, similar to their counterparts from other countries (94%). This confidence could chalk up to bigger profits for banks as Canadian businesses begin to realize their growth aspirations and turn to the country's strongest source of capital to help get them there.

Driving the innovation engine

As the consumer and business world continues to evolve, innovation is becoming imperative for banks to move forward. One banking analyst comments: "we have to grind forward and grow our business, prove ourselves in this new environment". Innovation is critical to help cut costs; respond to changing consumer and business expectations, particularly among different generations; and create the agility needed to compete. And, the industry couldn't agree more: according to our recent Global CEO Survey, 87% of banking and capital markets CEOs surveyed believe that innovations will lead to operational efficiencies; and 64% also believe that their IT investments will help them tap into new marketing and transactional opportunities.

So, what's driving innovation? Operationally, Canada's banks are looking inwards at the costs of their networks to make sure they're running as efficiently as possible while still delivering the best customer experience that exceeds expectations. Outsourcing has long been a reality, and labour arbitrage and service effectiveness continue to be the main catalyst in sending core operations outside of the organization. But, other innovative models to acquire scale benefits or drive revenue are still evolving. For many banks, co-sourcing and joint ventures in areas of operation where they don't compete (based on product or client service) are emerging. New global centres of excellence focus on streamlining service, while creating a new reality in efficiency and effectiveness. Increasingly, such centres are popping up at those banks with broad geographic footprints to leverage time zone differences, skill and labour in critical markets to achieve scale-back benefits and efficiencies.

The quick pace of new, emerging technologies is an imperative as Canada's banks approach innovation with an emphasis on customer experience. More and more clients are looking to interact through mobile and digital technologies, such as smart phones and tablets—and expect their bank to be onboard. Just as we saw Canadian banks welcome and promote innovation through the online experience some 15 years ago, today they're investing in new digital technology and applications to improve the customer experience across all channels in a very integrated manner—branch, web, call centres and mobile banking. For example, many banks are enabling their mobile workforce with sophisticated tools. Whether it's an investment advisor or a commercial banker, providing on-site and on-demand advice using digital devices is becoming the new battlefield for many segments. Further, all of the Big Six have launched innovative applications to help clients put banking at their fingertips, where we are really still in the early stages of this evolution.

Social media is spreading as a critical dimension to appeal to various segments of the banks' client base, particularly Gen X and Gen Y customers. Many banks have tapped into the root of what social media means to the community, pursuing strategies (through such tools as Twitter, Facebook, YouTube and LinkedIn) to directly communicate with clients: to recruit; build product awareness and start dialogues; showcase philanthropy; run contests and promotions; and, most importantly, create loyalty among the individuals following them. It is also breaking new ground in how banks report their earnings. Traditional annual reports presented only in a PDF format may soon be a thing of the past, as new interactive reports that incorporate video from bank executives, allow visitors to share content and are compatible with mobile devices create a fresh, unique experience for users. The time to take advantage of this captive—and ever expanding— audience is now; we have no doubt only seen the beginning of how banks plan to unleash the power of social media.

The evolving payments industry is also certainly top-of-mind, as customers and businesses alike demand more consumer-friendly payment options. For some this means opening up the doors to involve partnerships with other providers; others are looking inwards to upgrade their existing technology. Looking ahead, all banks will need to continuously reconsider how they can make these new technologies an integral part of their multi-channel strategy and if their legacy platforms can support innovation—or risk having their customers use alternative service providers.

When compared to historical levels, banks globally face a future of greater capital requirements, more liquidity and less risk taking. Canadian banks are in an enviable position compared to their global peers to continue to actively pursue their growth strategies, while navigating through regulatory reform. Just as we've seen with the positive results of the Big Six banks over the past year, there are opportunities for those who anticipate how business is changing and creatively search for value. The most successful banks are likely to be those that can make the most of their principal competitive strengths and focus on innovation to drive growth and efficiency further.

Want to learn more?

Visit and view our short video on the direction Canadian banks are taking.

Key banking and capital markets findings from the 14th Annual Global CEO Survey

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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