Abstract
This section provides a detailed analysis of the regulatory environment of the Canadian Banking sector, and the risks inherent to the financial sector. The 2007/08 global financial meltdown caught many financial institutions in developed markets unawares. The crisis led to the liquidation of many banking institutions, especially in the USA and other parts of Europe. However, the Canadian banking system remained resilient to the negative shocks, as no single bank in the country was bailed out or experienced risks of failure. The resilience of the Canadian banking sector portrayed the strength of its regulatory environment. Although the crisis did not hit the Canadian banking sector with the same adversity is did to their US counterparts, it underscored the importance of regulation and surveillance of the banking system. The Department of Finance and the Office of the Superintendent of Financial Institutions are responsible for the supervision of the banking system in Canada.
The Canadian banking sector is regulated by stable laws, which ensures fair play, prudence in financial management, and adherence to all financial regulations. The stability of a financial system is demonstrated by the strong performance of institutions within the system (Canadian Bankers Association, 2016). This means that the financial performance of Canadian banks should reflect its stable regulatory environment. As such, it is imperative to analyze the financial performance of major Canadian banks in relation to their US counterparts. The following table presents returns on equity ROE of 5 top Canadian Banks and 5 top US banks for the year 2014.
The table indicates the performance of Canadian Banks compared to their USA counterparts. According to the chart, Canadian Banks outperformed US banks regarding returns on owners' equity. Whereas the US top five banks reported an average of 8.98% return on equity, top five Canadian banks recorded substantial 18.37% returns on equity on average. This might imply that the regulatory environment in the Canadian banking sector is stable and favorable, as banks have the opportunity to develop good strategies for improved performance (Baron, 2013).
Competition in the Canadian Banking Sector
Another aspect the depicts efficiency in a financial system is the nature of competition. The nature of competition is also determined by the concentration ratio. According to Reinhart and Rogoff (2013), Canadian banking market is highly concentrated. For example, the largest six banks in the country account for over 90 percent of assets in the banking market (Bowman, 2012). Canada has a total of 20 domestic banking corporations. This indicates that the market is moderately competitive. On the other hand, the US has thousands of banking corporations, with the largest three banks accounting for 32% of the market share. This implies that the market in the US is concentrated. Using the Herfindahl-Hirschman concentration index, the Canadian market is highly concentrated, as it recorded >0.2. This is relative to the U.S. Banking market, which as a <0.08 Herfindahl-Hirschman concentration index. The high level of the concentration index in the Canadian banking sector implies that the industry is strictly regulated (White, 2014). According to Bowman (2012), the banking sector is subject to heavy regulation, which allows for fair play and safeguard of depositors’ wealth. The international banking regulation frameworks, such as the Basel I and Basel II, applies to Canadian Banks (Reinhart & Rogoff, 2015). This is the reason there is a high concentration in the market.
Even though the banking system in Canada prides itself as sound, there seems to be profitability discrepancy between banking institutions in Canada and their counterparts in the USA. There is stable regulatory environment in the Canadian Banking system. The 2007/08 global financial crisis led to many banking corporations in the United States and Britain collapsing or getting bailouts from their respective governments. Canada was one of the few developed markets that did not experience adverse effects on its financial markets. Studies indicate that no single bank in the country requested for a financial bailout (Canadian Bankers Association, 2016). In 2015, the World Economic Forum named Canada’s financial system as the most sound in the world for eight straight years. The strengths and stability of these banks indicate tight regulatory environment, which ensures that only the required operations and transactions are engaged by these banks. Nevertheless, it is paradoxical to learn that banks in the United States make more money than those in Canada, despite the stable operating environment in the latter. Poor regulatory environment in the United States, relative to Canada, allows a few banks to take advantage of information asymmetry and make significant money (Reinhart & Rogoff, 2015). However, not all banks in the country can penetrate the regulatory loopholes and make such substantial money (Guidara, Soumaré, & Tchana, 2013). This is the reason a few banks can command a substantial share of the market. Inadequacies in the regulatory environment led to the development of the bubbles in the real estate market, which ultimately burst to spur the global financial crisis (Walks, 2014). Conversely, in Canada, a combination of prudent regulatory environment, strong underlying credit fundamentals, sound fiscal policies, and stability in the real estate market contributes to the superior operating environment for banks.
Strategies of Big Five
Sound strategies have contributed to the stability of the Canadian banks. Aggressive strategies planning and implementation have led to the establishment of five strong banks in the Canadian financial system (Guidara, Soumaré, & Tchana, 2013).
Market Position
As at 2015, the five banks in the country accounted for over 90 percent of the market share. Royal Bank of Bank accounted for 30 percent of the total market share and thus becoming the largest bank by asset base. This was followed by TD at 20 percent market share, Bank of Nova Scotia with 15 percent, and CIBC with 12 percent of the market. The commercial banks engage in active growth strategies, as they have significantly expanded their territorial reach over the past decade.
Source: Financial Post
Wealth Management
Another growth strategy pursued by the top five banks in the country relates to efficient wealth management. Banks’ main source of resources is customer deposits, physical capital, and labor. It is interesting to note that Canadian banks are not legally allowed to acquire each other. This is a measure by the regulatory environment to increase concentration my limiting concentration (Guidara, Soumaré, & Tchana, 2013).
The Royal Bank of Canada has increased its wealth management aggressively over the past decade. The effectiveness of its wealth management has contributed to 11 percent of its profitability in the past two years (Greenwood, 2014). RBC operates in a low-risk environment, and thus requires limited capital. The Toronto-Dominion Bank has also strived to expand its domestic operations through efficiencies in its wealth management strategies. TD’s largest source of wealth comes from effective management of customer deposits and domestic lending. In 2015, TD attributed 90 percent of its profit to taking customer deposits and making loans (Greenwood, 2014). Another wealth management strategy implemented by TD bank is active participation in the capital markets. The CIBC has more assets in the domestic markets, and participates in the domestic real estate market. However, CIBC is exposed to substantial risks emanating from the volatility in the housing market. The bank must diversify its wealth management strategies to reduce risk exposure. Like CIBC, the Bank of Montreal has its wealth in the domestic deposits and real estate markets. The bank uses customer deposits to make loans and invest in the housing market.
Global Strategies
The top five banks in Canada have established their operations in both the domestic and regional markets. The Royal Bank of Canada has used its cautious strategy for expanding its operations globally. Them bank is seen as a truly global capital markets participant. Even though the bank is one of the largest investment bank globally, it is exposed to stricter regulatory environment in its domestic and regional operations (Greenwood, 2014). Toronto-Dominion Bank has a sound global expansion strategy. There is evidence of the banks operations in the U.S. TD has potential to realize significant growth in the US market because of the improving economic conditions in the foreign market. However, the bank will have to overcome stiff competition and slim profit margins in the U.S. BMO implemented a strong global strategy by entering the U.S. market through he acquisitions of Harris Bank in 1984 (Greenwood, 2014). In recent years, the Bank has made various acquisitions in the U.S., including Marshall & ILsley in 2010. Lastly, the Bank of Nova Scotia is perhaps the largest bank with significant international appeal, of the five big banks. BNS has operations in more than 55 countries, including Europe, Latin America, and Asia. International wealth management contributed $327 million in profits for the bank during the first quarter of 2015 (Greenwood, 2014).
Market Strategies and Success of Canadian Banks
Market strategies are important for the Canadian banking system as it has allowed banks to stabilize their operations. The regulatory environment in Canada is restrictive of malpractices in the investment and growth decisions of the banks (Longworth, 2014). This ensures that the interests of depositors and owners are balanced and protected. The concentrated market and efficient wealth management allows the system to increase its stability and thus shield the banks from negative shocks.
List of References
Baron, J. R. (2013). How regulating risk and eschewing competition can ameliorate a global financial crisis: Canada's perspectives and experiences. The Antitrust Bulletin, 58(4), 597-615.
Bowman, M. (2012). U.S. vs. Canada: How the big banks stack up. The Globe and Mail. Retrieved 1 March 2016, from http://www.theglobeandmail.com/globe-investor/investment-ideas/number-cruncher/us-vs-canada-how-the-big-banks-stack-up/article5510258/
Canadian Bankers Association, (2016). Global Banking Regulations and Banks in Canada. Cba.ca. Retrieved 1 March 2016, from http://www.cba.ca/en/media-room/50-backgrounders-on-banking-issues/667-global-banking-regulations-and-banks-in-canada
Greenwood, J. (2014). The 5 different ways Canada's big banks hope to squeeze out more profits. Financial Post. Retrieved 2 March 2016, from http://business.financialpost.com/news/fp-street/the-5-different-ways-canadas-big-banks-hope-to-squeeze-out-more-profits
Guidara, A., Soumaré, I., & Tchana, F. T. (2013). Banks’ capital buffer, risk and performance in the Canadian banking system: Impact of business cycles and regulatory changes. Journal of Banking & Finance, 37(9), 3373-3387.
Longworth, D. (2014). Strengths and weaknesses of Canadian financial regulation before and after the global financial crisis. Journal of Banking Regulation, 15(3-4), 277-287.
Reinhart, C. M., & Rogoff, K. S. (2015). Banking crises: an equal opportunity menace. Journal of Banking & Finance, 37(11), 4557-4573.
Walks, A. (2014). Canada's housing bubble story: Mortgage securitization, the state, and the global financial crisis. International Journal of Urban and Regional Research, 38(1), 256-284.
White, E. N. (2014). The regulation and reform of the American banking system, 1900-1929. Princeton University Press.
