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Canadian bank stocks not as safe as we think

IAN McGUGAN OPINION

Investors would be wise to consider the prospect of a future in which the institutions don’t churn out market-beating results regularly

Canadians are used to thinking of bank stocks as a safe, nearly guaranteed way to bet the market. They may want to think again.

The international evidence suggests that banking is becoming riskier and less profitable. While Canadian banks have been extraordinarily successful during the past two decades, it’s questionable how long they can continue to be an exception to the general malaise in the global financial sector.

Investors would be wise then to consider the prospect of a future in which Canadian banks no longer churn out market-beating results with clockwork regularity.

If this happens, it would mark a major change from the world many of us take for granted. From March, 2003, until today, the five largest Canadian banks rewarded their shareholders with total returns, including dividends, of between 9 and 11.7 per cent a year.

Those are eye-popping results. What is even more remarkable is that every one of the Big Five managed to perform better than the broad Canadian stock market. There were no failures, no disasters, no horrific underperformers.

An investor could have picked any Canadian bank stock and done just fine.

Why were Canadian banks so utterly and consistently wonderful during this two-decade stretch? It’s not entirely clear, but their sterling performance stands out from their international peers.

In the United States, Britain and the euro zone, investing in bank stocks was an exercise in masochism over the past 20 years. To be sure, a substantial part of this subpar international performance stemmed from the 2008 financial crisis, when seemingly solid institutions such as Bear Stearns and Wachovia in the United States and Anglo Irish Bank and Northern Rock in Europe blew up over the course of a few months. But international banks haven’t staged much of a bounceback even as the financial crisis has faded into history.

Major European banks such as HSBC Holdings PLC, Banco Santander SA, Barclays PLC and Deutsche Bank AG have staggered from one problem to another over the past decade while generating mediocre profits and little, if anything, in the way of share-price gains. The recent forced takeover of Credit Suisse in Switzerland suggests the problems at European financial institutions aren’t going away any time soon.

Meanwhile, big U.S. lenders such as Wells Fargo & Co. and Citigroup Inc. have inflicted serial disappointments on their shareholders. So have smaller U.S. regional banks. The collapse this month of Silicon Valley Bank in California and a couple of smaller lenders shows the strains on smaller U.S. banks may be growing.

The most plausible explanation for why Canadian banks have avoided such problems is laid out in a 2013 report from the Federal Reserve Bank of Richmond. The report attributes the stability of the Canadian system to its topheavy structure. A handful of big domestic banks dominate the Canadian market and carry out the bulk of all financial activity. A single strong regulator, the Office of the Superintendent of Financial Institutions, oversees them.

This system is much easier to supervise than its counterpart over the border. In the U.S., thousands of banks compete for business. Multiple regulators hold sway. Many financial functions occur in lightly supervised nonbank financial institutions that may not have much in the way of backstops if something goes wrong.

The contrast between the simplicity of the highly concentrated Canadian system and the sprawling complexity of its U.S. equivalent offers a reasonable explanation for the relative stability of Canadian banks. The top-heavy, oligopolistic nature of Canadian banking may also help to explain why Canadian banks have been so consistently profitable.

But it doesn’t guarantee that Canadian banks will forever escape the forces that have dogged banks in other countries. One of the biggest problems facing lenders everywhere is the generally saturated market for financial services and the ease with which savers and borrowers can transfer their business from one institution to another. That creates a vicious level of competition, which is only exacerbated by tighter postcrisis regulation, threats from high-tech disruptors, volatile interest rates and a sputtering commercial real estate sector.

In Canada, you can add the more specific challenge of a deeply indebted household sector. Some Canadian banks have sought out new frontiers with aggressive expansions into foreign markets. The problem there is that it isn’t clear why Canadian banks should be able to thrive in other countries when local banks aren’t.

Canadian banks remain highly rated, stable institutions that are unlikely to fail. However, their stocks seem quite vulnerable to a sustained period of lacklustre performance. In fact, that period may have already started: Over the past five years, the stocks of four out of five of Canada’s largest banks have lagged behind the broad stock market. Is that a temporary aberration? Maybe not.

REPORT ON BUSINESS | GLOBE INVESTOR

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2023-03-25T07:00:00.0000000Z

2023-03-25T07:00:00.0000000Z

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