Trends in the banking industry

Shareowner, Jan/Feb 2003

These are difficult days for the Canadian banks. Reeling from large corporate loan losses and a prolonged slump in the investment markets, banks are being forced to rethink their strategies.

Lots of Resources

Previously profitable foreign lending is now far more risky and there is less scope for acquisitions. On the domestic scene, competition is intensifying as credit unions and other financial institutions use the Internet to attract new customers. However, all of the major banks have: strong balance sheets; resourceful management; a loyal customer base; and, an array of business opportunities as we head into 2003.

Despite all the talk of a need for consolidations and mergers, the Canadian banking system is in excellent shape. We never worry about our banks. That's testimony enough. Just ask the people in Argentina.

All our banks have sizeable reserves. As a matter of fact, the banks comfortably exceed the government's stringent capital requirements.

Moreover, while Canadian banks are often accused of being stodgy, the reverse is true; they are surprisingly flexible and innovative.

New products are being introduced all the time and the big six banks were high tech pioneers, weaning customers away from traditional services to electronic facilities. Banks spent $3.3 billion on technology in 2001 and plan to spend even more in the future as banking moves to the Internet. Technology is viewed by many as a bank's principal vehicle for reducing its high-cost `bricks and mortar' infrastructure.

As a result banks are well equipped to change course and refocus their efforts. Already, significant trends are emerging that are likely to gain momentum during 2003 and beyond.

Increasing Focus On Retail Banking

Accounting for approximately 50% of the banking system's net income, retail banking is the heart of the business. It is also the engine that can generate future earnings growth as the banks reduce their corporate and foreign loan exposure. Although it rarely attracts headlines, serving individuals is one of banking's growth industries.

Earnings from this business at the six major banks have grown at a compound rate of more than 10% since 1997. Better still, the return on equity used to support these operations, always a good yardstick for measuring a bank's performance, was 22% in 2001, up from 19% in 1997. Now the banks are likely to devote even more resources to retail banking. That should benefit both shareholders and consumers.

There is another reason, besides profitability, that makes personal, or retail banking so important to the banks. This is their defensive hedge against foreign competition. Certainly new institutions can offer websites but they cannot duplicate the extensive branch networks already in place. Even with the substantial pruning that has taken place in recent years, the major banks still have about 6,300 outlets across the country. The intriguing thing is that even though many people complain about the shift to bank machines, domestic branch deposits have been growing at an annual rate of 6%. The public has adapted.

All of which suggests that we are going to see more intensive competition in the Canadian retail banking sector as the major players fight for market share. Look for mortgage rate "discounts", low interest rate loans and increased efforts to attract and retain deposits.

More Technology

As part and parcel of the renewed thrust into retail banking, the banks will almost certainly introduce new, user-friendly technology. As competition for personal business intensifies, profit margins are going to shrink and the banks will have no other options for maintaining margins than shifting to low-cost electronic transactions for continued earnings growth.

Fortunately, the public seems receptive to more mechanization. Currently more than 90% of banking transactions occur electronically - and we are just on the threshold of the PC/Internet era. In 2003 approximately 5.6 million Canadian households will have Internet access compared to 3.9 million at the end of 2001. The banks are moving quickly to capitalize on this entree into Canadian homes. We are going to see campaigns to encourage us to bank in our living rooms, as well as more advertising on the Net to promote the banks themselves.

More Favourable Demographics

A thrust into retail banking would have made a lot of sense even if there had been no Enron, Argentina, Teleglobe or any of the other corporate loan disasters. The truth is, Canadians are older, wealthier and more interested in managing their money than they were 10 years ago. At the same time their financial needs are more complex as they increasingly shift from being borrowers to lenders and investors.

Increasingly, retail clients want guidance about financial planning, insurance, securities transactions and savings as well as access to the appropriate products. That's a heaven sent opportunity for the banks that are able to provide one-stop financial shopping centres.

So, as part of their new emphasis on domestic retail operations, look for banks to offer an array of new savings and investment products to the aging baby boomers. Personal loans, especially credit card balances, will remain important. However, the interest rate spreads are likely to dwindle as everybody tries to grab market share and banks will probably use personal loans as a lure to attract customers and sell other services.