Trends in the banking industry

Shareowner, Jan/Feb 2003

Going forward, it's safe to say that the banks will try not to repeat their most recent mistakes. However, most of us can remember their huge writedowns for real estate loans in the early 90's and for loans to less-developed countries in the late 80's. Clearly, some banks learned better than others from these earlier lending debacles. But they all did recovered quite nicely.

Those banks that do learn from the recent loan losses will surely make smaller and better scattered corporate loans to increase diversification. At the same time, rapidly growing residential mortgage portfolios - with their excellent loss experience - will improve the banks' overall loan performance in the future. Indeed, total loan loss provisions are expected to drop to the $5.5 billion level in 2003. Having been burned overseas and in the U.S. most of the Canadian banks will attempt to increase their Canadian corporate loans, but even here, they are unlikely to chase the business. Credit committees will look for better quality risks and avoid the high tech and other speculative business they were so willing to write during the bull market, even if that means lower interest-rate spreads.

The important thing to remember is that the banks are so strong that they can take the current corporate loan losses in their stride. They have never been better positioned. During the last recession banks had $21 of risk-weighted assets for every dollar of capital. Today the number is down to $12. That provides a solid base for when the banks start increasing credit once more in order to fuel the recovery.

More Focused Financial Services

A year or so ago the banks' brokerage subsidiaries were making a significant contribution to profits. So much so, that some analysts felt that financial services were the wave of the future. Going forward, banks were expected to generate a substantial part of their earnings growth from investment fees and commissions, underwriting and mergers and acquisitions. Lending money was expected to become far less important. Unfortunately, the bear market has shown that the financial services business can be highly cyclical for some banks. Many of the investment subsidiaries are struggling. The CIBC has withdrawn from a few of its U.S. brokerage operations and there is talk of other banks vacating the field.

Here again the banks' strength and resilience are big factors. They can weather the storm while competitors such as Merrill Lynch and Schwab have backed out of Canada. The chances are however that from now on, the banks will promote their financial services to attract and retain customers. Brokerage facilities and investment advice are going to form part of the full financial package available in the branches. On the other hand, there will be far less money spent on expensive mergers and acquisitions or the high-risk underwriting business. While less exciting, this approach would stabilize the banks' earnings as substantial financial services overheads are reduced.