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Not yet, but They might be soon: Canadian Banks in Trouble B Y A le x a n der M assa ( ‘ 10 ) Alexander comes from Montreal, Canada and is a senior at the Wharton School, University of Pennsylvania. He is concentrating in Finance.


or the second consecutive year, the

also an oligopoly of five too-big-to-fail banks.

market required “vigilance, but not alarm”.

World Economic Forum has ranked

To mitigate the risk of a systemic collapse,

Meanwhile, 35 year fixed-rate mortgages

Canada as the country with the

regulators were forced to impose more

below 6% continue to push housing prices up.

soundest banking system in the world. The

stringent regulations, including maximum

The housing market is also supported by

big 5 Canadian banks also enjoyed near-

leverage ratios and higher tier 1 capital

a fully nationalized version of Freddie Mac

record profits in 2009. Scotiabank, for

requirements. This tougher supervision

and Fannie Mae called the Canada Mortgage

example, saw its fourth quarter earnings

did prevent balance sheets from expanding


nearly triple from the same period a year

out of control in the last decade and,

guarantees all mortgages with loan-to-values

ago. While many countries are struggling

compared to the casino-institutions south

above 80% and purchases mortgage backed

to rebuild their troubled banking systems,

of the border, Canadian banks certainly

securities directly from issuers. As a result

Canada and its profitable banks appear

have been better prepared to withstand the

of low interest rates and explicit government

to be a shining light in an otherwise dark

economic downturn. Unfortunately, Canada

guarantees, the fluid mortgage market has

and murky financial world.

is now suffering from many of the same ills

helped keep house prices well above their long-





But appearances can be deceptive.

that have plagued western economies in the

run averages. Rapid credit expansion has also

Some troubling signs point to dangerous

last decade. But unlike in other parts of the

made Canadians some of the most indebted



world, the distortionary effects of artificially

people in the world.

policies and those that almost brought down

low interest rates and excessive credit have

As Canadians have taken on more debt

the entire world economic edifice a few

yet to severely impact the banking system

to purchase homes, cars and electronics,

years ago. Dangerously low interest rates,

– in fact, it’s the complete opposite: free

the debt-to-income ratio has swelled to an

a faltering real economy and aggressive

money has spurred lending activity and

all time high of 145%. That means that for

banking activities are all threatening

boosted banking profits. However, if history

every $100 of personal disposable income,

to drag Canada and its banks down a

is any guide, Canada and its banks might

Canadians carry $145 in debt. In 1990 that

dangerous, yet all too familiar path.

be setting the stage for trouble ahead.

number was $88.60. While predatory lending



certainly is not as prevalent as it was in the The Canadian Narrative

Too Much Credit

United States during the subprime debacle, it

Canadian banks weathered the financial

Wholesale bank funding costs in Canada

nevertheless remains a problem. For instance,

crisis relatively un-scathed; not only did they

are currently at all time lows. Like in the

home hardware store/gas station Canadian

not directly receive any federal bailouts,

United States, the overnight target rate

Tire (TSE: CTC.A) has been aggressively

but all, except CIBC, recorded profits in

has been at 0.25% since April of last year.

expanding its financial services business in

2008. Lower risk appetite and structural

But the Canadian banking system is not

the last few years by issuing credit cards to



in gridlock and this free money is flowing

customers waiting in line to fill up on gas

oncoming storm. Toronto-Dominion (TD),

rapidly into the economy, causing asset

priced at below-market rates. Similar to what

for instance, exited the structured products

inflation and ample malinvestment.

happened in the United States, cheap money




business in 2005, while RBC imposed

Housing prices, for example, are at

is creating an illusion of growth by burdening

several years ago a limit of 30% on the share

exorbitant levels and have barely fallen

consumers with an ever increasing amount

of earnings its capital-markets business

from their peak. A Bank of Canada official

of debt. Canada is on a credit binge that will

could contribute. The Canadian system is


eventually need to end.


S PRIN G 2 0 1 0





International Business Review - Spring 2010  

The Spring 2010 edition of the IBR.