Canada’s banks under pressure due to growing competition in a ‘ruthless oligopoly’, RBC chief executive says

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Canada’s banks are facing a flurry of competition from each other – a suddenly “ruthless oligopoly” that is putting unexpected pressure on profit margins, says Royal Bank of Canada RY-T, CEO Dave McKay.

The new dynamic is most obvious in the mortgage market, where banks are jockeying to keep or increase their share of customers, some of whom are renewing home loans and looking for the lowest interest rate to ease the shock from rising payments. But it is also playing out in a race to gather deposits, which are typically a cheap base of funding to make those loans, but are costing banks more to attract.

That has spurred fierce competition for customers – especially the coveted clients who have more than one of a bank’s products – that is out of step with the U.S. market, which is known for being especially cutthroat, Mr. McKay told investors at a Bank of Nova Scotia conference on Wednesday that featured major bank chief executives.

“They talk about Canada as being an oligopoly. It is a ruthless oligopoly, at the end – ruthlessly competitive,” Mr. McKay said.

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Banks’ funding costs have gone up as a period of high interest rates spurred customers to look harder for a better rate of return on their savings. The U.S. banks have largely been able to pass those higher costs on by charging more for loans, he said.

“In Canada, we’ve absorbed them, we’ve competed them away. And we’ve absorbed them into our [profit] margins through competition that’s, I think, destroying shareholder value in many cases,” Mr. McKay said. He added that it is frustrating to see the U.S. banking market, often described as “hyper-competitive,” achieving more profitable pricing on loans and deposits than the Canadian market, which “people called an oligopoly, which is ruthlessly competitive right now, and maybe more competitive than the U.S.”

Victor Dodig, CEO of Canadian Imperial Bank of Commerce CM-T, told Wednesday’s conference that most large Canadian banks have targets to earn a return on equity of 15 per cent to 16 per cent, or more, and right now, ROE “is on everyone’s mind.”

When it comes to customers, “the deeper the relationships … the higher the ROE of those relationships,” he said.

For clients who are most sensitive to prices, and don’t form deep attachments to one bank by holding multiple accounts and products, CIBC is content to steer them to digital-first channels such as its low-cost subsidiary Simplii Financial. The mantra is: “Don’t get caught up in the aggressive pricing game. At times that might mean you lose some market share, but you should benefit in margin,” Mr. Dodig said.

At Bank of Nova Scotia BNS-T, CEO Scott Thomson has declared that the “north star” is landing more customers who make Scotiabank their primary bank – and letting go of some lower-margin clients. He sums the strategy up as having “less focus on volume, more focus on value.” The share of the mortgage portfolio made up of home loans that are a customer’s only product with Scotiabank is down by 13 per cent or 14 per cent, he said, and the bank is working to extend the same approach to auto loans and corporate lending.

Mr. McKay said there is “huge pent-up demand” for residential mortgages, and “we hope at some point we see better margins in the mortgage portfolio.” But he also acknowledged that RBC has taken steps to “re-engineer the business towards, maybe, a longer-term lower-margin business. We have to prepare for that.”

At Wednesday’s conference, Toronto-Dominion Bank TD-N, CEO Bharat Masrani also addressed the bank’s efforts to overhaul its anti-money-laundering systems as the bank anticipates fines totalling more than US$3-billion from U.S. banking regulators. He said TD has “a very strong risk-culture foundation,” but that the problems regulators uncovered – which have dented the bank’s share price and scuttled a potentially transformative acquisition of U.S. regional bank First Horizon Corp. – have demonstrated that “you can’t take anything for granted, including the culture and the foundation.”

“It’s easy in a bank of our size to sometimes not look at accountabilities as clearly as we should. So here, one of the key lessons is to deepen accountabilities for such types of risk in all three lines of defence – not only the front lines and the control function but, as well, our audit practices – to make sure that folks understand these risks right through the organization and act with urgency,” Mr. Masrani said.

“A bank of our size, we’re a global bank, there’s lots of information available,” he added. “And it’s important to co-ordinate and make sure that the right information is available to the right individuals and right areas of the bank on a real-time basis.”