David McKay, right, president and CEO of the Royal Bank of Canada, chats with Rod Bolger, RBC chief financial officer, at the company's annual meeting in Halifax on April 4, 2019.Andrew Vaughan/The Canadian Press
Kevin Yin is a contributing columnist for The Globe and Mail and an economics doctoral student at the University of California, Berkeley.
It would be all too easy to roll our eyes after Royal Bank of Canada RY-T chief executive Dave McKay argued last week that Canada’s banking sector is a “ruthless oligopoly” – not that lenders are ruthless to their customers but are “ruthlessly competitive” with each other.
After all, more than 80 per cent of all commercial assets in Canada have been held by the big five banks for about a decade, compared with about 50 per cent in the United States. Yet Mr. McKay’s comment holds more truth than we might think, and the way our concentrated market affects consumers is more benign than conventional wisdom suggests.
Competition is good because it drives prices down and innovation up. But that logic alone doesn’t tell us how much competition is necessary to keep prices at reasonably low levels. The simplest thing to do, rather than argue vaguely about whether things feel competitive enough, is to look directly at the markups banks are offering.
Banks exist for two reasons: They offer liquidity to savers, which are mostly households, and they offer capital for borrowers, which are mostly companies. We can get a sense of how monopolistic the Canadian banking industry is relative to other countries by looking at how much more they earn on these two services.
But they don’t actually earn more. Non-interest income as a percentage of assets, which includes things such as fees on consumer deposit accounts or payments for advisory and underwriting businesses, is lower in Canada than in other developed countries such as the United States, Germany and Australia. And net interest margins (NIM), which measure how much interest income the bank earns per dollar of assets, are lower here than in Britain and Australia, and significantly lower than in the U.S.
This is a shocking fact. The United States has more than 4,000 banks compared with Canada’s 28. Canadian assets are far more concentrated among its big banks. Yet our banks seem to earn and charge less for their services over all. And while Canadians pay more in fees for bank accounts specifically, this does not capture the fact that they pay less for the entire array of banking services, which includes mortgages, business loans and the like.
Nor can the differences be attributed to the Fed’s higher interest rates compared with the Bank of Canada, since this pattern existed well before the recent bout of U.S. rate hikes. You might also think that U.S. investments simply earn higher returns owing to higher productivity growth. But then we’d still be left scratching our heads about why Britain, with its hundreds of banks and slowing productivity, is still being charged more than we are per dollar of assets. While the Canadian financial industry is concentrated, banks do not appear to be colluding.
Not only is the Canadian banking sector more cutthroat than we would expect, the concentration we see has benefits that are often ignored. Big banks can diversify their businesses while small banks must focus on one or two. When a few income streams dry up, small banks are at a much higher risk of failure. Silicon Valley Bank’s singular focus on venture capital and tech gave it advantages in that sector, but also contributed to its failure.
Furthermore, regulation is much more difficult with more banks. Regulators need to observe, evaluate and then criticize the balance sheets of many more entities in the U.S., which dilutes the regulator’s ability to do all of the above. Economists have argued this was a key difference between Canada and other countries that helps explain their relative performances during the 2008 financial crisis.
As a result, Britain had five bank failures in 2008 alone. The United States, with its fragmented banking sector and mass of small banks, has had 563 bank failures since 2001. Canada has had zero. All in all, the Canadian banking sector looks relatively competitive and particularly resilient.
It’s still the case that fees on deposit accounts could be lower in Canada and that perhaps some foreign financial products could also start to be offered here; perhaps an extra degree of competition might accomplish these goals. Nor is size a sufficient criteria for stability or diversification. American International Group (AIG) was huge; it had nearly US$1-trillion in assets, about the size of Bank of Nova Scotia after exchange rates, before its collapse during the financial crisis. But looking only at market concentration makes for a limited understanding about the pros and cons of our financial system.
Canadian banking is not perfect and a critical evaluation of our industries and regulations is always a welcome exercise. But in the grand scheme of things, the state of the Canadian banking sector is something to be celebrated, not scorned.