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The Globe and Mail

Banks as utilities: A new paradigm for Canada’s Big Six

The Bank of Montreal sign on the northwest corner of King St. West and Bay St. in Toronto's financial district is pictured on Nov. 19, 2015.

Fred Lum/The Globe and Mail

Canadian bank executives are slashing like crazy, racking up $2-billion in restructuring charges over the last two years because they are worried about revenue growth. And in the face of such danger, Big Six share prices are steadily creeping back toward their record highs.

With technology reshaping the way we live, from how we deposit cheques to the way we manage our retirement savings, and with regulators piling on rules to make Canada's financial institutions more bulletproof, the country's largest banks are revamping their businesses, largely by taking an axe to their cost structures.

Investors, at least lately, have barely batted an eye. They panicked when energy loan losses were the hot topic earlier this year, but piled back into their precious bank stocks as soon as the oil price rose again, putting those fears on the back burner – at least temporarily.

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It could be they feel there's nowhere else to turn, because commodity companies are far too volatile. I worry we've become addicted to bank profit growth, blinding us to the current reality.

Because the Big Six emerged from the financial crisis relatively unscathed, they had ample funds to foster a lending boom, and that translated into earnings per share growth sometimes higher than 10 per cent a year. That lofty achievement, among many others, just isn't easy any more – not in this new world.

A better way for investors to think about banks is not as growth stocks, but as utilities. Collecting those fat dividends should make us happy enough, at least for the next few years, even if they aren't increased as quickly.

Investors may struggle with this, because they've grown accustomed to the recent rally, but they deserve frank talk and transparency from bank executives.

Senior bank executives may worry that acknowledging their woes will be seen a sign of weakness. It isn't. Shareholders respect it when CEOs tell it like it is.

And boy, are there woes. One of the hottest topics has been the threat of disruption from financial technology, or fintech, startups. The narrative has been cast as a battle of nimble, tech-savvy neophytes against big, bureaucratic banks. That's true, but it skips over the ease with which new firms can attract clients in an industry with lower barriers to entry.

Historically, banks controlled the game through their branches, then their call centres, then their proprietary online portals. Today most transactions are completed on mobile phones or websites, and digital portals are much easier to replicate because technology has advanced so rapidly. It means lenders must rely much more on their brands to keep clients.

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The economy's a real drag, too. The levers the banks pull to shelter themselves from a broad slowdown, such as extending credit to compensate for weak wage increases, or to offset lost jobs, aren't as accessible any more because household credit levels are already so high.

And it's harder to profit off new loans. Banks used to borrow money for short periods at low rates, and then turn around and lend it for longer terms, such as with five-year mortgages, at higher levels. With interest rates so low globally, that differential, or margin, keeps getting squeezed.

Then there's regulation. The banks are all but mandated to meet a tier one, common equity ratio of 10 per cent, so they can't reinvest as much of their earnings into future growth because they must hold more profit as a buffer against potential losses.

These new rules affect acquisitions. It used to be the banks could snap up wealth managers, or smaller domestic lenders such as ING Bank Canada, to keep churning out earnings growth. But the domestic market is already heavily consolidated, and any future deals are subject to regulations that force banks to hold more capital against acquired goodwill. That makes big deals much harder to justify, especially when buying wealth managers, because they normally have a lot of it.

The Big Six aren't exactly doomed. They each make at least half of their profits from Canadian personal and commercial divisions, and these units grow at a multiple to gross domestic product. If our economy expands by 1 per cent, as it likely will this year, the banks will still get, say, 3 per cent growth from their biggest franchises – providing funds to finance growth in other units.

They've also earned incredible goodwill, or trust, from Canadians, which helps fend off fintech startups. Their recent restructuring charges should also deliver better earnings over the next three years, because legacy costs will be stripped out. And certain acquisitions are still possible – Royal Bank of Canada and Canadian Imperial Bank of Commerce both did big billion-dollar deals in the United States.

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So the sky isn't falling. But we can't forget the pace of change could suddenly increase. In the 1970s, the famous futurist Alvin Toffler, who died this year, warned about "future shock," an era in which technological evolution would happen so quickly it would make us sick.

It's starting to seem like he was on to something. The mobile revolution is already giving way to virtual reality, and keeping up with these techtonic shifts is going to be costly.

Which is why we should be thankful if the banks stay somewhat stable and merely ride these headwinds out, so long as they keep paying those juicy dividends.

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