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An ING Direct cafe in Vancouver

Bank of Nova Scotia's quarterly results show the cost the bank was willing to shoulder for stable sources of funding.

Not only did the lender pay a premium for ING's Canadian banking operations, it is now paying again with lower margins.

Bank of Nova Scotia wanted deposit funding, to reduce its reliance on bond and money markets for sources of funds, so it outbid others, including Canadian Imperial Bank of Commerce, for ING.

Now the other cost is becoming apparent via a significant decline in net interest margins – caused by the higher rates on ING accounts that are narrowing the spread between what Scotiabank pays to borrow from depositors and what it rakes in from borrowers.

ING's low mortgage rates are also likely adding to the margin squeeze on the lending side.

In its quarterly report, the bank said that net interest margin for Canadian banking decreased 10 basis points to 2.08 per cent due to the acquisition of ING Direct. "Excluding ING Direct, the margin was in line with the previous quarter" Scotia said.

Returns also declined in Canadian banking. The returns on the capital the bank attributes to Canadian banking (which Scotia calls "return on economic equity") declined to 36.3 per cent from 38.8 per cent the year prior, "mainly reflecting the inclusion of ING Direct."

Scotia could try to widen the margins again by cutting back on interest rates on deposit accounts offered by ING, or by telling ING to compete less hard on the mortgage and lending side.

But it's unlikely Scotia would tinker much on the deposit front, as explored in this previous Streetwise, because of the importance of that stable deposit base.

(Boyd Erman is a Globe and Mail Capital Markets Reporter & Streetwise Columnist.)

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