• Cognizant Reports
Canadian Banking Industry:
Performance and Perspectives
Executive Summary
Prudent lending, borrowing and risk management practices, as well as regulatory compliance, have helped the Canadian banking industry
wade through prolonged recessionary tides fairly
unscathed. As such, Canada’s banks are consistently lauded and rated as sound and safe, and
— unlike financial institutions in other portions of
the developed world — they are seen as strongly
positioned to grow. Canada’s Big Six1 banks operate under a government charter, with a national
presence and in various business lines. They
are well capitalized, well managed and deeply
entrenched in the nation’s economy, contributing
significantly to its growth.
The Big Six overall turned in a solid performance
in 2010 compared with 2009, reporting increases
in revenues, net income and return on equity, and
have reported strong results through the third
quarter of 2011.
Because they operate in a saturated market,
Canada’s banks need to work aggressively to
grow, and many are turning to emerging market
economies to do so. Stringent regulatory reforms,
as well as the pace at which these are unfolding,
could dampen growth. As a result, Canada’s banks
still need to invest additional resources, especially
technology, to not only remain competitive but
cognizant reports | november 2011
also outmaneuver the competition. Increasing
regulatory pressures call for additional reporting capabilities that existing legacy systems will
be hard-pressed to accommodate. For now, we
believe Canadian banks should take a middle path
by gradually upgrading their systems and adding new technology to help comply with evolving
regulations.
Going forward, the Canadian banking industry will
face challenges on a multiplicity of fronts, including regulatory requirements, economic conditions,
changing demographics and new technologies
(see Figure 1, next page). Canada’s banks can rely
on the experience they gained through successful navigation of the global financial meltdown,
as well as extending operational strategies that
have kept them solvent in times of turmoil. This
will help them maintain consumer confidence in
an industry whose reputation worldwide has been
tarnished by questionable tactics and decisions.
Forces Shaping the Industry
Canadian banks are enjoying relatively strong
growth and stability compared with financial institutions in many developed markets. The industry
continues to be influenced by economic challenges, new growth strategies, changing consumer
behavior and the need for technology upgrades.
New Forces
Area
Economy
Industry /
Business
Drivers
Regulations
Drivers
Impact
Implication
Conservative lending market
and slow uptake of credit.
Decreasing demand for debt.
Banks need to be ultra-competitive and
innovative to drive demand.
Households with high aggregate
debt-to-income ratio.
Decreased ability to service
debt in adverse macroeconomic
conditions.
Customers enter deleveraging mode.
Increasing competition in a
limited domestic market.
Customer retention and
acquisition challenges.
Efficient channels are adopted to
differentiate and address customer needs
Well-capitalized, well-managed
and well-regulated banks.
A strong and stable banking
industry.
Banks are well-equipped to deal with
economic uncertainties.
Expansion into international
markets for growth.
Regulatory, economic and
business challenges.
Banks need to anticipate required
changes and include these in their
long-term plans.
Heavily regulated domestic
marketplace.
The need to invest in effective
risk management, governance
and compliance systems.
Increased compliance costs.
Increasing regulatory reforms
globally.
Lower profitability and required
transformation of existing
business models.
Need to invest in systems to improve
profitability and manage regulatory
change.
Decreased ability to operate
and succeed in markets.
The need to use low-cost, SOA and
cloud-based technology platforms.
Inability of legacy systems to
accommodate regulatory changes
Technology and business needs quickly.
Business expansion into newer
markets.
Increased load on existing IT
Gradual overhaul of existing IT systems.
systems to support new businesses.
Figure 1
Canada’s Real GDP
Quarter-over-quarter % change, annualized rate
8
6
4
2
0
-2
Annual growth rates
-4
2009
-2.8%
-6
2010
3.2%
2011
2.4%
2012
2.5%
-8
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Forecasted values
Source: Statistics Canada, RBC Economics Research
Figure 2
Economic Trends
Canada’s banking industry survived the global
financial crisis largely intact. The industry, which
contributed 3.4% of the nation’s GDP in 2010,
faces a scenario in which customer deleveraging
and continuing global turmoil in the financial markets could affect lending volume and profitability.
According to the Royal Bank of Canada’s
Economic and Financial Market Outlook for
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September 2011,2 the country’s GDP growth is
forecast to decline from 3.2% in 2010 to 2.4%
in 2011 and remain at that level for the next few
years (see Figure 2). The unemployment rate,
which peaked just above 8% during the global
economic crisis, now hovers below 7.5% (see
Figure 3, next page). Canada’s economy recovered quickly compared with the U.S., whose
unemployment rate has plateaued at 9%;
however, as the report cautions, consumer
2
Unemployment Rate
% of labor force
9.0
8.5
8.0
7.5
7.0
6.5
6.0
5.5
5.0
2005
2006
2007
2008
2009
2010
2011
Source: Statistics Canada
Figure 3
Interest Rate
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
Mar-11
Sep-11
Source: Bank of Canada
Figure 4
spending on goods and services is likely to
decrease to 2.1% year over year in 2011 before
improving slightly in 2012 to 2.4%.
The overnight rate, Canada’s key policy-setting
interest rate set by the Bank of Canada, has
been at 1% or below since January 2009 (see
Figure 4). This low interest rate regime has
kept the cost of servicing debt low for consumers; however, fluctuation in interest rates due to
uncertain market and economic conditions will
force consumers to deal with a very high cost to
service their debt. The debt service ratio of Canadian households, which decreased after the crisis,
has increased in 2010 (see Figure 5, next page).
Unlike the U.S., Canada’s housing market has been
relatively strong. It grew in 2010, although the
market is showing signs of cooling, with flat sales
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expected in 2011 and 2012 due to the economic
uncertainty prevailing in global markets (see
Figure 6, next page). Sales declined by 3.9% in
2010 and are forecast to grow marginally by
0.9% in 2011 and remain at that level in 2012.
Motor vehicle sales are also forecast to remain
stagnant at the 1.6 million mark for the period
from 2010 to 2012.
Industry Landscape
The Canadian banking system was rated as first
in the world for financial strength by Moody’s
Investors Service for the past two years, and the
World Economic Forum rated it as the soundest
for the last four years. Canada’s banking industry comprises 77 domestic and foreign banks (see
Figure 7, page 5). Bank of Canada, the central
bank of Canada, is the sole issuer of currency
and is responsible for monetary policy, providing
3
central banking services, promoting a safe and
sound financial system and managing funds. It
uses its ability to set the interest rate for borrowed money to achieve the goal of containing
inflation below the 3% mark.
Five of the six banks (not including Royal Bank
of Canada3) reported an increase in revenues in
2010 over 2009. However, all the banks in the Big
Six recorded increased net incomes and return on
equity over 2009. Personal and commercial lending contributes more than half of their revenues.
The banking industry is dominated by the Big
Six banks, which account for 90% of the country’s banking business. In 2010, the Big Six had a
combined net income of $20.4 billion, an increase
of $6 billion from 2009. Interest income accounts
for a major portion of Canadian banking income.
The banking industry currently employs more
than 260,000 people from diverse backgrounds
and accounts for 1.5% of total employment in
the country. Many Canadians hold shares in
banks. Operating in a limited domestic market,
Debt Service Ratio
Interest payments as a % of personal disposable income
11.0
10.5
10.0
9.5
9.0
8.5
8.0
7.5
7.0
6.5
6.0
1990
Canada
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
U.S.
Source: Statistics Canada, Bureau of Economic Analysis, RBC Economics Research
Figure 5
Home Resales in Canada
Thousands of units (seasonally adjusted annual rate)
600
500
400
300
200
100
0
2004
2005
2006
2007
2008
Source: CREA, RBC Economics Research
* Forecast
Figure 6
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4
2009
2010
2011*
2012*
Canadian Banking Industry: A Snapshot
77
Number of banks in Canada
6,150
Number of bank branches across Canada
3.4%
Contribution by banks to Canada’s GDP
267,240
Canadians employed by banks in Canada in 2010
$8.3 billion
Taxes paid by Canada's six largest banks in 2010
$10.1 billion
Taxes paid by Canada's six largest banks worldwide in 2010
$18.2 billion
Salaries and benefits paid by banks in Canada in 2009
$10 billion
Dividend income paid to shareholders by Canada's banks in 2010
$5.8 billion
Amount six largest Canadian banks spent on technology in 2009
489.4 million
Number of online banking transactions completed with the six largest banks in Canada in 2009
932 million
Number of transactions logged at bank-owned ABMs in Canada in 2010
Source: Canadian Bankers Association
Figure 7
banks compete aggressively to acquire customers
and market share. This has led to a plethora of
affordable consumer product offerings. Banks are
also a key source of credit to Canadian business,
representing 58% of all commercial lending.
stance. Some Canadian banks are employing
diverse growth strategies that combine international acquisitions with improving core domestic
operations through enhanced offerings as a way
to boost revenues and sustain growth levels.
Canadian banks emerged stronger from the
financial crisis due to strong retail deposit flows,
conservative risk appetites and diversification
across regions and business lines, as well as low
exposure to risky markets. The capital ratios,
mandated by Canadian banking regulators and
higher than those of Basel II,4 also helped them
maintain greater liquidity levels. The ability of
banks to raise high-quality capital from private
markets, riding on the confidence in the Canadian
banking sector, ensured they were sufficiently
capitalized to deal with unexpected losses.
Consumer Behavior
The quick recovery of Canada’s housing industry has played an important role in limiting the
recession’s impact. In the past 25 years, national
house prices have been 3.5 times the average household disposable income; today, that
number has increased to 4.5. This has resulted,
for the first time in 12 years, in a debt-to-income
ratio (148.1%) that surpasses that of the U.S.
(147.2%), according to Statistics Canada. This
is largely due to the increase in mortgage debt.
Homeowners have also maintained a healthy
amount of equity (72%) compared with debt in
their home investments. As of July 2011, the percentage of arrears to total number of mortgages
was just 0.4%, which is one-tenth the mortgage
arrears in the U.S.
Canada’s Financial Consumer Agency, charged
with protecting consumer interests, largely
restricted subprime-type lending by banks and
helped them avoid the crisis that befell their
brethren in the U.S. Other factors, such as leverage restrictions and incentives that discouraged risky securitization products, also helped
Canadian banks avoid toxic assets.
With limited growth opportunities at home, many
Canadian banks are expanding into emerging
economies with solid growth potential. International expansion, while somewhat risky, is seen
as complementary to a conservative domestic
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Consumers understand that global economic
uncertainty and disruptions in key industries can
leave them exposed to high debt with low income.
A survey by the Certified General Accountants
Association of Canada says, “Canadians are
more likely to gauge their debt as decreasing,
whereas the level of concern over increasing
debt has declined: 37% of indebted respondents
reported their debt as decreasing, while 35% as
5
increasing; the proportion of those concerned with
increasing debt declined from 86% in 2010 to
78% in 2011; 82% of respondents are confident
that they can either manage their debt well or
take on more debt; the proportion of those who
think they have too much debt and have trouble
managing it declined from 21% in 2008 to 18%
in 2011.”5
Meanwhile, Canadian consumers have a very
positive opinion about their banks. Eighty-one
percent believe Canadian banks are more stable
and secure than other banks around the world,
while 75% have a favorable impression of their
banks. A total of 76% believe that banks in
Canada do an important job of contributing to the
economic recovery, according to the Canadian
Bankers Association (CBA).6
Regulatory Challenges
Banks in Canada come under the purview of two
regulators: The Office of the Superintendent of
Financial Institutions (OSFI) for prudential regulation and the Financial Consumer Agency of
Canada (FCAC) for consumer matters. Every five
years, Canada’s Bank Act is reviewed and updated
to stay abreast of industry changes.
Regulations and regulatory compliance have been
key to the Canadian banking industry, enabling it
to remain strong and stable. However, the moveforward impact of regulatory changes worldwide
is a big concern for banks in Canada. As they
enter international markets, Canadian banks will
be more exposed to global turmoil and conditions that are in a state of flux due to economic
troubles, worries of sovereign debt and stringent
regulations. Adjusting to the regulatory changes
will require transformation of business operations that could slow growth and cause tradeoffs
to be made between risk and profitability.
The key for Canadian banks will be to navigate
changes that will have an impact on their business operations, models, systems and profitability, as regulators continue to introduce and implement new measures to ensure transparency and
stability to the banking system. Banks, therefore,
must effectively manage their resources while
complying with regulations, which calls for retooling and investing in IT systems to ensure compliance and competitive advantage. Moving forward,
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this type of investment will put additional pressure on profitability and operational efficiencies.
Technology Challenges
The sound business practices of Canadian banks
helped them weather the global financial storm
effectively compared with banks from other
nations. Going forward, technology will play a
key role for these banks to achieve the balance
between compliance and growth.
The Big Six have invested $55.8 billion between
1996 and 2009 in technology to provide their
customers with secure, accessible and convenient
banking systems. Investments, especially on the
compliance and reporting front, can be expected
to grow as Canadian banking regulators mandate
early adherence with new regulations. Basel III
will require banks to pay more attention to integrating data sources and using newer data modeling techniques. Liquidity reporting is another
area in which banks will need to invest significantly. They will also need to ensure they have a
robust IT infrastructure to deal with data integrity
and usability.
Legacy modernization is a major challenge for
the Canadian banking industry. Newer banks are
using IT to attract new customers and improve
their level of service. More established institutions face a difficult time deploying new technologies, as a major portion of their businesses
is supported and run on legacy systems. Celent, a
prominent research house, predicts that a significant percentage of IT budgets in the future will be
allocated to maintaining legacy systems.7
Modern-day innovations such as service-oriented
architecture-based systems and cloud-based technologies can help alleviate upgrade expenditure
challenges. Recently, Scotiabank signed up for a
cloud-based software as a service (SaaS) solution
to replace its multiple legacy trade and supply
chain applications for its global trade services.8
These kinds of systems provide an efficient way of
allocating capital, in which the bank pays only for
computing resources that are actually used, while
providing a means to quickly enter new markets
and offer new and innovative services.
The call for replacing legacy systems is a longstanding need. Canadian banks need to address
6
this with a slow and steady, incremental approach,
since these heritage systems are pervasive across
business lines; it is too risky to replace them all at
once. Competition for customers in the ultra-competitive Canadian banking market also calls for
newer technologies to achieve market and mind
share. Given the state of banking and the economy, taking a middle path is the best approach for
banks that want to conserve capital and maintain
operating margins over the short term.
Preparing For The Future
For all the recognition that the Canadian banking
industry receives, it operates in a limited and insular market. The industry’s move outside Canada
for growth will expose banks to global economic
challenges, as well as a slew of regulatory compliance challenges. The industry can overcome
these obstacles by leveraging its strong banking
system, built on plain-vanilla products, limited
exposure to riskier businesses and products, as
well as a strong focus on long-term returns and
customer service.
Another strength is that the government offers no
incentives for consumers to take on higher debt,
resulting in prudent borrowing. The Dodd-Frank
Act began mandating stress-testing to measure
the health of banks following the global economic
crisis, but OSFI, the Canadian banking regulator,
has been administering stress tests even before
the crisis took place. This places Canadian banks
in a strong position to contend with new challenges and opportunities.
Emerging technologies such as analytics, social
media, mobile devices and cloud computing will
play a greater role in the coming years. As the
millennial generation grows in size and influence,
demand for services that make use of these tools
and techniques will play a significant role in determining growth and pecking order. Social media is
already proving to be a critical platform to appeal
to various segments of customers. According to
the JD Power 2011 Canadian Retail Banking Customer Satisfaction Study,9 more than 60% of
retail banking customers use social media, and
among those who use social media for banking
purposes, 24% say they do so to discuss their
banking experience or inform their bank of a
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customer service issue. As more and more consumers use online and mobile banking services, it
will be imperative for banks to consider how they
can integrate these technologies and tap into
their power to support and grow their businesses.
Regulations and economic conditions worldwide remain a cause for concern. Banks today
are required to deal with more stringent capital,
liquidity and risk management requirements. In
such a scenario, improving operational efficiencies and gaining additional ground by utilizing
their existing competitive advantages will determine which banks will succeed in the future.
Canadian banks will do well by:
Maintaining the fine balance of meeting growth
targets while complying with more stringent
regulatory requirements.
Diversifying into markets and related businesses with strong growth potential, while
applying the experience gained in their home
markets.
Effectively dealing with the economic, political, cultural and regulatory hurdles in markets
where they operate.
Developing and providing innovative products
and solutions. A recent Global CEO survey by
PricewaterhouseCoopers says that 87% of
banking and capital market CEOs believe that
innovation will lead to operational efficiencies; 64% believe that IT investments will help
them tap into new marketing and transactional
opportunities.10
Achieving operational efficiencies with smart
use of technology and third-party services
to keep focused on acquiring, retaining and
delighting customers.
The Canadian banking industry weathered the
global financial storm. In fact, no Canadian financial institution required a government bailout.
Given their strong fundamentals, track record
and operational strategies, Canadian banks are
well positioned to tap into new growth opportunities. But this can only happen if they can quickly
and cost-effectively upgrade their legacy systems
and apply historically solid risk mitigation strategies to expand into new geographies and offer
ancillary products that will enable them to incrementally improve their top and bottom lines.
7
Footnotes
1
Big Six refers to the six biggest banks that dominate banking in Canada. They include Royal Bank of
Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Bank of
Montreal and National Bank of Canada.
“Economic and Financial Market Outlook,” Royal Bank of Canada, September 2011. http://www.rbc.
com/economics/market/pdf/fcst.pdf
2
“Royal Bank of Canada: Annual Report 2010,” www.rbc.com/investorrelations/pdf/ar_2010_e.pdf.
Total revenue decreased $776 million, due to significantly lower total trading revenue. Also contributing to the decrease were lower securitization gains and reduced revenues, to the tune of $1.2 billion
on account of a strong Canadian dollar.
3
4
“Lessons for Banking Reform: A Canadian Perspective,” Central Banking Publications Ltd., Vol. 19,
No. 4, May 2009. http://www.osfi-bsif.gc.ca/app/DocRepository/1/eng/osfi/osfi_cbnk_e.pdf
“A Driving Force No More: Have Canadian Consumers Reached Their Limits?” Certified General
Accountants Association of Canada, June 2011. http://ppm.cga-canada.org/en-ca/Documents/
ca_rep_2011-06_debt-consumption.pdf
5
“What Canadians Think About Their Banking Industry,” Canadian Bankers Association, July 12, 2011.
http://www.cba.ca/en/media-room/50-backgrounders-on-banking-issues/480-what-canadians-thinkabout-their-banks
6
Maria Bruno, “Celent Predicts an Increase in Bank IT Spending in 2010,” Bank Systems & Technology,
Oct. 29, 2009. http://www.banktech.com/management-strategies/221200022
7
“CGI to Work with Scotiabank for Global Rollout of Trade360,” CGI, August 10, 2011. http://www.cgi.
com/en/CGI-work-Scotiabank-global-rollout-CGITrade360
8
“2011 Canadian Retail Banking Customer Satisfaction Study,” JD Power, July 26, 2011. http://
www.jdpower.com/news/pressRelease.aspx?ID=2011107
9
“14th Annual Global CEO Survey: Banking and Capital Markets Industry Summary,” Pricewaterhouse
Coopers, January 2011. http://www.pwccn.com/home/eng/annual_global_ceo_survey_14th_bcm.html
10
Bibliography
“Moving Beyond Compliance: How Banks Should Leverage Technology to Capitalize on Regulatory
Change,” The Boston Consulting Group, October 2011. www.bcg.nl/documents/file89614.pdf
Cameron French, “Dealtalk: Canadian Banks Look Abroad to Grow at Home,” Reuters, August 29, 2011.
http://www.reuters.com/article/2011/08/29/us-banks-idUSTRE77S3JB20110829
“What Basel III Means for Banks IT,” Finextra, February 14, 2011. http://www.finextra.com/community/
fullblog.aspx?blogid=4988
“Basel Capital Framework,” Canadian Bankers Association, January 27, 2011. http://www.cba.ca/en/
research-and-advocacy/47-regulatory-enviornment/72-basel-capital-framework
“Top 7 Ways Basel III Affects U.S. Banks and Their IT Departments,” Bank Systems & Technology,
September 2010. http://www.banktech.com/regulation-compliance/227400445
“Canadian Banks 2011: Perspectives on the Canadian Banking Industry,” PricewaterhouseCoopers, 2011.
http://www.pwc.com/ca/en/banking-capital-markets/publications/canadian-banks-2011-en.pdf
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“Positioned to Lead: Achieving Regulatory Balance,” Insights into Canadian Banking, KPMG, Spring 2011.
http://www.kpmg.com/Ca/en/IssuesAndInsights/ArticlesPublications/Documents/4949_Insights
CdnBankingIss2_v6_WEB2.PDF
“Canada's Banks See Slower Retail Revenue Growth,” Reuters, Sept. 22, 2010. http://www.reuters.com/
article/2010/09/22/canada-banks-lending-idUSN2210541120100922
Sean B. Pasternak and Doug Alexander, “Canada Banking System Is World's Soundest, Economic Forum
Says in Survey,” Bloomberg, Sept. 9, 2010. http://www.bloomberg.com/news/2010-09-09/canada-banking-system-is-world-s-soundest-economic-forum-says-in-survey.html
“Taking Stock of Regulatory Reform,” Insights into Canadian Banking, KPMG LLP, 2010. http://www.
kpmg.com/Ca/en/IssuesAndInsights/ArticlesPublications/Documents/Insights%20into%20Cdn%
20banking%20FINAL.pdf
Suzanne McGee, “Canada, By a Long Shot,” Portfolio.com, April 2010. http://www.portfolio.com/
industry-news/banking-finance/2010/04/02/canada-banks-emerge-from-financial-crisis-lookingstrong/index.html
Author
Aala Santhosh Reddy, Cognizant Research Center
Analyst
Svetlana Malu, Cognizant Research Center
Subject Matter Experts
Bala Loganathan, Associate Director, Projects, Banking & Financial Services,
Cognizant Technology Solutions
Ganesh Rajamani, Senior Manager, Projects, Cognizant Technology Solutions
About Cognizant
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