Does Canada Have the Answer?
Simon Carswell, The Irish Times, 4th September 2009
Royal Bank of Canada’s chief executive Gordon Nixon explains how the conservativeness of Canadian banking has given them the reserves to cope with the world recession
FEW BANK chief executives in the current financial climate have the opportunities facing Gordon Nixon. As head of Royal Bank of Canada (RBC), the country’s largest bank, and the second longest-serving bank chief executive in the world (after Josef Ackermann at Deutsche Bank), Nixon’s years of conservative banking have left the lender well poised to take advantage of the global financial crisis.
Canada’s tradition of fiscal conservativeness, prudent lending, strict regulatory requirements on setting aside capital for the bad times and a stable property market meant the country’s banks avoided the excesses of global banking that damaged rivals around the globe.
The country steered clear of leverage, which has become a dirty word for bankers. Nixon says RBC’s peak leverage – the ratio of loans to capital – amounted to just over 20 times, compared with 50, 60 times or more for some European banks.
“How did we let certain banks get to the kind of leverage that they had?” asks Nixon of journalists from European papers, including The Irish Times, who travelled to Toronto to try to understand why Canada’s banking system has held up in the crisis.
“How did we let the US residential market get to the point where someone with $30,000 a year income could buy a $1 million home and that home could be originated by a broker and securitised six times and sold to a bank in Germany?”
Canada avoided this pass-the-parcel game in the debt markets, preferring to keep their loans well within sight on their balance sheets. This meant the underwriting credit standards on the loans remained high – only borrowers who could repay were given loans.
“You have generally far less leverage in the system in Canada because most of those mortgages remain on the balance sheets of the banks,” Nixon says. “As a result, residential real estate – the biggest source of weakness in the US system – has been a source of strength in Canada. Real estate prices have come off their peak levels of a couple of years ago, but the strength of the underwriting practices is such that the losses on mortgages have been relatively small in the Canadian system.”
That’s not to say RBC doesn’t have problems. The bank was the only lender among Canada’s top four banks to post a quarterly loss this year – the first such loss for the bank since 1993. The $1.6 billion (€1.1 billion) takeover of US bank Alabama National in 2007 has had mixed results, though Nixon is keen to grow the bank as a large regional lender in the US.
Nixon says the bank has taken mark-to-market losses of between $3 billion Canadian dollars (€1.9 billion) and $3.5 billion over two years. But these are bearable given its strong profitable franchise compared with losses of tens of billions for some international banks.
“A culmination of strength at home and less leverage have enabled our operations to earn through a lot of the losses,” he says.
The share price of RBC, which has assets of more than $630 billion and employs more than 65,000 people, has almost doubled in the past six months, giving the bank a market capitalisation of $71.8 billion, more than nine times the combined market value of Ireland’s three remaining public banks, Allied Irish Banks, Bank of Ireland and Irish Life Permanent.
Nixon says European banks had far too much leverage and were not generating enough profit to cope with the rising losses. “Irish banks stand out as having way too much leverage in relation to the size of the institutions,” he says. “British banks in general also fit that mould.”
He says the British banks were very aggressive in commercial lending and RBC could never figure out why they pursued this strategy. “If there was a surprise to me it was the ability of the banks to fill their capital hotels as quickly as they did,” he says.
As credit became cheap during the heady boom years, between 2005 and 2007, banks lost control, Nixon argues. They were unable to maintain the discipline to ensure that if they grew their balance sheets by selling more and more loans, then the growth should come at a strong rate of return. But it didn’t and margins were squeezed, creating too much risk and, ultimately, heavy losses for the banks.
“That is where a lot of the European banks lost their way. It wasn’t just that the balance sheets were exploding – it was the return on that incremental growth on the balance sheet,” he says.
“It just didn’t make a huge amount of sense. If you are going to grow your balance sheet and expand your assets, you have to be making a very good rate of return.”
Nixon says he was always “a little surprised” with the lending growth of many banks. He says it was “very difficult” to justify making loans at the margins that were in the market place from 2005 to 2007 unless the banks were drawing a lot of income from ancillary business.
“European banks were just extending capital by lending money, there wasn’t any incremental business. It was just a lending business because liquidity was available, capital was cheap and growing balance sheets was easy,” he says.
“I tell my staff: ‘Never expect to get paid a bonus for just growing a balance sheet.’ You can always go out and lend money and buy bonds and securities. It is always about earning a return from growing your balance sheet – a return in the short and long term.”
Nixon believes European banks failed to keep enough in reserve for recession-driven losses. These banks worked off the global minimum of 6 per cent pure equity capital when Canadian banks worked off at least 8 per cent but were in fact more comfortable with 9 per cent.
By maintaining a stable banking system, Canada has attracted much attention from overseas as governments and regulators assess its structures to understand what creates solid banks. While international attention has turned to Canada, Nixon is looking overseas to see how RBC can take advantage.
“The conservative nature of the system has been a source of strength. The big issue is does that create opportunity?”
Nixon says RBC could become involved in joint venture opportunities, mergers and acquisitions as international banks withdraw from various sectors – he cites fund administration as an example where the bank could grow its operations.
The bank’s rival, Canadian Imperial Bank of Commerce (CIBC), has recently been sniffing around Allied Irish Banks with a view to investing in the bank. The bank has also been eyeing up a possible purchase of Anglo Irish Bank’s €10 billion loan book in the US.
Nixon has adopted a similarly acquisitive eye. “When we look at the overall global landscape, we see opportunity amongst the fallout from a very challenged environment,” he says. “But it continues to be an environment where caution is warranted.”