Retail banking has been operating in the ‘comfort’ zone for the past two to three years with good credit quality and consequent low provisioning for loan losses, while demand for mortgages and commercial loans has been strong.
Recovery of corporate loans and reversals of general allowances have also benefited the bottom line. But is this about to end? Loan loss provisions are starting to rise, partly as a result of strong retail loan growth but also perhaps as a reflection of rising interest rates in North America.
In the short term, increased interest rates will reduce the trend for shrinking margins but the gain will be limited by the competitiveness of the domestic market. To ensure continued retail profitability, banks will have to focus on increasing revenue in fiscal 2006 as they have already taken significant amounts of cost out of their retail operations.
Wealth management delivered strong earnings growth in 2005, although there were mixed performances among banks on the capital markets front. Problems have been seen in wholesale operations, with the continued fallout from the Enron litigation.
The profitability of wholesale banking at three of the top five banks has been hit by provisions for litigation. Canadian Imperial Bank of Commerce (CIBC) announced in August 2005 that it had agreed to settle the Newby et al class action lawsuit with a payment of $2.4bn, and the Megaclaims bankruptcy court action with a payment of $250m, both subject to court approval.
With the need to grow revenues becoming paramount, it would be logical to assume that the banks would look outside their very competitive home market and the equally competitive banking market of their neighbour, the US. However, of the acquisitions announced in fiscal 2005, only that of Banco de Comercio in El Salvador by Scotiabank, was outside North America.
Toronto-Dominion acquired the Banknorth group in the US and through them will acquire Hudson United Bancorp in a deal due for completion in early 2006. Scotiabank, whose primary international focus is on Latin America and the Caribbean, with a secondary one on Asia, can justifiably claim that it is the most international of Canadian banks with 24.8% of total average assets in 2005 domiciled outside Canada and the US, from which it generated 30.1% of its pre-tax income. RBC heads the rest with 20.1% of total average assets generating only 10.5% of pre-tax income.
