Canadian Banks May Face Profit Losses Due to Shrinking Margins

Canadian Banks May Face Profit Losses Due to Shrinking Margins

Canadian banks are becoming more cautious in their efforts to attract mortgage customers amid intense competition and shrinking margins. Speaking at the Scotiabank Financials Summit, Royal Bank of Canada (RBC) CEO Dave McKay said the bank has become more selective when offering mortgage deals that do not meet its target return thresholds.

"We’ve been more careful in saying we won’t chase hot money, where our customer is just shopping their mortgage at a below hurdle rate," McKay said.

This cautious approach comes as high interest rates have slowed the housing market and reduced mortgage growth, forcing banks to compete more aggressively for business.

Competition in an Oligopoly

Although Canada’s banking sector is often referred to as an oligopoly, McKay emphasized that it is a "ruthless oligopoly" with fierce competition. Unlike U.S. banks, which have managed to pass on their increased costs to borrowers, Canadian banks have absorbed these costs within their margins.

"In Canada, we’ve absorbed them; we’ve competed them away and absorbed them into our margins through competition," McKay added.

While McKay laments the shrinking margins, he emphasized that RBC will still aggressively pursue customers who show potential for long-term, multi-product relationships.

"Where we sense there’s a multi-product, longer-term relationship with a customer, we’ll certainly go after that hard," he said.

Shifting Focus from Volume to Value

Scotiabank CEO Scott Thomson has focused on multi-product relationships, which has been reflected in the bank’s mortgage business. Over the past 18 months, Scotiabank has reduced the number of clients who only have a mortgage with the bank by approximately 14%. This shift is part of a strategy to increase the value of each customer relationship, rather than simply growing volume.

"Will we be willing to think about a competitive price when we have a multi-product relationship? Absolutely. Will we think about a competitive price for a single mortgage product? Probably not," Thomson said.

Impact of Interest Rates and Future Outlook

A potential drop in interest rates could revive the mortgage market. The recent reduction by the Bank of Canada lowered the central bank's rate to 4.25%, prompting Canada’s major banks to lower their prime rates to 6.45%. Rates may drop further, possibly by another 1.75 percentage points by the end of next year. However, despite the intense competition, the margin added to the prime rate remains elevated, around two percentage points.

Even if lower rates increase demand, McKay emphasized that RBC is working to reduce costs in its mortgage business due to continued pressure on profits.

"We’re trying to kind of re-engineer the business towards maybe a longer-term, lower-margin business," McKay noted.

U.S. Expansion Challenges

In addition to competition in the mortgage sector, U.S. expansion was another key topic at the summit. What once seemed like a promising growth area is now facing challenges. TD Bank Group is dealing with

investigations into its anti-money laundering program, and BMO has reported unexpectedly high provisions for credit losses in the U.S.

TD Bank CEO Bharat Masrani assured that the bank is addressing these issues and expects to resolve the case by the end of the year, with possible penalties of around $3 billion. He also stressed that the U.S. market remains a strong opportunity.

"The fundamentals of our U.S. business are a strong franchise in very important markets, that has not changed," Masrani said.

BMO CEO Darryl White acknowledged that the bank’s U.S. operations were affected by the pandemic but expressed confidence that the situation would improve over time.

"It’s a timing issue," White said. "Nothing’s changed on our expectations or confidence level."

Conclusion

Canadian banks are facing the prospect of profit losses due to shrinking margins, fierce competition, and rising interest rates. While they are adjusting their strategies to focus on long-term relationships with customers, economic conditions continue to put pressure on profitability. The outlook remains uncertain, especially with challenges in international markets and the potential for further rate cuts.

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Canadian Banks May Face Profit Losses Due to Shrinking Margins

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