Rethinking Canada's Highly Profitable Banks

Andrew Spence is a veteran finance executive and the author of the forthcoming book Fleeced: Canadians Versus Their Banks, available now for pre-order.

The quarterly earnings releases of the Big Banks are appointment viewing for Canada’s business journalists. Seen as an indicator of economic health, high profits are celebrated while sub-par performance is taken a signal of deteriorating economic fortunes.

But not all profits are alike. Some firms make a lot of money by outperforming competitors, satisfying customers with quality service, and delivering valuable products. Others leverage a position of dominance to soak their customers while absorbing competitors that might upset the arrangement.

Highly profitable banks are not always an indicator of broad economic vitality. Canada is plagued by sluggish economic growth, weak productivity performance, and inferior economic adaptability, and the Big Banks are a part of it. High profits in our over-consolidated banking sector reflect a bigger slice of the pie going to the banks at the expense of savers, homeowners and entrepreneurs.

Corporations – including our banks – should be rewarded with robust profits for providing efficient solutions to everyday problems. But our banking market is neither competitive nor efficient. As oligopolies, the Big Banks deliver lower output at higher prices compared to a competitive outcome. Instead of celebrating large profits, we should instead ask whether they result from the competitive frictions and problems market dominance creates.

As I outline in some detail in my book Fleeced: Canadians Versus Their Banks, evidence of high prices and lower output is clear to see. Our banks provide woefully inadequate credit to the small and medium sized business sector at interest rates far above those in like markets, such as Australia and the UK. Small businesses are in every nook and cranny of the economy, they provide two-thirds of all jobs and generate just over half of Canada’s GDP. Inadequate financing for individually small businesses that combine to leave a large economic footprint has profound implications.

Banks are not in the risk business so they are less likely to make loans they perceive as too risky, loans that might otherwise be granted if the market were more competitive. Canada’s banks charge small and medium sized businesses much more for less credit than our peers. Confirmation on pricing comes from the OECD which showed the spread between small and large company loans in Canada was 2.48 percent compared to just 0.48 percent in the more competitive United States. Confirmation on poor credit supply comes from the Canadian Federation of Independent Business. Their 2023 member survey showed a ten-year trend decline in the median amount of credit offered to SMBs to just $156,000 in 2022. Moreover, after adjusting for inflation, bank financing for small business in real terms is now half of what it was in 2012 a derisory amount to finance half of Canada’s GDP.

We don’t know for sure the magnitude of lost economic output from constrained credit supply, because we cannot quantity what would otherwise have been. But what we do know is that banks are in the profitability business, working to the interests of executive ease and shareholder satisfaction which comes at a cost. When Canadian entrepreneurs cannot get project financing, they often just give up. This marker of opportunity cost shows an economy missing-out on innovation, invention, and progress because Canada’s large firms have no incentive to take up the slack.

Market dominance also creates economic problems in the labour market. Together, Canada’s banks amount, effectively, to one single employer showing little wage dispersion outside of the higher executive ranks. Their dominance of the domestic market allows them to push down labour costs. After all, if the employer sets the wage it is unlikely to be the highest possible, identifying an additional problem from which profits are made.

The dead weight loss to economic activity from high-priced, risk-reducing, credit rationing and labour market dominance are the most jarring examples of how the structure, conduct and performance of our banking system creates economic problems from which profits are made. There are many more.

Canada obsesses over financial stability above all, yet our officials show moments of doubt questioning how well the financial sector balances stability, efficiency and utility. The answer is clear: not at all well but yet nothing is done. Canadian consumers have no voice over high prices, nowhere else to turn, and scant protection compared to our peers. What then is the benefit conferred by our concentrated banking system?

Incentives matter, but our political leaders have no incentive to respond. Without a powerful consumer protection agency backed by political concern and bureaucratic support, our banks will manage their businesses the way they do – mostly in the interests of their shareholders with consumers taking the hindmost.

To address market dominance, Canada needs to slay a few sacred cows: our authorities must become more assertive and demanding. In 2016, the UK Financial Conduct Authority put the industry on notice that open banking was coming whether they liked it or not, arriving two years later to deliver better choice, better service, and at lower cost. Meanwhile, Canadians continue to wait.