Canadian banks looking to grow their profits should refocus their efforts at home by improving efficiency and consolidating the investment banking business, rather than making acquisitions in the U.S., says ratings agency Standard & Poor’s.

“Efficiency has been a challenge for Canadian-owned banks in the U.S.,” explained Tanya Azarchs, credit analyst
and managing director at Standard & Poor’s Ratings Services.
They have higher expense-to-revenue ratios compared to the U.S. regionals. They also trail their U.S. counterparts in fee income, although they do better than other foreign-owned banks in the U.S. on this measure, probably because they have more sophisticated products.”

Like other foreign financial institutions trying to establish a presence in the U.S., Canadian banks are competing against regional banks whose traditional lines of business are eroding. S&P notes that the U.S. credit card and mortgage sectors have become concentrated in the hands of large, complex banks and specialty lenders.

“Regionals are kind of marginalized and have to do some of the riskier things,” Azarchs observed. This has put the apparently more risk-averse foreign-owned banks at a competitive disadvantage, she adds, noting they have less of the riskier but more profitable commercial real estate loans. Canadian-owned banks have also reduced their mortgage-backed securities holdings because these instruments are so tricky to hedge.

Even on their own turf, Canadian banks’ consumer and smaller commercial banking operations underperform those at U.S. banks, S&P says. “Improving the performance of their domestic operations would help boost earnings at Canadian institutions with less risk than venturing abroad,” it concludes.

“The weak pricing power at Canadian institutions, seen in narrow mortgage spreads and low account fees, indicates these banks need to make improvements on the efficiency front. They could also benefit from consolidation of their fragmented investment-banking market as well as changes to branch configuration and back-office processes.”

S&P report
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