Throughout human history, banking has been one of the most dangerous businesses to be in. It involves very thin margins, a scary balance sheet, and riding the giant waves of the economic cycle. Financial meltdowns and panics are not uncommon, with the most recent one occurring less than a decade ago.
In Canada, there are some especially dangerous signs, with an arguably overheated real estate market and sky-high consumer debt levels. Yet Canadian banks are still seen as a place to go for stability and reliable dividends. Why is that the case?
Below are three reasons why Canadian banks can be viewed as “safe” by investors.
1. Capital
The most important measure of a bank’s capital position is the Basel III Tier 1 Common Equity ratio, or CET1 ratio. Under the new international rules, banks must bring this ratio to 7% by 2019. But under Canadian rules, banks are already required to meet that threshold. And for the big six, the minimum is 8%. So by international standards, Canadian banks have very high capital requirements.
But even these high minimums don’t seem to be enough for the big six, all of which have a capital position well above the minimum. Canadian Imperial Bank of Commerce (TSX: CM)(NYSE: CM) has been the leader in recent years, and has just reported a 10% CET1 ratio; the other banks are close to that number too.
2. Diversification
Banks do a lot more than take our money and loan it back out. They also have wealth management, insurance, investment banking, and international operations. If one unit falters, the others may be able to pick up the slack.
Bank of Nova Scotia (TSX: BNS)(NYSE: BNS) is the best example. In fiscal 2013, Canadian banking accounted for only about a third of total net income. The rest came from international banking, global wealth and insurance, and global banking and markets.
3. Profitability
What’s more likely to slide backward: a car that’s standing still or a car that’s driving forward? Obviously, the moving car is less likely, because it must be stopped first before it can start sliding in the opposite direction.
A similar case can be made for the Canadian banks. They are so profitable in Canada that even if conditions get worse, it likely means they will simply make less money. Toronto Dominion Bank (TSX: TD)(NYSE: TD) is a good example, with a 47% return on equity for its Canadian banking operations.
