• Cognizant Reports

Canadian Banking Industry: Performance and Perspectives

Executive Summary also outmaneuver the competition. Increasing Prudent lending, borrowing and risk manage- regulatory pressures call for additional report- ment practices, as well as regulatory compli- ing capabilities that existing legacy systems will ance, have helped the Canadian banking industry be hard-pressed to accommodate. For now, we wade through prolonged recessionary tides fairly believe Canadian banks should take a middle path unscathed. As such, Canada’s banks are consis- by gradually upgrading their systems and add- tently lauded and rated as sound and safe, and ing new technology to help comply with evolving — unlike financial institutions in other portions of regulations. the developed world — they are seen as strongly positioned to grow. Canada’s Big Six1 banks oper- Going forward, the Canadian banking industry will ate under a government charter, with a national face challenges on a multiplicity of fronts, includ- presence and in various business lines. They ing regulatory requirements, economic conditions, are well capitalized, well managed and deeply changing demographics and new technologies entrenched in the nation’s economy, contributing (see Figure 1, next page). Canada’s banks can rely significantly to its growth. on the experience they gained through success- ful navigation of the global financial meltdown, The Big Six overall turned in a solid performance as well as extending operational strategies that in 2010 compared with 2009, reporting increases have kept them solvent in times of turmoil. This in revenues, net income and return on equity, and will help them maintain consumer confidence in have reported strong results through the third an industry whose reputation worldwide has been quarter of 2011. tarnished by questionable tactics and decisions.

Because they operate in a saturated market, Canada’s banks need to work aggressively to Forces Shaping the Industry grow, and many are turning to emerging market Canadian banks are enjoying relatively strong economies to do so. Stringent regulatory reforms, growth and stability compared with financial insti- as well as the pace at which these are unfolding, tutions in many developed markets. The industry could dampen growth. As a result, Canada’s banks continues to be influenced by economic chal- still need to invest additional resources, especially lenges, new growth strategies, changing consumer technology, to not only remain competitive but behavior and the need for technology upgrades.

cognizant reports | november 2011 New Forces

Area Drivers Impact Implication

Conservative lending market Decreasing demand for debt. Banks need to be ultra-competitive and and slow uptake of credit. innovative to drive demand.

Economy Households with high aggregate Decreased ability to service Customers enter deleveraging mode. debt-to-income ratio. debt in adverse macroeconomic conditions.

Increasing competition in a Customer retention and Efficient channels are adopted to limited domestic market. acquisition challenges. differentiate and address customer needs

Industry / Well-capitalized, well-managed A strong and stable banking Banks are well-equipped to deal with Business and well-regulated banks. industry. economic uncertainties. Drivers Expansion into international Regulatory, economic and Banks need to anticipate required markets for growth. business challenges. changes and include these in their long-term plans.

Heavily regulated domestic The need to invest in effective Increased compliance costs. marketplace. risk management, governance and compliance systems. Regulations Increasing regulatory reforms Lower profitability and required Need to invest in systems to improve globally. transformation of existing profitability and manage regulatory business models. change.

Inability of legacy systems to Decreased ability to operate The need to use low-cost, SOA and accommodate regulatory changes and succeed in markets. cloud-based technology platforms. Technology and business needs quickly. Business expansion into newer Increased load on existing IT Gradual overhaul of existing IT systems. markets. systems to support new businesses.

Figure 1

Canada’s Real GDP Quarter-over-quarter % change, annualized rate

8

6

4

2

0

-2 Annual growth rates -4 2009 2010 2011 2012 -6 -2.8% 3.2% 2.4% 2.5%

-8 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Forecasted values

Source: Statistics Canada, RBC Economics Research Figure 2

Economic Trends September 2011,2 the country’s GDP growth is Canada’s banking industry survived the global forecast to decline from 3.2% in 2010 to 2.4% financial crisis largely intact. The industry, which in 2011 and remain at that level for the next few contributed 3.4% of the nation’s GDP in 2010, years (see Figure 2). The unemployment rate, faces a scenario in which customer deleveraging which peaked just above 8% during the global and continuing global turmoil in the financial mar- economic crisis, now hovers below 7.5% (see kets could affect lending volume and profitability. Figure 3, next page). Canada’s economy recov- ered quickly compared with the U.S., whose According to the Royal Bank of Canada’s unemployment rate has plateaued at 9%; Economic and Financial Market Outlook for however, as the report cautions, consumer

cognizant reports 2 Unemployment Rate % of labor force

9.0

8.5

8.0

7.5

7.0

6.5

6.0

5.5

5.0 2005 2006 2007 2008 2009 2010 2011 Source: Statistics Canada Figure 3

Interest Rate

5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0 Sep-06 Mar-07Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11

Source: Bank of Canada Figure 4 spending on goods and services is likely to expected in 2011 and 2012 due to the economic decrease to 2.1% year over year in 2011 before uncertainty prevailing in global markets (see improving slightly in 2012 to 2.4%. Figure 6, next page). Sales declined by 3.9% in 2010 and are forecast to grow marginally by The overnight rate, Canada’s key policy-setting 0.9% in 2011 and remain at that level in 2012. interest rate set by the Bank of Canada, has Motor vehicle sales are also forecast to remain been at 1% or below since January 2009 (see stagnant at the 1.6 million mark for the period Figure 4). This low interest rate regime has from 2010 to 2012. kept the cost of servicing debt low for consum- ers; however, fluctuation in interest rates due to Industry Landscape uncertain market and economic conditions will The Canadian banking system was rated as first force consumers to deal with a very high cost to in the world for financial strength by Moody’s service their debt. The debt service ratio of Cana- Investors Service for the past two years, and the dian households, which decreased after the crisis, World Economic Forum rated it as the soundest has increased in 2010 (see Figure 5, next page). for the last four years. Canada’s banking indus- try comprises 77 domestic and foreign banks (see Unlike the U.S., Canada’s housing market has been Figure 7, page 5). Bank of Canada, the central relatively strong. It grew in 2010, although the bank of Canada, is the sole issuer of currency market is showing signs of cooling, with flat sales and is responsible for monetary policy, providing

cognizant reports 3 central banking services, promoting a safe and Five of the six banks (not including Royal Bank sound financial system and managing funds. It of Canada3) reported an increase in revenues in uses its ability to set the interest rate for bor- 2010 over 2009. However, all the banks in the Big rowed money to achieve the goal of containing Six recorded increased net incomes and return on inflation below the 3% mark. equity over 2009. Personal and commercial lend- ing contributes more than half of their revenues. The banking industry is dominated by the Big Six banks, which account for 90% of the coun- The banking industry currently employs more try’s banking business. In 2010, the Big Six had a than 260,000 people from diverse backgrounds combined net income of $20.4 billion, an increase and accounts for 1.5% of total employment in of $6 billion from 2009. Interest income accounts the country. Many Canadians hold shares in for a major portion of Canadian banking income. banks. Operating in a limited domestic market,

Debt Service Ratio Interest payments as a % of personal disposable income 11.0

10.5

10.0

9.5

9.0

8.5

8.0

7.5

7.0

6.5

6.0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Canada U.S. Source: Statistics Canada, Bureau of Economic Analysis, RBC Economics Research

Figure 5

Home Resales in Canada Thousands of units (seasonally adjusted annual rate)

600

500

400

300

200

100

0 2004 2005 2006 2007 2008 2009 2010 2011* 2012*

Source: CREA, RBC Economics Research

* Forecast Figure 6

cognizant reports 4 Canadian Banking Industry: A Snapshot

77 Number of banks in Canada

6,150 Number of bank branches across Canada

3.4% Contribution by banks to Canada’s GDP

267,240 Canadians employed by banks in Canada in 2010

$8.3 billion Taxes paid by Canada's six largest banks in 2010

$10.1 billion Taxes paid by Canada's six largest banks worldwide in 2010

$18.2 billion Salaries and benefits paid by banks in Canada in 2009

$10 billion Dividend income paid to shareholders by Canada's banks in 2010

$5.8 billion Amount six largest Canadian banks spent on technology in 2009

489.4 million Number of online banking transactions completed with the six largest banks in Canada in 2009

932 million Number of transactions logged at bank-owned ABMs in Canada in 2010

Source: Canadian Bankers Association Figure 7 banks compete aggressively to acquire customers stance. Some Canadian banks are employing and market share. This has led to a plethora of diverse growth strategies that combine interna- affordable consumer product offerings. Banks are tional acquisitions with improving core domestic also a key source of credit to Canadian business, operations through enhanced offerings as a way representing 58% of all commercial lending. to boost revenues and sustain growth levels.

Canadian banks emerged stronger from the Consumer Behavior financial crisis due to strong retail deposit flows, The quick recovery of Canada’s housing indus- conservative risk appetites and diversification try has played an important role in limiting the across regions and business lines, as well as low recession’s impact. In the past 25 years, national exposure to risky markets. The capital ratios, house prices have been 3.5 times the aver- mandated by Canadian banking regulators and age household disposable income; today, that higher than those of Basel II,4 also helped them number has increased to 4.5. This has resulted, maintain greater liquidity levels. The ability of for the first time in 12 years, in a debt-to-income banks to raise high-quality capital from private ratio (148.1%) that surpasses that of the U.S. markets, riding on the confidence in the Canadian (147.2%), according to Statistics Canada. This banking sector, ensured they were sufficiently is largely due to the increase in mortgage debt. capitalized to deal with unexpected losses. Homeowners have also maintained a healthy amount of equity (72%) compared with debt in Canada’s Financial Consumer Agency, charged their home investments. As of July 2011, the per- with protecting consumer interests, largely centage of arrears to total number of mortgages restricted subprime-type lending by banks and was just 0.4%, which is one-tenth the mortgage helped them avoid the crisis that befell their arrears in the U.S. brethren in the U.S. Other factors, such as lever- age restrictions and incentives that discour- Consumers understand that global economic aged risky securitization products, also helped uncertainty and disruptions in key industries can Canadian banks avoid toxic assets. leave them exposed to high debt with low income. A survey by the Certified General Accountants With limited growth opportunities at home, many Association of Canada says, “Canadians are Canadian banks are expanding into emerging more likely to gauge their debt as decreasing, economies with solid growth potential. Interna- whereas the level of concern over increasing tional expansion, while somewhat risky, is seen debt has declined: 37% of indebted respondents as complementary to a conservative domestic reported their debt as decreasing, while 35% as

cognizant reports 5 increasing; the proportion of those concerned with this type of investment will put additional pres- increasing debt declined from 86% in 2010 to sure on profitability and operational efficiencies. 78% in 2011; 82% of respondents are confident that they can either manage their debt well or Technology Challenges take on more debt; the proportion of those who The sound business practices of Canadian banks think they have too much debt and have trouble helped them weather the global financial storm managing it declined from 21% in 2008 to 18% effectively compared with banks from other in 2011.”5 nations. Going forward, technology will play a key role for these banks to achieve the balance Meanwhile, Canadian consumers have a very between compliance and growth. positive opinion about their banks. Eighty-one percent believe Canadian banks are more stable The Big Six have invested $55.8 billion between and secure than other banks around the world, 1996 and 2009 in technology to provide their while 75% have a favorable impression of their customers with secure, accessible and convenient banks. A total of 76% believe that banks in banking systems. Investments, especially on the Canada do an important job of contributing to the compliance and reporting front, can be expected economic recovery, according to the Canadian to grow as Canadian banking regulators mandate Bankers Association (CBA).6 early adherence with new regulations. Basel III will require banks to pay more attention to inte- Regulatory Challenges grating data sources and using newer data mod- Banks in Canada come under the purview of two eling techniques. Liquidity reporting is another regulators: The Office of the Superintendent of area in which banks will need to invest signifi- Financial Institutions (OSFI) for prudential regu- cantly. They will also need to ensure they have a lation and the Financial Consumer Agency of robust IT infrastructure to deal with data integrity Canada (FCAC) for consumer matters. Every five and usability. years, Canada’s Bank Act is reviewed and updated to stay abreast of industry changes. Legacy modernization is a major challenge for the Canadian banking industry. Newer banks are Regulations and regulatory compliance have been using IT to attract new customers and improve key to the Canadian banking industry, enabling it their level of service. More established institu- to remain strong and stable. However, the move- tions face a difficult time deploying new tech- forward impact of regulatory changes worldwide nologies, as a major portion of their businesses is a big concern for banks in Canada. As they is supported and run on legacy systems. Celent, a enter international markets, Canadian banks will prominent research house, predicts that a signifi- be more exposed to global turmoil and condi- cant percentage of IT budgets in the future will be tions that are in a state of flux due to economic allocated to maintaining legacy systems.7 troubles, worries of sovereign debt and stringent regulations. Adjusting to the regulatory changes Modern-day innovations such as service-oriented will require transformation of business opera- architecture-based systems and cloud-based tech- tions that could slow growth and cause tradeoffs nologies can help alleviate upgrade expenditure to be made between risk and profitability. challenges. Recently, Scotiabank signed up for a cloud-based software as a service (SaaS) solution The key for Canadian banks will be to navigate to replace its multiple legacy trade and supply changes that will have an impact on their busi- chain applications for its global trade services.8 ness operations, models, systems and profitabil- These kinds of systems provide an efficient way of ity, as regulators continue to introduce and imple- allocating capital, in which the bank pays only for ment new measures to ensure transparency and computing resources that are actually used, while stability to the banking system. Banks, therefore, providing a means to quickly enter new markets must effectively manage their resources while and offer new and innovative services. complying with regulations, which calls for retool- ing and investing in IT systems to ensure compli- The call for replacing legacy systems is a long- ance and competitive advantage. Moving forward, standing need. Canadian banks need to address

cognizant reports 6 this with a slow and steady, incremental approach, customer service issue. As more and more con- since these heritage systems are pervasive across sumers use online and mobile banking services, it business lines; it is too risky to replace them all at will be imperative for banks to consider how they once. Competition for customers in the ultra-com- can integrate these technologies and tap into petitive Canadian banking market also calls for their power to support and grow their businesses. newer technologies to achieve market and mind share. Given the state of banking and the econ- Regulations and economic conditions world- omy, taking a middle path is the best approach for wide remain a cause for concern. Banks today banks that want to conserve capital and maintain are required to deal with more stringent capital, operating margins over the short term. liquidity and risk management requirements. In such a scenario, improving operational efficien- cies and gaining additional ground by utilizing Preparing For The Future their existing competitive advantages will deter- For all the recognition that the Canadian banking mine which banks will succeed in the future. industry receives, it operates in a limited and insu- lar market. The industry’s move outside Canada Canadian banks will do well by: for growth will expose banks to global economic Maintaining the fine balance of meeting growth challenges, as well as a slew of regulatory com- targets while complying with more stringent pliance challenges. The industry can overcome regulatory requirements. these obstacles by leveraging its strong banking Diversifying into markets and related busi- system, built on plain-vanilla products, limited nesses with strong growth potential, while exposure to riskier businesses and products, as applying the experience gained in their home well as a strong focus on long-term returns and markets. customer service. Effectively dealing with the economic, politi- cal, cultural and regulatory hurdles in markets Another strength is that the government offers no where they operate. incentives for consumers to take on higher debt, Developing and providing innovative products resulting in prudent borrowing. The Dodd-Frank and solutions. A recent Global CEO survey by Act began mandating stress-testing to measure PricewaterhouseCoopers says that 87% of the health of banks following the global economic banking and capital market CEOs believe that crisis, but OSFI, the Canadian banking regulator, innovation will lead to operational efficien- has been administering stress tests even before cies; 64% believe that IT investments will help the crisis took place. This places Canadian banks them tap into new marketing and transactional in a strong position to contend with new chal- opportunities.10 lenges and opportunities. Achieving operational efficiencies with smart use of technology and third-party services Emerging technologies such as analytics, social to keep focused on acquiring, retaining and media, mobile devices and cloud computing will delighting customers. play a greater role in the coming years. As the millennial generation grows in size and influence, The Canadian banking industry weathered the demand for services that make use of these tools global financial storm. In fact, no Canadian finan- and techniques will play a significant role in deter- cial institution required a government bailout. mining growth and pecking order. Social media is Given their strong fundamentals, track record already proving to be a critical platform to appeal and operational strategies, Canadian banks are to various segments of customers. According to well positioned to tap into new growth opportuni- the JD Power 2011 Canadian Retail Banking Cus- ties. But this can only happen if they can quickly tomer Satisfaction Study,9 more than 60% of and cost-effectively upgrade their legacy systems retail banking customers use social media, and and apply historically solid risk mitigation strat- among those who use social media for banking egies to expand into new geographies and offer purposes, 24% say they do so to discuss their ancillary products that will enable them to incre- banking experience or inform their bank of a mentally improve their top and bottom lines.

cognizant reports 7 Footnotes 1 Big Six refers to the six biggest banks that dominate banking in Canada. They include Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Bank of Montreal and National Bank of Canada.

2 “Economic and Financial Market Outlook,” Royal Bank of Canada, September 2011. http://www.rbc. com/economics/market/pdf/fcst.pdf

3 “Royal Bank of Canada: Annual Report 2010,” www.rbc.com/investorrelations/pdf/ar_2010_e.pdf. Total revenue decreased $776 million, due to significantly lower total trading revenue. Also contribut- ing to the decrease were lower securitization gains and reduced revenues, to the tune of $1.2 billion on account of a strong Canadian dollar.

4 “Lessons for Banking Reform: A Canadian Perspective,” Central Banking Publications Ltd., Vol. 19, No. 4, May 2009. http://www.osfi-bsif.gc.ca/app/DocRepository/1/eng/osfi/osfi_cbnk_e.pdf

5 “A Driving Force No More: Have Canadian Consumers Reached Their Limits?” Certified General Accountants Association of Canada, June 2011. http://ppm.cga-canada.org/en-ca/Documents/ ca_rep_2011-06_debt-consumption.pdf

6 “What Canadians Think About Their Banking Industry,” Canadian Bankers Association, July 12, 2011. http://www.cba.ca/en/media-room/50-backgrounders-on-banking-issues/480-what-canadians-think- about-their-banks

7 Maria Bruno, “Celent Predicts an Increase in Bank IT Spending in 2010,” Bank Systems & Technology, Oct. 29, 2009. http://www.banktech.com/management-strategies/221200022

8 “CGI to Work with Scotiabank for Global Rollout of Trade360,” CGI, August 10, 2011. http://www.cgi. com/en/CGI-work-Scotiabank-global-rollout-CGITrade360

9 “2011 Canadian Retail Banking Customer Satisfaction Study,” JD Power, July 26, 2011. http:// www.jdpower.com/news/pressRelease.aspx?ID=2011107

10 “14th Annual Global CEO Survey: Banking and Capital Markets Industry Summary,” Pricewaterhouse Coopers, January 2011. http://www.pwccn.com/home/eng/annual_global_ceo_survey_14th_bcm.html

Bibliography “Moving Beyond Compliance: How Banks Should Leverage Technology to Capitalize on Regulatory Change,” The Boston Consulting Group, October 2011. www.bcg.nl/documents/file89614.pdf

Cameron French, “Dealtalk: Canadian Banks Look Abroad to Grow at Home,” Reuters, August 29, 2011. http://www.reuters.com/article/2011/08/29/us-banks-idUSTRE77S3JB20110829

“What Basel III Means for Banks IT,” Finextra, February 14, 2011. http://www.finextra.com/community/ fullblog.aspx?blogid=4988

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cognizant reports 8 “Positioned to Lead: Achieving Regulatory Balance,” Insights into Canadian Banking, KPMG, Spring 2011. http://www.kpmg.com/Ca/en/IssuesAndInsights/ArticlesPublications/Documents/4949_Insights CdnBankingIss2_v6_WEB2.PDF

“Canada's Banks See Slower Retail Revenue Growth,” Reuters, Sept. 22, 2010. http://www.reuters.com/ article/2010/09/22/canada-banks-lending-idUSN2210541120100922

Sean B. Pasternak and Doug Alexander, “Canada Banking System Is World's Soundest, Economic Forum Says in Survey,” Bloomberg, Sept. 9, 2010. http://www.bloomberg.com/news/2010-09-09/canada-bank- ing-system-is-world-s-soundest-economic-forum-says-in-survey.html

“Taking Stock of Regulatory Reform,” Insights into Canadian Banking, KPMG LLP, 2010. http://www. kpmg.com/Ca/en/IssuesAndInsights/ArticlesPublications/Documents/Insights%20into%20Cdn% 20banking%20FINAL.pdf

Suzanne McGee, “Canada, By a Long Shot,” Portfolio.com, April 2010. http://www.portfolio.com/ industry-news/banking-finance/2010/04/02/canada-banks-emerge-from-financial-crisis-looking- strong/index.html

Author Aala Santhosh Reddy, Cognizant Research Center

Analyst Svetlana Malu, Cognizant Research Center

Subject Matter Experts Bala Loganathan, Associate Director, Projects, Banking & Financial Services, Cognizant Technology Solutions

Ganesh Rajamani, Senior Manager, Projects, Cognizant Technology Solutions

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