Calgary Bank of Montreal by Jasonwoodhead23

Bloomberg Markets Magazine has recently released its annual list of the world’s strongest banks. Overall it was great news for Canada as four Canadian banks ranked in the top 10 and another two in the top 25. Even though it is not very common to hear “profit” and “bank” in the same sentence these days, Canadian banks have managed to show their strength in this sphere.

While the banks in the US or France are facing tough times trying to find ways to raise money before new global capital rules, Basel III, are put into effect; Canadian lenders find themselves in a totally different situation. The current state of the global economy offers them the opportunity to do some serious shopping.

Let’s go back to Bloomberg’s list. Singapore’s Oversea-Chinese Bank came in first on the list, followed by BOC Hong Kong Holdings. Canadian banks dominated third to sixth places with Canadian Imperial Bank of Commerce being third, Toronto-Dominion Bank fourth and National Bank of Canada fifth. Royal Bank of Canada ranked sixth. Eighteenth place belongs to Bank of Nova Scotia and Bank of Montreal was 22nd.

Royal Bank of Toronto by Vanrite17

In contrast to Canada, the United States had only three banks on the list – JPMorgan Chase (No. 13), PNC Financial Services Group Inc. (No. 17) and BB&T Corp. (BBT) (No. 20). Moreover, Europe was represented only by two Swedish banks, one Swiss bank and one lender from the United Kingdom in top twenty. Given the continuing debt problems and uncertainties in those parts of the world, however, these results were not so surprising. Their problems give a competitive advantage to Canada because the opportunities of investors seeking a safe haven are limited and under such circumstances Canadian banks appear to the one of the most attractive options. China and Brazil completed the list of featured countries.

Criteria for The Ranking

To be honest, this year’s competition was a bit thin because criteria was particularly strict. This was caused by the fact that no bank that posted a loss or failed a government stress test was considered for the ranking. Therefore, many of the world’s largest and most famous banks such as The Bank of America, Citigroup, the Royal Bank of Scotland or Unicredit were automatically disqualified. Moreover, only banks with at least $100 billion in assets were eligible for consideration.

Bloomberg’s global study is based on the following criteria: comparing Tier 1 capital to risk-weighted assets, non performing assets to total assets, loan-loss reserves to nonperforming assets, deposits to funding, and efficiency (costs to revenue).

What is Tier 1 capital? Well, it is the core measure of a bank’s financial strength from a regulator’s point of view. It consists of the bank’s cash reserves, outstanding common stock and some classes of preferred stock. To put it simply, Tier 1 is the least risky asset of any bank.

Why Do Canadian Banks Perform So Well?

It seems that Canadian banks are riding high at the moment, but what is their secret? There is a number of possible answers, but some facts are pretty clear. Strong capital levels, the conservative lending culture and strict regulatory oversight under a single supervisor are just some of the reasons for having one of the soundest banking systems in the world. Canadian banks are forced to hold their level of capital higher than the most other countries. While banks in different countries follow the rules of the Basel Committee on Banking Supervision based in Basel, Switzerland, Canada set up its own, stricter regulations.

Since the introduction of Basel Committee’s rules, they have undergone several changes. Basel I, the first set of regulations created in 1988 focused on credit risk and according to these, banks were required to hold total capital, at least half of it in Tier 1 capital, equal to at least 8 percent of their risk-weighted assets.

Basel II was put forth in 2004 and unlike Basel I, its purpose was to create standards and rules on how much capital financial institutions have to put aside to reduce the risks associated with its investing and lending practices.

Bank of Nova Scotia by Ann Baekken

Most recent global regulatory framework for more resilient banks and banking systems, Basel III, was introduced in 2010 as a result of ongoing financial crisis. The long-awaited agreement aims to find a way to make banks more resilient to financial shocks by setting a new key capital ratio of 4.5 per cent, more than double the current 2 per cent level, plus a new buffer of a further 2.5 per cent. Banks whose capital falls within the buffer zone will face restrictions on paying dividends and discretionary bonuses, so the rule sets an effective floor of 7 per cent. The new rules will be phased in from January 2013 through to January 2019.

Canada’s regulator has always gone beyond those levels in its requirements. Its decisions has not always met with a positive response. However, time has shown that such steps were the best possible tactics. When in January 1999 Canadian banks were told to set aside more than 10 percent of their total capital January against possible losses, their managers were not happy and often complained. Another set of rules required those same banks to hold 75 percent of their capital in equity. Once hated decisions turned out to be one of the most important factors that saved Canadian banks from going bankrupt when the crisis spread across the world. Staying way above Basel turned out to be a great idea.

Making The Most of Every Opportunity

Last year, Canadian banks reportedly spent $14.4 billion on acquisitions. Many of them even started expanding to the US. TD Bank, for example, has now more branches in the US than it has in Canada. Bank of Montreal (BMO) bought Marshall & Ilsley Corp., a Milwaukee-based bank, and added it to the previously owned Chicago-based Harris Bank franchise. Royal Bank invested about $1.1 billion in RBC Dexia Investor Services Ltd.

Even though things look great at the moment, Canadian banking system must not ease up. There might be tough times ahead as profits are expected to decrease from 13 percent to 7. However, if we manage to keep the pace with the high tempo, we are very likely to retain our status as world’s best banking system once again.