Tuesday, September 21, 2010

(No.114) Canadian banks: mistakes & excessive praise

Earlier this month I spoke to a conference of life insurance brokers at the Crowbush Resort on Prince Edward Island. The meeting was organized by the MGA firm Younker and Kelly. What follows is taken from that presentation.


In the wake of the financial services meltdown in the U.S. and Europe I have read and heard much praise heaped upon Canadian banks for their admirable strength and stability during the international financial crisis. The credit actually belongs mostly to strong Canadian federal banking rules (about which Canadian bank executives have periodically pissed and moaned) and even more important, to strong federal regulators who enforced the rules whether the banks liked it or not. Both of these key regulatory elements were deficient in the U.S. and Europe.

Those were the factors that had most to do with preventing Canadian banks from following some of the worst of what their American and British peers were doing in their pursuit of the financially ridiculous. Nor is it true that the Canadian banks received no crisis-related financial backing from Ottawa unless one excludes a $200 billion low interest line of credit.

In any case it is interesting that the big Canadian banks, despite their supposed superior management, in the three years 2007 through 2009 wrote off an estimated $21.5 billion they would otherwise have recorded as profit because of their exposure to bad bets they made largely on U.S. 'investments' that went down the porcelain convenience. [For other comments on this subject in RickardsRead.com, see column No.90: "Banks, stability & insurance: the silly & the wise".]

Still, not to worry; the huge profits the banks make quarterly from the Canadian retail banking customer serve as far more than an adequate offset for these and other losses in their non-Canadian adventures. It reminds me of the profits Sun Life derives from -- as its corporate perspective would have it -- its 'small population market' Canadian operation (compared with Sun Life in China, India, Indonesia and the U.S.). Funny thing though, these Canadian dollars serve as a predictably reliable financial foundation supporting the company in the absence of sufficient profits from its international operations.

In terms of government expansion of the big Canadian banks' still limited ability to retail insurance (life as well as property insurance) in their branches I do not look for any change, at the very earliest, before the election of a majority federal government, and probably not then. Keeping the status quo is a political reality that has been reconfirmed by federal finance Minister Jim Flaherty, in major part because no federal government (including his) wants another political fight with insurance agents, and all the more so if it is a minority government.

If it is also a government, like Prime Minister Harper's Tories, whose core political support is in areas of the country like the prairies where historically dislike for the big eastern banks is almost bred in the bone, it will not be seeking ways to accommodate the Bay Street banks' insurance wish list no matter how fervent their desire for change.

Even if the feds decided to change the rules for bank branch retailing of insurance (something they could do tomorrow by regulation rather than statute) it would still be a matter for each province to decide on what basis they would permit expansion of bank insurance retailing. Remember: which individuals can sell insurance, where and how has been confirmed by the Supreme Court of Canada to be a matter of provincial jurisdiction.

I confess that for more than two decades I longed both privately and publicly for the big banks to make the mistake to which I believed their unique combination of size, arrogance and ignorance might eventually lead them: to challenge in court provincial jurisdiction over insurance distribution as it involved federally chartered and regulated banks and how banks could and could not go about selling insurance.

I published (in a series of articles by the late life insurance company general counsel Benson Rogers in my Canadian Journal of Life Insurance) the definitive treatment, then and now, of the legal and regulatory history of the Canadian federal/provincial constitutional divide in insurance. I was confident that the bankers would lose, blinded as they were by their Pavlovian view that whatever banks do (including selling insurance) is banking and therefore excluded from provincial regulation even when it involved agency insurance distribution. And they did lose -- big time, to quote former U.S. Vice-President Dick Cheney.

The mistake I had long awaited was made by the banks in challenging Alberta insurance legislation. The banks lost their challenge in Alberta court, lost again on appeal and then compounded their mistake (God bless their arrogance and high-priced legal advice) by appealing the Alberta case [Western Bank v. Alberta] to the Supreme Court of Canada --- where in a May 2007 SCC precedent-setting decision they lost on all important counts, as I had predicted they would.

As for what the big banks can hope for in terms of provincial regulation, provincial governments have shown little affection for them and their persistent efforts to get their own way, not least because lobbying by p&c and life insurance agents can be even more politically potent at the provincial level than it has been in Ottawa. In fact at both the federal and provincial levels the p & c side of the insurance business has become the strongest element in the political fight over expansion of bank branch retailing of insurance.

When I think of the big Canadian banks' indefatigable commitment to getting ever larger as well as their dependence on the Canadian retail banking customer to bankroll their extra-Canadian financial adventures, I recall a comment made by K.R. MacGregor, Canada's federal Superintendent of Insurance and later CEO of the Mutual Life Assurance Company of Canada which he said "is not seeking growth merely for the sake of growing, but rather growth in order to serve better and more completely. The dinosaur's lesson is that if some bigness is good, an overabundance of bigness is not necessarily better."

While that seems today both wise and prescient it also sounds quaintly old-fashioned in an era when the pursuit of inflated executive compensation ensures that ramping up short term corporate profit through questionable activity (leveraged and otherwise) is too often the guiding light for senior management. Consider what has happened since 2007 in North American financial services and the economy (indeed the western world's) and one appreciates not only the foresight of Mr. MacGregor's observation but its relevance today to the largest Canadian banks and life insurance companies.

[For background on the reality of banks and insurance in Canada see also, for example, in RickardsRead.com: column nos. 33, 34, 47, 48 & 69.]


Alastair Rickard


email: Alastair.Rickard@sympatico.ca