Covid-19 and Canadian Retail Banking - Things are not looking too bad for the Dinosaurs
Covid-19: When will it end? What will be the damage to the economy? What will be the impact on the major players in Canadian Retail Banking?
Looking at the S&P 500 over the last few weeks, it seems that it will all be over soon, with limited economic damage. Let’s call this the mild outcome.
A Reuters poll of 25 economists says the Canadian economy will shrink by 27.5% this quarter. In April the US growth in unemployment equals the total working population of Canada (~20 million people). Per The London Times Britain is on course to suffer its worst recession for 300 years. Economic indicators say this will go on for quite a while and the damage to the economy will be significant. I’ll call this the severe outcome.
Now, the efficient markets hypothesis says that stock prices reflect all available information and is therefore the best possible prediction of the future. There is also a view that stock markets are driven by irrational human psychology, amplified by trading algorithms. Then again, economic data is reported by publications and neutral stories don’t attract eyeballs or win Pulitzer prizes.
Bottom line: We don’t know which scenario will materialize.
So, let’s look at both scenarios and the impact on Canadian Retail Banking.
In the mild outcome, we just go back to normal. Malcolm Gladwell, in a recent appearance on the Munk Debates, said it nicely, “We will be so thoroughly sick of each other we will race back to the way things were.” He justifies his view by roughly two arguments: (1) It feels like an eternity, but really, it’s been less than 10 weeks. World War Two was five years. The Depression ten. It actually takes time to change behaviours; (2) Refugees who leave their country of origin reconstruct the best parts of their lives in their new countries. We will do the same and go back to all the things we love.
We may debate this, but there is something to say for the human tendency to stick with what has worked in the past. Like the Y2K scare, this may just come to pass.
For Canadian Retail Banks, in this scenario the challenges remain the same, just more pronounced: Low interest rates, indebted customers, and a homogeneous oligopoly mean the only way to grow EBIT is to cut cost, i.e. be more efficient, convert more customers to digital and accelerate the painful process of closing branches.
In this scenario we would return philosophically to muse about the question in the slow cooker: Are RBC and TD opening a gap between them and the rest of the Big 6 and what does that mean for the future?
On a more practical note, the next mortgage season will be a red ocean, lots of liquidity, very low rates, pent-up demand. Better be ready.
The severe outcome makes for a more interesting story. My synthesis of the views in the press is that the world will change in 4 ways:
De-globalization as manufacturing of perceived key products and services are moved back within national borders, coupled with nationalism, and a larger role for the state.
Growth in digital adoption and commerce, as the population sticks to new behaviours which turn out to be more convenient.
Focus on resilience, not just efficiency, and more energy spent on planning for Black Swan type events.
Consolidation of economic power with large organizations that survive the pandemic and face a world with less competition.
For Canadian Retail Banks, like for most established businesses, this will be a grim time.
Delinquencies and losses will go up as the “instantly unemployed” due to Covid-19 become the long term unemployed. When the six-month mortgage deferral expires (10-15% of all Canadian mortgagors participated) potentially a whole swath of customers will default simultaneously.
Low interest rates “forever” will cut into Deposit revenue.
Lower spend will eat into Payments revenue. In the last week of March spend on cards were down 60% according to RBC.
Lending growth will disappear, as the customers who are still employed are probably over-indebted anyway, and everyone is less confident and more conservative.
Home prices will fall. In Canada this may not be catastrophic due to mortgage insurance providing an incentive for the CMHC to backstop the market. However, there will be less equity in homes to enable HELOCs.
And yet, in the long term Covid-19 may lead to stronger banks, a stronger oligopoly and higher earnings for patient shareholders. New attitudes will favour local banks, changes that were underway with glacial speed will accelerate and sharply reduce cost. The survivors thrive post-pandemic.
In the names of the Big 6 Banks we find the following words: Royal, Canada, Toronto, Dominion, Nova Scotia, Montreal, Canadian, Imperial, National. In a more nationalistic world, the Big 6 are as Canadian as it gets. As we have already seen, the banks will work together and with government institutions to pull Canada through the recession. This couldn’t be bad for public perception.
In the UK the use of cash is down 70% due to Covid-19. This reduces the cost of managing a high risk, manual payment method. It also reduces the need for branches and ATMs.
As customers flock to digital during the pandemic, many branches may not come out of the mothballs. CIBC temporarily closed 20% of branches, and reduced hours in the remaining 80%. Total Canadian branch capacity is probably down 30-50%.
On BNN, BMO reported up to 80% of workers may switch to blended home-office work. This means lower real estate cost.
Competition will be obliterated. Successful disruptors will be acquired. On the other side of the pandemic will emerge fewer, bigger players with higher barriers to entry. Stringent capital and regulatory requirements that act as a moat today to protect incumbents will be lauded as the reason Canadian banks did well during the pandemic.
However, for established banks the Regulator working with other government institutions will be less stringent to help Canada get back on its feet. I imagine B-20 will not be interpreted as literally as it is today. This will open the door to new and exciting ways to adjudicate loans.
Open Banking has already been delayed. If it happens there will be fewer participants, and Open Banking may paradoxically provide an inoculation of ennui that discourages customers from future adventures with start-ups.
Either way, things are not looking too bad for the Dinosaurs.
There will be some pain as Canadian banks do what they always do and over-provision for loan losses at the start of a recession. In the medium term, they will thrive like they did in the decade after the Financial Crisis.
To be clear, when I say Dinosaurs I don’t refer to outdated, extinction-bound corporations. I mean hugely powerful institutions set up to thrive in the new normal.
Wikipedia says the Dinosaurs survived for 165 million years. Humanoids have only been around for 6 million years. We may only be at the beginning of the Jurassic period.