- August 29, 2011
Are Canadian banks the safest in the world
While pricing data and quotes on Canadian bank CDS is somewhat spotty (which itself could be interpreted as a signal of market strength since liquidity is often driven by demand, especially to protect from default, or alternatively as an area lacking focus and understanding from institutional investors) the prices and quotes which are available seem to indicate that investors view Canadian banks as among the least, if not the least, risky in the world.
The Financial Post specifically quotes CIBC CDS at 85 bps and the Bank of Nova Scotia CDS at 31 bps compared to one of the strongest American banks, JP Morgan Chase at 122 bps. Other well-known banks such as Bank of America, the UK’s Lloyd’s, Royal Bank of Scotland, Spain’s Banco Santander, Italy’s Unicredit, or France’s Societe General are in excess of 300 bps.
Not everyone agrees with the CDS market’s assessment of banking risk though. Zerohedge recently took a shot at the strength of Canadian banks by pointing out that on a comparison of Tangible Common Equity ratios (TCE to total assets), Canadian banks are actually among the riskiest in the world with all the majors except for Bank of Montreal (that is, Royal Bank of Canada, TD Bank, Bank of Nova Scotia, Canadian Imperial Bank of Commerce and National Bank) with TCE ratios below 4%. The Zerohedge report, however, drew a quick reply from Boyd Erman of the Globe & Mail who suggested that the traditional TCE-to-total-assets is not as good a measure to use as TCE-to-risk weighted assets (TCE/RWA).
Interestingly, a 2009 study by McKinsey found that, when looking at the global banking crisis from 2007 to 2009, the ratio of tangible common equity to risk-weighted assets was the best predictor of bank distress.
It doesn’t appear that McKinsey looked at the debate over which TCE ratio to use. What the analysts did find is that as the TCE/RWA ratio rose above 7.5 per cent, the likelihood of banks getting into distress declined sharply. Below that level and banks started to get into trouble.
And in that case, Canadian banks, with average ratios over 10 per cent, look very strong.
Here’s an excerpt from McKinsey’s survey of the 2007-2009 period.
“Banks with a TCE to RWA ratio of less than 6.5% to 7.5% accounted for a disproportionate share and the vast majority of distressed banks. Approximately 21% of the largest global banks became distressed during the crisis. Banks with a TCE to RWA ratio of less than 6.5% prior to the depths of the crisis had a distress rate of 33% and made up 58% of distressed banks. Banks with a TCE to RWA ratio of 6.5% to 7.5% had a distress rate of 25% and, together with those with a lower ratio, made up 83% of all distressed banks.”