Canada's Big Six banks overshadow a whole bunch of minnows

It could be easy to think there are only five or six banks in Canada. RBC, TD, BMO, Scotiabank, CIBC and National Bank lay claim to the tallest towers on Bay Street, the biggest sponsorship of major events, and seemingly half of the commercial time on TV with ads reminding you of the value of (their) sound financial advice.

But labouring in the shadow of the “Big Six” is a handful of smaller banks struggling for a toehold in a crowded market, and getting little help from regulators, according to a new study by the C.D. Howe Institute.

According to the report, entitled “Swimming with Whales”, Canadian regulations, which were largely put in place before the Internet came along, and then were tweaked after the 2008 financial crisis, limit the growth prospects of the smaller banking.

And while you might be thinking ‘Who cares? My TD credit card works fine!’, the upshot is that this regulatory bias leads to less innovation and competition, which can only hurt the Canadian market in the long term.

“The fundamental question is whether our regulatory framework is too narrow, thereby limiting the ability of new entrants to provide the services that today’s consumer demand and inhibiting their ability to become economically viable,” lawyer and author John Jason says in the report.

The top-heavy nature of Canada’s banking industry follows years of mergers that have left us with six banks controlling the lion’s share of the industry’s assets. It’s a far cry from the U.S., for instance, where there are big players, but also a healthy mid-tier sector that allows for competition and customer choice.

Canadian governments have had a stated goal to promote competition in the sector since 1999, but the results have been mixed. While the number of Canadian banks has actually grown from eight to about 30 during that period – with more on the way – the ‘big six’ have actually increased their market share to 93 percent from 90 percent over the past decade. So there are new players, but they’re fighting for scraps.

“Given that there are now many more competitors in the market, why have we not seen a greater redistribution of market share?” says Jason.

This may not affect the vast majority of bank customers out there, who see little difference in a mortgage offered by BMO or Scotiabank.

But smaller banks do serve a key niche in the economy, filling the needs of often under-served local businesses and households, says James Shanahan, a Canadian bank analyst at Edward Jones.

“Community banks, and especially credit unions, often have stronger relationships and can sometimes offer lower-priced products and services than the larger banks,” he says.

First National Bank of Canada, for instance, caters to the needs of the Aboriginal market, while Wealth One Bank of Canada, which just opened last month, focuses on the Chinese Canadian market.

And then there’s the whole innovation aspect. While the big banks are all pushing diligently into the smartphone age, smaller banks have the benefit of being nimble and faster to adapt services to new technology.

And new technology is fast elbowing its way into the market, with a burgeoning financial technology, or ‘fintech’ market, also offering services and looking to steal customers away from the banks.

But while the government says it aims to balance the needs of efficiently, utility and stability in the sector, James says the rules focus too much on promoting stability.

“Instead of acting as an innovator, a new bank is incented [sic] to offer the same products and services in the same manner as every other bank,” he says.

The emphasis on stability is likely in part a hangover from the 2008 crisis, when the government imposed tighter rules on lending, forcing banks to set more money aside to ensure they could stay afloat in the event of a major market disruption. While the big banks can easily handle that kind of cost, it makes life tough on smaller players that don’t have the same resources.

And besides, Jason argues, is it that necessary to eliminate risks at smaller banks? If a major bank fails, it could trigger an economic crisis, but if a tiny lender specializing in a niche market goes under, it’s not exactly going to destroy the system. And new businesses by their nature are more risky.

Jason suggests the government should consider new regulatory approaches to pump up the role of the smaller banks.

This could include allowing smaller lenders to seek a kind of regulatory relief, since they pose a smaller risk to the system, and reducing the smaller banks’ capital requirements, or money essentially held on their balance sheet to guard against disaster.

“If the government continues to believe that a level playing field is required, then it may be time to reconsider the regulatory model across the industry,” he says.