Moody’s cautions Canadian banks

Grant Robertson

As Canadian banks expand their capital markets businesses, they are taking on significant amounts of risk, a new report from bond-rating agency Moody’s Investor Services says.

Though no Canadian bank derives more than 30 per cent of its business from capital markets activities, the expanding role investment banking is playing in the otherwise low-risk Canadian banking environment represents an increase in risk, the report points out.

“Several Canadian banks are now expanding their wholesale investment banking activities... For bank bondholders, this growth in capital markets activity creates a significant amount of incremental risk,” said Peter Nerby, senior vice-president and co-author of the report.

The notion of increased risks from heightened capital markets activity is to be expected, since trading revenue is considered more volatile than the more safe and steady retail deposit and lending operations that are the core businesses of the big banks.

Though Canadian banks outperformed banking systems around the world during the credit crisis, and became an example of stability to other countries, the report argues that there was still a significant impact from increased exposure to capital markets.

Moody’s estimates the wholesale investment banking divisions of Canadian banks as a whole tallied $22-billion of losses during the three-year period from early 2007 to the end of 2009. That drop, which came during the heart of the financial crisis, represents 22 per cent of aggregate core earnings during that period, the report says.

“The sub-prime mortgage and structured credit crisis illustrated the opacity of many risks to bank bondholders and the challenges facing Canadian bank managers of accurately measuring capital markets risks,” said Moody’s analyst Ali Mozaffari, a co-author of the report.

The impact of volatile markets on the capital markets divisions of Canadian banks has been an issue over the past week as several lenders reported significant drops in trading revenue in the third quarter. The drops came as bond and equity trading slumped this summer amid concerns about European sovereign debt, dragging down the capital markets divisions at Bank of Montreal, Royal Bank of Canada, National Bank, Bank of Nova Scotia and Canadian Imperial Bank of Commerce. A similar trend is expected when Toronto Dominion Bank reports its third quarter earnings on Thursday.