Canadian Banks: Hanging onto $40 Billion

By Tara Perkins

Canadian banks will be holding on to about $40 billion in excess capital by the end of fiscal 2012, UBS analyst Peter Rozenberg estimates in a note to clients Tuesday.

The key measure of a bank’s capital level is called the Tier 1 ratio - a comparison between the amount of capital it has to the amount of risk in its assets (i.e. loans) - and Canadian banks are currently required to keep it above 7%. The G20 has said that it intends to ratchet up capital requirements in coming years, and Mr. Rozenberg assumes that Canadian banks will be required to keep the ratio at 10%.

Even at that level, he expects that the big six banks will collectively hold more than $30 billion in excess capital by the end of 2011 and $40 billion in excess capital by the end of 2012. That means that their extra financial cushions would equate to 16.7% of their current market value, up from 6.4% at the end of this year.

The banks Tier 1 ratios currently range from 10.4% at Bank of Nova Scotia (BNS) to 12.9% at Royal Bank of Canada (RY), and the group already has $15.7 billion more in capital than it would need to maintain a 10% Tier 1 ratio.

“We estimate that Royal Bank alone could generate upwards of $17 billion in excess capital by the end of fiscal 2012, which would represent a significant 22 per cent of its market capitalization,” Mr. Rozenberg wrote. “Similarly, we estimate that Bank of Montreal (BMO), Bank of Nova Scotia, CIBC and TD Bank, will each have $4-6 billion in excess capital, or a significant 11-22% of their market capitalization.”

Mr. Rozenberg suggests that the best use of all that money when the economy rebounds will be making more loans, rather than acquisitions or share buybacks. Toronto-Dominion Bank is still only making a 5% rate of return on its U.S. consumer and business banking business, while Royal Bank’s return on the same business is negative, he notes.