There is trouble afoot for the banks. For the first time in a long time, bank stocks are sharply lower, like just about everything else on the Toronto Stock Exchange. But I'm here to tell you about the bright side.
Canada's biggest banks are currently being hit by a double whammy: Two of its most reliable and lucrative sectors to lend, oil and property, are in danger of retreat.
In some ways it's just bad luck. The causes of the two are completely unconnected. But according to my way of thinking, what seems like bad news will spur our banking giants into efforts that will be good for the entire Canadian economy — and ultimately good for the banks themselves.
First a little reminder about how banks make money. While Canadians are prone to think first of those annoying bank fees, they are nothing compared to their real business.
To repeat an analogy I've used before, banks make money renting money like Hertz makes money renting cars. But banking is much more lucrative than car rentals.
U.S. bank Morgan Stanley puts a $43 price on oil. If it's right, that will hit expansion, and therefore bank lending, in the energy sector. (Norm Betts/Bloomberg News)
One reason is that in banking you can lend about 20 times more money than you have. That would be like renting out 100 cars when you only own five, which of course is impossible.
The other great thing about renting money rather renting cars is that people can only use so many rental cars. The desire for money is much, much larger.
Looking for a payback
There is a similarity between renting cars and lending money, however, and which is that you have to make sure you get paid. Lending $10,000 to a friend who can't pay you back is like lending your car to a friend who drives it over a cliff. Not a good business plan.
That's why banks love lending to people like middle-class Canadian homeowners with steady jobs. They are very reliable at repaying, especially when those loans are mortgages and lines of credit backed by the value of the homes. But there is a danger this business may be slowing down.
The world's big loan rating agencies like Fitch and Moody's are uttering serious warnings about Canadian personal debt — including mortgages — being "unsustainable." The banks themselves realize an improving U.S. economy means interest rates could soon begin rising, giving the homeowner lending market a sharp knock over the head. The construction sector would also feel the pinch.
The Canadian housing market has been the cornerstone of lending since before the downturn, but banks may have to start looking elsewhere. (Nathan Denette/Canadian Press)
The other safe area for lending has been in the resource sector. With oil prices high, with full support from federal and provincial governments, lending for exploration and expansion in the petroleum sector has seemed like a sure bet.
Reports last week show Canadian banks do up to 20 per cent of their lending to the sector. Add to that a big U.S. bank, Morgan Stanley, projecting the price of oil will fall to $43 U.S. a barrel, down from more than $100 in June.
Lower prices mean oil companies are already cutting back on expansion plans, which means they will need to borrow less.
The bright side
Now here is the good part. With consumers, construction and oil taking a smaller share of bank lending, banks must look for new places to lend that money. Remember, they have to lend. It's their bread and butter.
With the U.S. industrial economy charging ahead, there is every likelihood that Canada is not far behind. The Canadian industrial economy is ready for a takeoff. But to do so, young and expanding businesses will need loans.
It's well known that Canadian startups have trouble getting their money at home. And you can see why, with banks pouring so much of their money into the safe and lucrative world of secured lines of credit and loans to the ever-expanding resource sector. Lending to entrepreneurs is much harder work.
This is a business the Canadian banks have always been in. But maybe with easy money in property and the oil business, they have been getting rusty. Certainly young entrepreneurs have said it has been hard to get support from the domestic banks.
Banks need to lend to survive. With extra money on the table, with a pool of great ideas waiting for funding and a Canadian economy loaded with spare capacity, this is an opportunity.
The banks must do the hard work. They must try to pick winners, knowing they cannot always succeed. But in the process they will show Canadians they are about more than high executive salaries, high fees and cheap mortgages. Instead bankers will be able to hold up their heads as champions of Canada's sunrise economy.
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