The Canadian Press

Top Canadian bank executives say merger and acquisition activity in their industry has stalled due to uncertainty about where global banking regulations are headed, but that consolidation will lurch back into gear this year and next as new rules come into effect.

M&A activity in the sector has been hampered by fears that the rules will be changed dramatically in response to the 2009 credit crisis, which has been largely blamed on reckless lending, particularly in the United States.

President Barack Obama is pushing to recover the public money used to bail out failing banks and insurance firms at the height of the financial crisis through a tax on the country’s largest financial institutions. He renewed his call Thursday for a regulatory overhaul of the industry and scolded bankers for opposing the tighter oversight in legislation moving through Congress.

The Canadian banks, while generally avoiding the excesses and resulting calamity that affected major financial institutions in other developed countries, have been cautious about making major deals in such a politically charged environment.

“The last 12 months has been a difficult period to conclude any kind of transaction with a quality company,” Bill Downe, president and CEO of BMO Financial Group (TSX:BMO), told a banking conference in Toronto on Thursday.

“Most of the transactions that have been done have been confused by (U.S. Federal Deposit Insurance Corporation) involvement and changing rules,” he said.

Downe’s counterpart at Royal Bank (TSX:RY), Gord Nixon, said it would be “almost irresponsible” for banks to be overly aggressive while they await details about rules from the Basel Committee, an international body based in Switzerland that sets international banking standards.

“Today we’re operating in an environment where conservatism is being pushed to the limit because the regulators don’t want to be caught offside, nor do financial institutions want to be caught offside,” the RBC president and CEO said.

The Basel Committee — although it has no enforcement role — has released a string of proposals aimed at improving the risk protection and transparency of the global banking industry, particularly by boosting banks’ capital requirements so they have a bigger cushion against future periods of financial stress.

On top of potential regulatory changes, Canadian banks with major U.S. operations — including BMO, Royal and TD Bank (TSX:TD) — could face higher taxes from the U.S. government as the Obama administration fights to regain some of its bailout money.

TD chairman and CEO Ed Clark said he does foresee higher taxes on the bank’s U.S. operations, which include a 45% stake in TD Ameritrade and an insurance business.

“Clearly there’s a risk here that we’re going to have to put up more capital against our 45% stake in Ameritrade, and we’re going to have to put more capital against our insurance business. It’s too bad, but you don’t change your business strategy because of that,” Clark said.

CIBC (TSX:CM) president and CEO Gerald McCaughey said all the uncertainty in the industry is keeping bankers cautious for the time being.

“Because of the uncertainty, first in terms of the broad environment and now in terms of the regulatory environment, I think ourselves and a number of our competitors are not engaging in activities that would be capital-reducing other than normal business growth,” McCaughey said.

Although Canada’s Big Five banks generally have much higher capital levels than their American counterparts, they have been reluctant to move ahead with any major acquisitions until the new regulations are in place, the Royal’s Nixon said.

However, with final implementation of the Basel Committee’s proposals targeted for the end of 2012, clarity is on its way, Downe said.

“I think consolidation is going to start in 2010 and accelerate into 2011,” he said, adding that banks that are well capitalized will see “more than their fair share” of growth.

BMO sees particular opportunities in the American Midwest, including Chicago, where it already has a strong presence and the “relative weakness of competition” will allow it to expand, Downe said.

Meanwhile, TD’s Clark said he’s open to small deals in the United States, but only if they make financial sense.

“I don’t think most Canadian bank CEOs are going to be rushing to burn through their capital until they have some certainty of (the new rules), so that probably means you’ve got to look at the deals and say, ‘Would I be willing to issue shares to finance these deals internally,’ and if they don’t make sense that way, they probably don’t make sense any way,” he said.

@page_break@TD, Royal and BMO all have major retail banking operations in the U.S., while Scotiabank (TSX:BNS) has international operations all over the world and CIBC is primarily focused on Canada with some operations in the Caribbean.

The banks will likely focus on “incremental growth” in their existing markets as M&A activity in the industry ramps up, said Colin Ciezynski, an analyst at CMC Markets Canada.

“Because Canada’s banks have come through this global structural mess in the banking sector quite in tact and in a lot better shape than everybody else, that puts them in the position where they can go shopping,” Ciezynski said.