The latest federal budget has some negative implications for the Canadian banks, but shouldn’t do much to dent their overall profitability, according to a report from Moody’s Investors Service.

Some of the budget announcements affecting banks will have positive credit implications, while several others are likely negatives, notes Moody’s senior vice president, Peter Routledge, in a research note, “but in aggregate they paint the picture of a very profitable, stable domestic banking system that will continue to benefit from systemic support in times of stress.”

In terms of negatives, Moody’s points to the government’s plan to stop bolstering bank funding by purchasing pools of insured residential mortgages, which is also coming as the Bank of Canada is pulling back some of its extraordinary liquidity measures. “These programs have been withdrawn gradually and with ample advance warning, and have not de-stabilized the system in any way. That said, the withdrawals are credit negative,” it says.

Another negative for the banks is the move to allow credit unions to incorporate federally. “We believe a smaller number of centralized credit unions could pose a longer-term strategic challenge for the Canadian banks. While we do not wish to overstate the case, we point out that credit unions today have a 15% share of residential mortgages and an 18% share of deposits in Canada. To the extent this segment consolidates, streamlines its operations, and expands its offerings, we believe it would boost its share of the Canadian retail financial services market,” it says.

Additionally, the federal government announced its intention to institute a number of measures to bolster consumer protection, Moody’s notes. This includes measures such as expanding the Financial Consumer Agency of Canada’s mandate; prohibiting negative option billing; standardizing mortgage pre-payment penalty disclosure and calculation; reducing the maximum cheque-holding period to four days from seven days; and requiring banks to join an approved third-party dispute handling body to adjudicate customer complaints.

Moody’s suggests that the government is seeking to enhance competition and improve consumer protection in the banking sector for a couple of reasons. “The domestic banking system is, in our view, an oligopoly in which the incumbents earn substantial rents. Canadian banks’ retail financial services arms produce return-on-equity ratios of 30%-40%,” it reports. “In addition, we believe Canadian authorities have taken as a key lesson learned in the financial crisis the need for proactive consumer protection.”

Notwithstanding these negative steps, “The budget was not all bleak for Canada’s banks,” Moody’s Routledge adds. “Most importantly, the government announced it would introduce legislation setting out a legal framework for covered bonds in Canada.” He says that Canada’s banks have so far issued relatively small amounts of covered bonds, but that the new legal framework will likely “fuel greater domestic appetite for a long-term and low-cost funding alternative.”

“The withdrawal of extraordinary systemic support implies market confidence in the Canadian banking system, which we view as an indirect, but positive credit implication. Canada’s banks were not excluded from the loss of confidence in late 2008 and early 2009, otherwise the authorities would not have advanced liquidity support. That those same authorities have now chosen to withdraw support signals their comfort that market confidence is durable,” Moody’s observes. “The prior existence and magnitude of Canadian systemic support suggest the government would re-activate them, and other measures, when the need arose.”

“Looked at in summary, these measures reflect an underlying gradualism that guides the public policy approach to the banking system. On balance, these measures, individually and in totality, will only impact the banks’ credit profiles at the margin,” it concludes.

IE