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Canadian Banks' Sterling Reputation An Illusion, Financial Blog Argues

Since the financial crisis of 2008, Canada’s banks have become the darlings of the financial world, lauded by experts and observers for weathering the global storm arguably better than banks anywhere else in the world.

But according to an influential U.S. finance blog, that status is an illusion, and Canada's banks face potential catastrophe if their assets drop in value.

According to "Tyler Durden," the pseudonymous blogger behind Zero Hedge, "there is one place that has been very much insulated from the whipping of the market, and one place where banks are potentially in just as bad a shape as anywhere else in Europe. That place is ... Canada."

Durden's argument centres around the Canadian banks' tangible common equity ratio -- a measure of banks' ability to absorb losses. Durden reports that all of Canada's major banks have a TCE ratio below 4 per cent, meaning the banks could be insolvent if their assets lose more than 4 per cent of their value -- a narrow margin indeed.

According to Boyd Erman at the Globe and Mail, such a scenario could happen if Canada's housing market weakens considerably.

"In Canada, the concern would have to be the housing portfolios, the biggest chunks of Canadian banks' assets," Boyd writes. "If you believe that housing is in for a severe correction in Canada, and that Canadians won't repay their mortgages when the value of their homes falls, and that the banks will have to take significant write downs on the portions of their mortgage portfolios that are not insured by the federal government, then maybe you will come to the conclusion that Mr. Durden is onto something."

A chart comparing world banks' TCE ratios shows that all of Canada's six largest banks are among the 21 banks with the lowest TCE ratios, or the highest risk of becoming insolvent if the economy goes south.

CIBC's TCE ratio places it fourth in the world, with only Societe Generale, Deutsche Bank and Credit Suisse showing lower ratios. The National Bank, Scotiabank, RBC, TD and BMO all make the list as well, with five of the banks showing TCE ratios below 4 per cent, meaning a 4 per cent decrease in the value of their assets could sink the banks.

Canada's banks commonly report TCE ratios of 6.5 per cent or better, but as the Globe's Boyd explains, those ratios are based on risk-weighted assets rather than total asset values.

"Risk weighted assets adjust for the chance that the assets will go bad, and that's hardly a science. Total assets doesn't allow for such judgement calls," Boyd writes.

UPDATE: Campbell Harvey, a professor of international business at Duke University, disagrees with Boyd's assessment.

"You have to look at the quality of assets," he told BNN Friday afternoon. Canadian banks' assets include large holdings of AAA-rated Canadian sovereign debt and other high-quality assets, and "that's a lot different" from European banks that hold troubled Greek debt, for example, Harvey argued.

When you look at the quality of assets, "Canadian banks are amongst the most conservative in the world," Harvey said.

Original story continues below

For the time being, Canada's banks are likely to retain their sterling reputation at home and abroad, and most analysts list Canadian banks as among the most stable in the world.

On Thursday, Global Finance magazine released its 2011 list of the world's 50 safest banks, and six Canadian financial institutions found themselves on it. RBC led the Canadian pack, ranking 11th in the world, with TD Bank (13th), Scotiabank (18th), Caisse central Desjardins (20th), BMO (30th) and CIBC (31st) rounding off the list.

Despite its founder's use of a pseudonym from a 1990s cult film, the Zero Hedge blog is among the most influential financial blogs in the U.S. It has been credited with being the first to raise concerns about high-frequency trading.

News reports suggest that "Tyler Durden" is the pseudonym of Dan Ivandjiiski, a Bulgarian immigrant to the U.S. who was banned from working in brokerages over insider trading. Ivandjiiski has denied he's Zero Hedge's founder.

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