the future of canadian banking - oliver wyman · 2020-03-03 · 2. economic backdrop for canadian...

Financial Services

THE FUTURE OF CANADIAN BANKING

AUTHORJoe Fielding, Partner

Copyright © 2012 Oliver Wyman 2

CONTENTS

1. INTRODUCTION 3

2. ECONOMIC BACKDROP FOR CANADIAN BANKING 5

2.1 Household Indebtedness 6

2.2 Interest Rate Environment 8

2.3 Housing 9

3. OPPORTUNITIES FOR CANADIAN BANKING 12

3.1 Customer Relationship Data and Analytics 13

3.2 The 55+ Segment 16

3.3 Small/Mid-sized Enterprises (SME) Banking 20

3.4 Innovation in Operational Efficiency 21

4. CONCLUSION 23

1. INTRODUCTION

Canadian Banking has been a pillar of strength during

the global financial crisis, delivering strong financial

performance even in the face of challenging economic

conditions. In stark contrast, US banks had $2.7 TN1 in

write-offs during the crisis and are still struggling to find

firm footing amid increased regulation, compressed

margins, and lingering issues centred on housing and

mortgages. Major European banks face significant

hurdles around sovereign debt and the broader fate

of the Eurozone. Yet while these global markets have

struggled, the Canadian banking system has won

global recognition as the “the world’s soundest” for

the past four years as identified by the World Economic

Forum.2 The industry is perceived to be well-regulated

and banking practices and risk appetite are generally

believed to be more conservative than global peers’.

Even Australia, which shares structural similarities to

Canada and has exhibited resilience in both their macro

economy and financial sector, has seen major markets

experience home price declines. Can the relative

outperformance of banking continue in Canada, or will it

follow a path similar to the rest of the world? This report

provides context to answer this key question and discuss

the specific implications and opportunities for Canada’s

retail and business banking sector.

A broad analysis of the macroeconomic environment in

Canada suggests that the domestic banks are unlikely to

experience a major downturn, barring a global economic

shock from a disruption of the Eurozone or escalating

socio-political unrest in the Middle East. This is due in

large part to a resilient domestic economy with strong

natural resource and commodities sectors. However,

there are clear indications that the economic landscape

in Canada is likely to change meaningfully in three areas:

A. HOUSEHOLD INDEBTEDNESS: Household debt-to-

income in Canada has reached historically high levels.

While the debt burden is manageable so far, it poses

two threats: near-term, in the form of sluggish asset

growth rates; and long-term, as a risk to debt service

ratios from rising rates. Should home prices also

decline in certain markets, consumer finances and

household balance sheets would be further stressed.

B. INTEREST RATE ENVIRONMENT: Canada’s interest

rate has been at extremely low levels for two years,

squeezing bank margins. Rates are likely to remain

low through 2013, and this expectation is already

shifting emphasis to higher-margin lending and fee-

based revenue streams. When rates do eventually

rise, banks will need pre-established strategies to

attract and retain the best customers – some of

whom will have been starved for yield – and to deal

with over-indebted customers.

C. HOUSING: There is clear evidence that certain

geographic markets in Canada will experience

slower home price appreciation and even home price

depreciation over the next two years. This will soften

demand for purchase mortgages and result in lower

asset and earnings growth. In addition, home price

depreciation will require banks to align operations to

handle over-indebted customers, qualify mortgages

in a tightening risk and regulatory environment, and

deliver sound financial advice to customers.

As a result of these dynamics, Canadian Banking will

experience at least modest headwinds to growth over

the next 2-4 years. Compounding these challenges

is a continued shift in how consumers interact with

their banks on a day-to-day basis for transactions and

advice, which has put emphasis on multi-channel

interoperability and reduced operational complexity

and cost. Oliver Wyman sees four opportunity areas


1 “Further Action Needed to Reinforce Signs of Market Recovery: IMF” by Peter Dattels and Laura Kodres, IMF Monetary and Capital Markets Department (Apr 21, 2009)

2 World Economic Forum Global Competitiveness Report 2011-2012

for Canadian banks that will address these specific

challenges to near-term profitability and build

capabilities for long-term growth.

1. CUSTOMER RELATIONSHIP DATA AND ANALYTICS:

Banks globally are looking intensely at their data and

analytics environments to drive better depth of client

relationship from acquisition through retention. Banks

are rich data sources, but often struggle to use this

information consistently or lack the organization to

properly capitalize on it. It is accepted in the industry

that the deepest customer relationships are the most

profitable, but the paths to becoming a multi-product

customer are varied. Understanding and managing

this path-dependent process requires the analytical

capabilities – systems, organization, and people – to

enable sophisticated relationship management in

rich data environments. Analytics and efficient data

management will differentiate the best banks; the

starting point is for banks to establish cross-linked

programs that identify, leverage and organize around

impact-driven analytics.

2. THE 55+ SEGMENT: The 55+ age segment of

Canada’s population is expected to grow almost

50% in the next 20 years. This means that Canada is

getting older even faster than the US is, though it will

not experience the same extreme level of dependency

ratio as Japan or Europe will over the next two

decades. These consumers have accumulated

assets over their lifetimes and will be in need of

financial advice and products in order to manage

these assets and convert wealth into guaranteed/

safe income streams while mitigating longevity risk.

For Canadian Banking, this means attracting and

keeping these customers through their financial

life cycle into retirement. This will require proper

embedding of Registered Retirement Savings Plans

and eventually Pooled Registered Pension Plans into

distribution strategies.

3. SME BANKING: Small to mid-sized enterprises

(SME) present fertile ground, but banks often

struggle to serve them well. This stems from a long-

standing challenge of how to serve (i.e. is it retail

or commercial?). Two-thirds of small businesses in

Canada use just a single financial provider for their

needs,3 highlighting the importance of being their

primary bank. Taking share in this attractive segment

could help fill in the consumer asset growth gap,

provided the right operational model is in place from

distribution through client management.

4. INNOVATION IN OPERATIONAL EFFICIENCY:

While many banks often separate “innovation” and

“operations”, achieving operational efficiency is

possible through new ways of working and making

the business less complex. True innovation in

operations involves seamlessly aligning experience –

from the standpoint of both customer and employee

– with performance. Simple tools, from process

reengineering to metrics-driven management,

should create simpler ways for organizations to

operate, and in so doing, improve the bottom line.

3 2012 Oliver Wyman Survey of Canadian Consumers and Small Business Owners

DYNAMICS IN THE CANADIAN ECONOMY

1. CUSTOMER RELATIONSHIP DATA AND ANALYTICS

2. THE 55+ SEGMENT

3. SME BANKING

4. INNOVATION IN OPERATIONAL EFFICIENCY

ASSOCIATED OPPORTUNITY AREAS

A. HIGH HOUSEHOLDINDEBTEDNESS

B. RISIN

G INTE

RE

ST

RA

TES

C. S

LOW

ING

HOME

PR

ICE IN

CREASES


2. ECONOMIC BACKDROP FOR CANADIAN BANKING

Over the past decade, Canadian banks benefited from a strong national economy that

fared better than many other countries during and after the global financial crisis. Pre-

crisis, the Canadian economy grew at about the same rate as the US, while during the

crisis years of 2008 and 2009 the decline in GDP was less pronounced in Canada – the

result of exposure to commodities, the absence of a national housing crisis, and limited

exposure to subprime lending (Exhibit 1). Since then, the economy has reached pre-crisis

levels of growth, although it is off the high growth rates seen in 2010. Correspondingly,

the unemployment rate steadily dropped since reaching its peak in 2009, and remains

below that of the US (Exhibit 2).

ExHIBIT 1: YEAR OVER YEAR GDP GROWTH, CANADA AND US*

Canada

US-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

2003 2004 2005 2006 2007 2008 2009 2010 20112002

* Canada Real GDP calculated using 2002 prices. US Real GDP calculated using 2005 prices

Source: OECD


ExHIBIT 2: UNEMPLOYMENT RATE, CANADA*

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Country Unemployment (Dec 2011)

Canada 7.4%

US 8.5%

UK 8.3%

Australia 5.3%

*Seasonally adjusted

Source: Datastream, US Bureau of Labor Statistics, Eurostat, Australian Bureau of Statistics

This relative resilience has provided solid footing for Canadian banking. However, there are

three pressure points influencing the outlook for the sector: indebtedness, interest rates and

housing. We will examine each of these in turn, and then describe the opportunities that will

emerge as a result.

2.1. HOUSEHOLD INDEBTEDNESS

The extraordinary growth in Canadian household debt has contributed to record

profitability for the banking sector. However, consumer household debt and debt-to-

income are at record highs. Over the past decade, Canadian household mortgage and

non-mortgage debt grew more than 8% annually, and by 2011, total debt had more

than doubled from its level ten years ago (Exhibit 3). Relative consumer confidence,

low rates and banks’ willingness to lend combined to facilitate continued debt growth

and contributed to Canada’s relative macroeconomic stability in stark contrast to the

deleveraging that continues to play out the US.


ExHIBIT 3: CANADIAN TOTAL DEBT (C$TR)*

0

0.5

1.0

1.5

2.0

2.5

3.0

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

TOTAL DEBT

Commercial

Household Mortgage

Household Non-mortgage

CAGR ‘99 - ’11

8.9%

8.4%

4.6%

*Seasonally adjusted data

Source: Datastream

Since late 2007, Canada’s household debt-to-income ratio surpassed that of the US and has

continued to trend upward. While Canada’s household debt-to-income is still lower than that

of the UK or Australia, those countries’ ratios seem to be stabilizing or trending downwards

(Exhibit 4). In contrast, Canadian household credit has grown at 8% annually while personal

disposable income has grown at just 4% per year. This is sustainable only while rates fall, but

needs to reverse if rates are stable or rising.

ExHIBIT 4: HOUSEHOLD DEBT TO INCOME RATIO, CANADA, US, UK, AND AUSTRALIA

80%

40%

120%

160%

0%

200%

20%

60%

100%

140%

180%

Canada

US

UK

Australia

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: Haver Analytics, Statistics Canada, Federal Reserve Board, Office for National Statistics, Australian Bureau of Statistics


Despite the rise of aggregate indebtedness, the costs of managing this debt has been

relatively benign due to low interest rates. As rates drop, the interest payments required on

consumer debt also fall, in general. The Canadian debt service ratio (DSR), defined as the

portion of household disposable income dedicated to debt service payments, was 7.5%

in mid-2011, which was below the historical norm of 8.1%.4 The current DSR suggests

that debt is affordable despite aggregate high levels of debt-to-income, at least at today’s

historically low rates (Exhibit 5). In the beginning of the low-rate period, consumers were

motivated to take advantage of low borrowing costs and pushed household debt levels to

record highs. Canadian banks have capitalized on this steady rise in volume to offset lower

margins, but this phase is already nearing its end.

2.2. INTEREST RATE ENVIRONMENT

ExHIBIT 5: SHORT AND LONG-TERM INTEREST RATES, CANADA

3-month T-bill

10-year bond

0%

1%

2%

3%

4%

5%

6%

7%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: Datastream

If rates have to rise more quickly in response to a rebounding global economy – arguably a

good problem to have – DSR could experience a more rapid rise given the aggregate debt

burden, depending on how quickly incomes rise in response. This would arise through higher

pricing for both secured and unsecured consumer credit, which would increase the monthly

payments required to service those debts. Higher pricing on mortgage renewals, if combined

with dropping home prices in some markets, would have the potential to challenge some

borrowers. This would create a dynamic similar to the rate shock from ARM resets in the US that

forced some borrowers into foreclosure when their appraised home values were well below

their purchase price. Offsetting factors in Canada include lower LTVs, CMHC insurance for

LTVs above 80%, and lenders having full recourse to a borrower’s assets in the event of default.

That said, stress-testing portfolios for high-risk borrowers, high-risk markets or portfolio

sub-segments where debt burdens are at risk to unemployment, housing price shock, or rate

shock, is a prudent course of action for Canadian banks.

4 Statistics Canada


Canada still has room to lower its short-term rate, if required, and there remains some

speculation that the Bank of Canada could do so this year if confronted with trigger events

such as a Eurozone default or instability in commodity prices.5 While these pressures persist,

the spectre of rising rates will remain on the periphery even as interest margins remain

under pressure. To counter this impact, Canadian banks will need to explore avenues to

boost profitability, such as operational cost efficiency, higher margin-lending, and deeper

banking relationships.

2.3. HOUSING

As a whole, Canada’s housing market has performed well, exhibiting very low delinquency

and default rates. With relatively low unemployment, high immigration levels, and low

apartment vacancy rates, Canada’s housing prices have grown with the economy, and

banks have been both willing and able to lend to finance this expansion. This combination

of factors – low rates, rising incomes, appearance of benign risk in most portfolios – has

contributed to the consensus of strength.

But Canadian housing has also generated concerns of a bubble, and there are specific

markets that are cited as evidence of the frothiness that systematically overtook the US.

Consider Alberta (Exhibit 6), which experienced a doubling of mortgage delinquency rates

over the last three years.

ExHIBIT 6: MORTGAGE DELINQUENCY RATES, CANADA*

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

2000 2002 2004 2006 2008 2010

Canada

British Columbia

Atlantic

Quebec

Ontario

Manitoba

Saskatchewan

Alberta

*Includes data from BMO, CIBC, HSBC Bank Canada, National Bank of Canada, RBC Royal Bank, Scotiabank, and TD

Canada Trust

Source: Canada Bankers Association

5 “Bank of Canada interest-rate cut predicted” CBC News (Nov 9, 2011)


Alberta’s delinquency rates soared above the rest of Canada due to a struggling housing

market in the province’s major metropolitan areas, Calgary and Edmonton. The causes

were varied, including localized fraud and economic challenges arising from volatility in

crude oil prices. From June to December 2008, oil prices plummeted from $140 per barrel

to under $45.6 Oil and energy comprises the biggest component of Alberta’s GDP, so a large

price drop would have significant impact on the province’s economy. As oil prices have

rebounded, the housing market there has shown signs of stabilization and improvement in

delinquency rates.

Delinquency rates are still low in Canada, compared with recent international experience.

Even Alberta’s delinquency rate, which is around 0.75%, is far lower than the US’s, with a

national delinquency rate almost 5x higher at 3.5%. This includes states like Nevada, where

the delinquency rate is nearly 6%. So what should we believe about the future outlook for

Canada? Two measures of housing affordability – price-to-rent and price-to-income – offer

further insights into how home prices might trend.

ExHIBIT 7: HOUSING PRICE RATIOS, 2010*†

0

PRICE-TO-HOUSEHOLDINCOME RATIO2

PRICE-TO-RENTRATIO3

6.5

4.5 4.5

10.0

32.0835.44

31.09

47.13

0

2

4

6

8

10

12

Toronto Montreal Calgary Vancouver

0

25

50

Price to income

Price to rent

*Price is the MLS average price

†Median income data not available for 2010; 2009 data shown

Source: CMHC, Canadian Real Estate Association, Statistics Canada

One affordability metric some examine is the price-to-rent ratio, which measures the median

home price against the cost to rent. In four major cities, price-to-rent ratios are in excess of

30, with Vancouver over 47 (Exhibit 7). In several US cities where housing busts occurred,

such as San Diego, Palm Beach, and Las Vegas, the price-to-rent ratios reached peaks of

just over 30 before precipitously dropping.7 This would suggest that housing prices are

comparatively high in these four markets, at least relative to the cost-to-rent.

6 WTI Cushing Crude Oil FOB US$/barrel, USD, United Stated Department of Energy7 “Rent Ratios in U.S. cities” The New York Times (Apr 20, 2010)


A second metric commonly examined is the ratio of price to income, which looks at median

home price against the income of the buyer. Long-run averages of this metric vary around

the world, but experience suggests that values of this ratio under three indicate affordability,

while ratios in excess of four suggest lack of affordability, except in cities where structural,

regulatory or socio-economic conditions warrant long-run deviations. On first glance,

Vancouver’s high price-to-income ratio looks unsustainable with housing prices nearly ten

times the income. Structural factors matter, however, since Vancouver has largely prohibited

housing development on the urban fringe for decades, which has fixed the housing supply

in the city. Constrained supply explains how housing affordability can become distorted for

some cities, relative to long-run averages.

There are cities which at first look may not have affordability issues to the same degree

as Vancouver, but might be at even higher risk of a home price correction in a weakened

economic environment. For example, nearby Victoria has a price-to-income ratio of 6.6, but

does not have the “Green Zone” that Vancouver has to prohibit urban sprawl. This creates

elasticity in prices which, when demand softens, often leads to flat or declining prices.

Indeed, from 2010 to 2011, Victoria was the only major Canadian metropolitan area which

had a negative year-over-year change in housing prices. Even in seemingly similar housing

markets, structural factors affect risk in terms of the potential for declining home prices.

The idiosyncrasies of specific housing markets notwithstanding, the national residential real

estate situation is more clear: Canada is not poised to experience a re-enactment of the US

housing bust. The lax standards of subprime lending that lifted American housing prices to

excessive levels is not an issue in Canada. That said, housing prices in many markets have hit

levels that are not sustainable long term, and we suggest that a period of low/negative price

changes will become the norm. Absent a major macroeconomic trigger event (e.g. Eurozone

crisis, conflict in Middle East), there is unlikely to be a sharp decline in the national housing

market that would mirror the US correction. This, however, does not rule out the possibility

of more severe localized price declines, driven by the spectre of rising interest rates and

slower purchase demand.


3. OPPORTUNITIES FOR CANADIAN BANKING

For the major Canadian banks, the domestic business makes up a significant portion of total

earnings and has a much higher return on equity than the bank as a whole. Incredibly, over

the past five years, all of the major banks were able to improve their efficiency ratio8 while

increasing return on equity (Exhibit 8 and Exhibit 9).

ExHIBIT 8: 2011 “BIG 5” CANADIAN BANKING OVERVIEW

CANADIAN BANKING TD BANK RBC CIBC SCOTIABANK BMO

Key Statistics

NI C$MM (% of Total) 3,611 (61%) 3,492 (72%) 2,215 (69%) 1,862 (35%) 1,701 (52%)

ROE (Total ROE) 39% (14%) 33% (18%) 61% (21%) 38% (19%) 46% (15%)

Source: Company websites, annual reports and supplementary materials, and investor presentations

ExHIBIT 9: CANADIAN BANKING ROE VS. EFFICIENCY RATIO, “BIG 5” BANKS 2006-2011

40%

30%

20%

10%

60%

50%

EFFICIENCY RATIO

0%

70%

RETURN ON EQUITY

65%60%55%50%45%RBC

TD

BNS

BMO

CIBC

2011

2006

Source: Company websites, annual reports, supplementary materials and investor presentations

However, the domestic economic backdrop – household indebtedness that must moderate,

falling net interest margins and embedded risk in certain housing markets – is creating

urgency for Canadian banking to focus on high-impact areas to drive business performance.

These areas combine critical customer segments with operational excellence and a drive

towards greater simplification without sacrificing business innovation and readiness to

compete. We see four specific areas of opportunity:

8 Bank Efficiency Ratio = Non-Interest Expenses/Revenue


1. Customer Relationship Data and Analytics

2. The 55+ Segment

3. SME Banking

4. Innovation in Operational Efficiency

3.1. CUSTOMER RELATIONSHIP DATA AND ANALYTICS

The first opportunity for Canadian banks to explore is focused on the data environment used

to manage customer relationships. In many geographies, notably the US and UK, there has

been an inherent loss of trust in the financial sector, which the Canadian banks have largely

managed to avoid. Canadian customers generally tend to bank with just one or two financial

institutions for their financial needs. In fact, two thirds of Canadians tend to deal with only

one or two institutions, while two thirds of Canadian small businesses deal with only one

(Exhibit 10). A large part of this stems from the ability of the largest financial institutions to

meet their customers’ comprehensive financial needs. This becomes especially important

when dealing with more sophisticated customers – i.e. business owners who are investing

for retirement, entering the de-cumulation phase, or requiring estate planning. These

segments are very attractive in that (1) they will not be as affected by indebtedness, and (2)

they have a more robust, diversified financial services wallet better rounded by fee income.

The major development area for banks is in creating a data and analytics environment

that facilitates customer value measurement and management and allows for proactively

anticipated needs (and risk), rather than waiting to react to inbound inquiries.

ExHIBIT 10: CANADA: NUMBER OF BANKING RELATIONSHIPS

0%

10%

20%

30%

40%

50%

60%

70%

1 2 3 4 or more

64%

26% 28%

41%

7%

23%

1%

10% Small Business

Consumer

Source: 2012 Oliver Wyman Survey of Canadian Consumers and Small Business Owners

Note: Small businesses are businesses with less than 100 employees


The prevalence of social media, smartphones and tablet devices means that customers are

more connected than ever before. This creates a challenge around how to capture and utilize

the flood of information available to manage the customer relationship proactively across

the value chain. All banks will claim the customer relationship as a major strategic pillar, and

most use metrics like customer satisfaction or share of wallet to measure success, but these

metrics are insufficient. A real-time data and analytics environment capable of looking across

account, transaction and behaviour data are fast becoming prevalent in financial services.

This will drive satisfaction and deeper client relationships, as banks are able to increase their

relevance to their customers.

Oliver Wyman’s Survey of Canadian Consumers and Small Business Owners provides an

example of how customer analytics should form the pricing and marketing strategy of a

bank seeking larger share of wallet for an increasingly competitive product like mortages

(Exhibit 11).

ExHIBIT 11: DATA AND ANALYTICS TURNING INSIGHTS INTO ACTION IS KEY – DATA IS ONLY USEFUL IF YOU CAN ACT ON IT

60%

50%

40%

30%

20%

10%

90%

80%

70%

PRIMARY CHECKING ACCOUNT*

WHICH BANKS ARE SELLING MORTAGES TO YOURPRIMARY CHECKING CUSTOMERS?

Bank E

Bank C

Bank D

100%

0%

Bank A Bank B Bank C Bank D Bank E

PR

IMA

RY

MO

RTG

AG

E

Bank B

Bank A

SELECT OBSERVATIONS

• Bank A exhibits worst performance cross-selling other banks’ primary checking customers

• Bank C has two major competitors – B and E – to address

• Bank D customers most influenced by Bank E

ACTION PLAN DEVELOPED FOR BANK C

• Mortgage renewals will be critical as purchase volume slows

• Identify why two banks – B and E – are winning your customers

• Develop pricing and marketing approach to counter trend of lost cross-sale opportunity to those two competitors

• Equip sales force with talking points to best describe value proposition of the bank relative to B and E

• Identify and address gaps in process (e.g. turn- around time, rate and exception handling, etc.)

Source: 2012 Oliver Wyman Survey of Canadian Consumers and Small Business Owners *Only includes primary bank customers currently holding mortgages; “Other” not shown

Examining customer behaviours and preferences around banking highlights the importance

of tracking customers. Channel preferences have been shifting away from physical

channels to online and mobile, and Oliver Wyman’s Survey of Canadian Consumers and

Small Businesses reveals the online channel as the most important one cited by customers

(Exhibit 12). It also shows a sizable non-branch segment among younger customers, many

of whom will be multi-product users in just a few years’ time (Exhibit 13). Knowing when and

how these customers are interacting with the bank is critically important and only possible

with a robust customer data and analytics strategy across architecture and organization.


ExHIBIT 12: CHANNEL IMPORTANCE FOR INTERACTING WITH PRIMARY BANK WEIGHTED AVERAGE RANKS* FOR EACH CHANNEL THAT WAS RANKED BY CONSUMERS

4

3

2

1

Online/Mobile ATM Branch Telephone Text message/email

0

5

WEIGHTED AVERAGE RANK

*Ranking of channels is in descending order, rank 5 being the most important channel


ExHIBIT 13: FREQUENCY OF PRIMARY BANK BRANCH USAGE CONSUMER USAGE OF PRIMARY BANK BY AGE

60%

50%

40%

30%

20%

10%

90%

80%

70%

18-34 35-54 55 and older Overall

YEARS

RESPONDENTS

Frequent

Direct/Remote

Infrequent

100%

0%



The characteristics of a strong operational data environment to support relationship

banking are:

• A well-managed, central repository of information from account, transaction and

financial systems

• Trained and authorized expert users embedded throughout businesses and functions

• Strong governance and routine refreshing of commonly held assumptions around

risk-adjusted value stemming from customer analytics and marketing/risk testing

across businesses

The potential payoff for getting this foundation right in Canada is huge, and the economic

environment will increase the importance of relationship banking for SME and high-end

segments. With the mass market, deeper relationships have been shown to lead to much lower

delinquency and default rates. Knowing how to identify and categorize these customers at

origination and pre-delinquency should be based on relationship depth, requiring a robust

supporting data environment.

3.2. THE 55+ SEGMENT

Canada, like the US and other developed economies, has an aging population which will

reshape the financial services landscape over the next decade. Growth will primarily be

driven by the 55+ age bracket over the next 10-20 years, with this segment growing by 48%

in the next 20 years, while the rest of the country grows at only 1%. In just ten years, retirees

will comprise one-third of the population and control over two-thirds of all financial assets

(Exhibit 14). While changes in immigration policies could alter this dynamic at the margin, this

shift will still represent one of the major driving forces for Canadian banks seeking to meet the

complex and changing needs of this aging segment, both pre- and post-retirement.

Even today, retirement-related financial services business is large, representing an estimated

C$16 BN in revenue in 2010. This is expected to grow to approximately C$38 BN of revenue by

2020, with banking products anticipated to comprise the largest share at 40% (Exhibit 15). It is

plausible that many retirement-related assets and associated revenues will be “on the move” over

the next few years and thus open to competition. For this aging segment, dissaving, liquefaction

of illiquid assets, intergenerational wealth transfer (of both financial and non-financial assets),

pension system transformation (e.g. defined-benefit closeouts), and defined-contribution asset

allocations and product innovations will all affect current and future financial needs.


ExHIBIT 14

40

2005 2010 2015F 2020F 2025F 2030F % ofpopulation

28%

34%

61%

67%

23% 25%

% of liabilities

AGE COHORT

0

45

30

35

20

25

10

15

5

POPULATION (MM)

CANADIAN POPULATION BY AGE COHORT

% of assets

2010-20+31%

2020-30+13%

20-year growth+1%

0-54

55+

2010

2020F

55+ COHORT AS % OF CANADIAN POPULATION AND PERSONAL ASSETS AND LIABILITIES, 2010 VS. 2020F*

20-year growth+48%

*Personal assets are modeled based on Canadian demographics, GDP per capita, home price appreciation and actuarial projections, where available. Oliver Wyman maintains a proprietary Retirement Model for over 35 countries covering retirement wealth stock, FS revenues and growth forecasts by wealth segment, age cohort and asset class, including cash and deposits, tax-deferred and other investments, life insurance assets and annuities, occupational pensions, public pension reserves, business equity and home equity

Source: Statistics Canada, US Census Bureau, Oliver Wyman Retirement Model, Oliver Wyman analysis

Assets of the 55+ population are expected to grow to C$8.1TN9 over the next decade, with

half of that growth driven by home equity – even after assuming much slower home price

appreciation across Canada as anticipated in the discussion of macroeconomic conditions.

Increases in home equity would be driven by higher mortgage principal repayment

(alleviating the debt overhang) and real home price appreciation.10 Other major asset types

include business equity, direct investments and mutual funds, and registered pension

plans. Demand for retirement solutions will be shaped by four age- and needs-based

retirement sub-segments:

1. Retirement preparation: 55 – 64

2. Transition: 65-69

3. Active retirement: 70-79

4. Passive retirement: 80+

Providing banking solutions to these segments will drive a 12% CAGR on revenue, with

cash and deposits and home equity all tripling over the next decade. Exhibit 15 illustrates

the aggregate growth in demand for financial services over the next decade for these

four segments.

9 Source: Oliver Wyman Retirement Model, Oliver Wyman analysis10 Oliver Wyman conservatively assumes 3.0% real home price appreciation (vs. 5.2% historical average) and inflation of 2.0% p.a.


ExHIBIT 15: 55+ RETIREMENT-RELATED FS REVENUES, IN C$*

2010 ESTIMATE

RISKPROTECTION

WEALTH & AM

BANKING

2020 FORECAST

C$16 BN

C$38BN CAGR

9%

6%

12%

Life Insurance and annuities1

Life Insurance and annuities1

Cash and deposits

Home equity3

Pensions and investments2

Business equity

Cash and deposits

Home equity3

Pensions and investments2

Business equity

5.6

13.7

9.1

1.6

9.8

3.7

5.3

3.0

1.20.9

*Excludes revenues from credit products unrelated to retirement (e.g. credit card, auto, personal LOC); 1. Includes management and income guarantee fees on assets held on behalf of policyholders and annuitants, but excludes life insurance premiums and income from insurers’ own funds; 2. Includes externally managed DB pension plans, but excludes public pension plans (CPP/QPP); 3. Includes home equity release via new mortgage, home equity line of credit (HELOC) and closed-end/reverse mortgage.

Note: All revenues expressed before operating costs (e.g. sales and marketing)

Source: Oliver Wyman Retirement Model, Oliver Wyman analysis

In terms of opportunity, the successful retirement strategy should holistically address

customer needs in three ways:

1. Advice: Help customers plan, manage and execute retirement finances in a

streamlined model

2. Product and packaging: Manufacture investment and risk products to meet broader

needs of the customer and provide operating leverage to advice-led model

3. Distribution: Cultivate multiple distribution channels with retirement offerings to reach

customers with different needs and buying behaviours

The Oliver Wyman Retirement Survey found that retirement customers often feel that

they have no easy access to reliable investment and risk advice despite strong demand.11

The most recent Oliver Wyman survey revealed less than 10% of Canadians under age 54

feel “very prepared” for retirement (Exhibit 16), leaving the door wide open to serve these

customers with advice early and on into retirement. Presenting retirement solutions

tailored to customer needs is the key to growing share. For the mass affluent segment, a

platform-based solution can deliver many of the benefits of bespoke advice but at a lower

cost. This approach balances personalization and scalability via innovation in distribution.

To succeed, Canadian banks must adopt proper segmentation and provide the simplest

product and distribution capable of meeting customer preferences and buying behaviors

(Exhibit 17).

11 2010 Oliver Wyman Retirement Survey


ExHIBIT 16: CONSUMER PREPERATION FOR RETIREMENT, BY AGE

60%

50%

40%

30%

20%

10%

90%

80%

70%

18-34 35-54 55 and older Overall

YEARS

RESPONDENTS

Very prepared

Unprepared

Somewhat prepared

100%

0%


ExHIBIT 17: SOURCES FOR FINANCIAL ADVICE FOR CONSUMERS BY ANNUAL INCOME LEVEL

45%

50%

35%

40%

25%

30%

15%

20%

5%

10%

Financial Plannerat bank branch

Personalresearch

Independentadvisor

Friends/Family

Onlinebrokerage

RESPONDENTS

Less than $150,000

More than $150,0000%



3.3. SMALL/MID-SIZED ENTERPRISES (SME) BANKING

SMEs represent approximately 45% of Canadian GDP and employ close to 60% of the work

force. This has remained relatively constant over the past ten years and highlights just how

critical a segment this is to the Canadian economy. Yet in spite of this importance, some

banks struggle to get this segment right because it sits at the seam of retail and commercial.

Small business banking can provide counterbalance in a world of compressed margins, and

is worth getting right for several reasons:

• SME financing needs tend to grow after a downturn, and businesses will need credit even

if consumer indebtedness moderates

• Owners of small businesses tend towards greater affluence and are highly profitable

bank customers

• Regulation like Basel III should have minimal impact on SME, except to make SMEs more

attractive due to stable deposit funding

Oliver Wyman estimated that in Canada, about 60% of debt financing available to small

businesses is provided in the form of term facilities (i.e. maturities greater than one year)

while the balance comes in the form of operating lines of credit which revolve much like a

credit card.12 This split varies by institution, and some financial providers emphasize shorter-

term operating lines of credit while others focus more on term debt. While credit has become

cheaper and more widely available to SMEs, it is also true that many advances in serving this

segment have unintentionally reduced the perceived level of attention SME owners feel they

receive from their financial providers. Improvements in credit scoring, segmentation, and

channel diversification from multi-channel banking should meet three objectives:

1. Lower the cost of serving SME customers, especially at the small and micro end of small

business banking

2. Increase the speed of credit decisions, with more disciplined pricing

3. Coordinate distribution and customer management, including small business

Relationship Managers (RMs) in the field

Some banks have struggled with the ability to “mass customize” loan features, with RMs

expected to handle more accounts at the expense of personal attention, or even with

SME perception that the bank is not vested in their success because credit decisions are

made automatically and remotely. Banks can create a checklist of current capabilities

and initiatives to ensure that they adequately cover the SME segment overall – and more

importantly, the sub-segments from micro to high-end – in a focused and disciplined way.

This checklist of capabilities includes: Customer Information, RM Coverage, and Credit

Product Management, Measurement and Motivation, which is explored more fully in

Oliver Wyman’s recent Commercial Banking report.13

12 “The Supply of Financing to Canada’s Small and Medium-Sized Enterprise Market” Oliver Wyman and the Business Development Bank of Canada, April 2010

13 “Commercial Banking: Competing for Growth” Oliver Wyman, February 2012


3.4. INNOVATION IN OPERATIONAL EFFICIENCY

It has become standard practice to focus on “innovation” within financial services,

especially as the global economy feels its way out of the economic crisis and banks look

to the future. One of the most relevant types of innovation for Canadian Banking is the

reduction of complexity in operations, from policies, process, and governance to business

development.14 Efficiency should focus on the largest source of costs – i.e. people – but must

focus on working differently rather than on slashing capacity.

Innovation should play a role in how employees and teams operate by leveraging technology

(e.g. customers may not want to use video chat with simple transactions, but employees can and

do). This type of technology adoption can allow for more efficient consultation with internal

subject matter experts, whose time is often a major constraint, and also allow working teams

to better utilize capabilities through more efficient governance, planning and communication.

Being nimble and efficient is increasingly important as consumer behaviour continues to

evolve towards full channel agnosticism while customers still demand the expertise of the

bank in as few steps as possible. While the branch channel is still dominant today, frequency

of visits continues to drop, and the 25% of Canadians who still consider themselves frequent

(i.e. weekly) branch customers tend to fall into the older demographic. The branch must itself

evolve significantly, and benefits will be realized only if the cost environment evolves in terms

of roles and accountabilities. Oliver Wyman’s recent Branch Flexing report demonstrates several

ways to reduce variable branch costs through usage of flexible hours, increased utilization of

technology and virtual communications, and prioritization of resources toward the highest-

value customers (Exhibit 18).

ExHIBIT 18: GROSS BENEFITS OF VALUE-BASED FLExING (ORDER OF MAGNITUDE)

Variable30%

Semi-Fixed20%

50%

Fixed50%

Overall bank costs Branch costs… …after flexing

100% 100%

92%

OtherCosts

BranchCosts

50%

~42%

~∆2-8%reductionin totalcosts

~∆5-15%reductionin branchcosts

Flex half by~∆10-40%Flex all by~∆10-40%

IMPACT ON OVERALL COST STRUCTUREGROSS ECONOMIC BENEFITS

BENEFITS OF BRANCH FLEXING APPROACH

ECONOMIC BENEFITS

• Significant plausible gross savings (before reinvestment & restructuring costs − 5-15% of branch costs• No branch closures• Immediate realization of benefits

OPERATIONAL BENEFITS• Optimize sales and service capacity• Reversible

STRATEGIC BENEFITS

• Ability to optimize operational capacity will enhance next generation footprint design (e.g. hub and spoke, virtual branches, etc.)

• Achieving savings beyond 10% will likely require ops/tech enablement and value proposition redesign

• Extent of reinvestment for high value customers likely to decrease realized net savings to 2-12%

• We anticipate ~5% attainable net save in the short term

14 “The Complexity Imperative” Oliver Wyman, 2010.


Innovation around the human capital costs of sales, service and operations personnel is

progressing beyond performance management – which is critically important to align

objectives and rewards – and towards workforce planning involving recruiting, training

and talent development. The people cost of banks dominates the P&L, in some cases

representing more than 60% of all non-interest expense. Ensuring alignment of human

capital processes and performance measurement across the network, call centres and

headquarter operations will represent significant opportunity for Canadian Banking, as it has

for most global financial services institutions.


4. CONCLUSION

Overall, Oliver Wyman is cautiously optimistic on the outlook for Canadian Banking. Caution

stems from the likelihood of slowing consumer asset growth, the potential for local housing

market weakness, and possible global economic instability stemming from the Eurozone

crisis. Optimism arises from the fact that there are a) structural shifts in the Canadian

population that should expand demand for banking services, b) opportunities for increasing

revenue by refocusing on the most important customer segments and channels, and c)

operational efficiencies to be pursued that can both improve decision-making and reduce

cost. There is significant opportunity for those banks that can pursue a disciplined approach

to their portfolio of strategic initiatives in Canada to gain a competitive edge in positioning

themselves for the coming decade and beyond.


Copyright © 2012 Oliver Wyman

All rights reserved. This report may not be reproduced or redistributed, in whole or in part, without the written permission of Oliver Wyman and Oliver Wyman accepts no liability whatsoever for the actions of third parties in this respect.

The information and opinions in this report were prepared by Oliver Wyman. This report is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accountants, tax, legal or financial advisors. Oliver Wyman has made every effort to use reliable, up-to-date and comprehensive information and analysis, but all information is provided without warranty of any kind, express or implied. Oliver Wyman disclaims any responsibility to update the information or conclusions in this report. Oliver Wyman accepts no liability for any loss arising from any action taken or refrained from as a result of information contained in this report or any reports or sources of information referred to herein, or for any consequential, special or similar damages even if advised of the possibility of such damages. The report is not an offer to buy or sell securities or a solicitation of an offer to buy or sell securities. This report may not be sold without the written consent of Oliver Wyman.

www.oliverwyman.com

Oliver Wyman is a global leader in management consulting that combines deep industry knowledge with specialized expertise in strategy, operations, risk management, organizational transformation, and leadership development.

For more information please contact the marketing department by email at [email protected] or by phone at one of the following locations:

AMERICAS EMEA ASIA PACIFIC

+1 212 541 8100 +44 20 7333 8333 +65 6510 9700

ABOUT THE AUTHOR

Joe Fielding is a Partner in the Americas Retail & Business Banking Practice

the future of canadian banking - oliver wyman · 2020-03-03 · 2. economic backdrop for canadian...

Documents