Why Were Canadian Banks More Resilient?

Lev Ratnovski and Rocco Huang

IMF WP 09/152

Canada

– Six nation-wide, universal banks

– Domestic, Carib/LA, US operations

– No failures, no public capital

– Banks able to raise capital early in the crisis

The paper

• Policy-oriented study– Large OECD banks (assets >100B)– Which key pre-crisis fundamentals…

• Capital ratio, Balance sheet liquidity, Funding

… best predict performance during the crisis?• Equity returns, Jan 2007 - Jan 2009• Qualitative: public intervention, degree of stress

• Canada– Bank fundamentals + Specific regulations

• Wider implications for recent debates

Capital Ratios

Equity / Total assets

Equity is balance sheet equity = Assets – Debt

Table 2. Capital Ratios

Bank Country Capital* Value decline Intervention

1 Hypo Real Estate Holding AG GERMANY 2.1 97 Asset guarantees and public loans2 Deutsche Bank AG GERMANY 2.1 813 UBS AG SWITZERLAND 2.3 79 Capital injection4 Commerzbank AG GERMANY 2.5 89 Capital injection5 ABN Amro Holding NV NETHERLANDS 2.6 NA Nationalized (carved out from Fortis)6 Barclays Plc UNITED KINGDOM 2.7 857 Fortis BELGIUM 2.8 94 Broken up, part nationalized8 Dresdner Bank AG GERMANY 3.0 NA Capital injection9 Northern Rock Plc UNITED KINGDOM 3.2 100 Nationalized

10 Dexia BELGIUM 3.3 89 Nationalized11 ING Groep NV NETHERLANDS 3.3 81 Recapitalized, asset guarantees12 Lloyds TSB Group Plc UNITED KINGDOM 3.3 78 Capital injection

16 HBOS Plc UNITED KINGDOM 3.6 100 Recapitalized (part of Lloyds)20 Canadian Imperial Bank of Commerce CANADA 4.1 5421 Royal Bank of Canada RBC CANADA 4.3 4426 Credit Suisse Group SWITZERLAND 4.7 6628 Banque de Montreal-Bank of Montreal CANADA 4.8 5329 Bank of Nova Scotia (The) - CANADA 4.9 4235 Royal Bank of Scotland Group Plc (The) UNITED KINGDOM 5.2 96 Capital injection, asset guarantees36 Westpac Banking Corporation AUSTRALIA 5.3 3840 Commonwealth Bank of Australia AUSTRALIA 5.7 4641 National Australia Bank AUSTRALIA 5.7 5342 Toronto Dominion Bank CANADA 5.7 4344 Australia and New Zealand Banking Group AUSTRALIA 5.9 5450 Citigroup Inc USA 6.4 94 Recapitalized, asset guarantees55 HSBC Holdings Plc UNITED KINGDOM 6.6 4161 Washington Mutual Inc. USA 8.5 100 Failed, taken over by FDIC62 JP Morgan Chase & Co. USA 8.6 5063 Bank of America Corporation USA 9.3 87 Capital injection, asset guarantees64 Wells Fargo & Company USA 9.5 4768 Wachovia Corporation USA 10.3 100 Failed, acquired by Wells Fargo72 Capital One Financial Corporation USA 16.9 80

* Equity over total assets, end-2006 >85% Due to extreme stress Source: BankScope and staff calculations >70% Due to other weakness

Rest of the sample

Twelve most vulnerable

Balance Sheet Liquidity

Liquid assets / Total assets

Liquid assets = claims on government, other banks, parts of trading book

Table 3. Balance Sheet Liquidity

Bank Country Liquidity* Value decline Intervention

1 Capital One Financial Corporation USA 3.7 802 National City Corporation USA 4.0 100 Acquired by PNC Bank3 Citizens Financial Group Inc. USA 4.3 NA NA (owned by RBS)4 SunTrust Banks, Inc. USA 4.3 855 US Bancorp USA 4.4 586 Washington Mutual Inc. USA 4.8 100 Failed, taken over by FDIC7 Regions Financial Corporation USA 5.0 908 Nomura Holdings Inc JAPAN 5.6 769 Wells Fargo & Company USA 6.0 47

10 Northern Rock Plc UNITED KINGDOM 6.7 100 Nationalized11 Kookmin Bank KOREA REP. OF 7.8 5612 Bank of Ireland IRELAND 8.4 96 Capital injection, liabilities guarantee

13 Commonwealth Bank of Australia AUSTRALIA 8.90 4614 Australia and New Zealand Banking Group AUSTRALIA 10.32 5416 Westpac Banking Corporation AUSTRALIA 10.42 3817 Wachovia Corporation USA 10.69 100 Failed, acquired by Wells Fargo18 HBOS Plc UNITED KINGDOM 11.14 100 Capital injection (part of Lloys)19 National Australia Bank AUSTRALIA 11.15 5326 Lloyds TSB Group Plc UNITED KINGDOM 15.67 78 Capital injection41 Banque de Montreal-Bank of Montreal CANADA 23.99 5344 Toronto Dominion Bank CANADA 24.37 4345 Bank of Nova Scotia (The) - CANADA 24.43 4247 Royal Bank of Scotland Group Plc (The) UNITED KINGDOM 25.11 96 Capital injection, asset guarantees49 Bank of America Corporation USA 25.59 87 Capital injection, asset guarantees50 Canadian Imperial Bank of Commerce CANADA 26.00 5456 Royal Bank of Canada RBC CANADA 32.11 4459 HSBC Holdings Plc UNITED KINGDOM 33.20 4163 Citigroup Inc USA 39.46 94 Recapitalized, asset guarantees64 Barclays Plc UNITED KINGDOM 40.75 8569 JP Morgan Chase & Co. USA 46.80 5071 Credit Suisse Group SWITZERLAND 64.93 6672 UBS AG SWITZERLAND 65.20 79 Capital injection

* Liquid assets over total liabilities, end-2006 >85% Due to extreme stress Source: BankScope and staff calculations >70% Due to other weakness

Rest of the sample

Twelve most vulnerable

Funding Structure

Deposits / Total liabilities

Deposits = retail, interbank, transaction accounts

Table 4. Depository Funding

Bank Country Value decline Intervention

1 Hypo Real Estate Holding AG GERMANY 24.0 97 Asset guarantees and public loans2 Northern Rock Plc UNITED KINGDOM 28.7 100 Nationalized3 Deutsche Bank AG GERMANY 34.1 814 BNP Paribas FRANCE 36.7 655 Citigroup Inc USA 37.8 94 Capital injection, asset guarantees6 HBOS Plc UNITED KINGDOM 41.0 100 Capital injection (part of Lloyds)7 Société Générale FRANCE 42.0 748 Banca Monte dei Paschi di Siena SpA ITALY 44.1 689 Dexia BELGIUM 44.9 89 Nationalized

10 DnB Nor ASA NORWAY 45.4 7411 Danske Bank A/S DENMARK 46.3 7812 Commerzbank AG GERMANY 47.0 89 Capital injection

13 JP Morgan Chase & Co. USA 47.3 5014 Barclays Plc UNITED KINGDOM 47.7 8515 Bank of America Corporation USA 47.9 87 Capital injection, asset guarantees21 National Australia Bank AUSTRALIA 51.7 5324 Commonwealth Bank of Australia AUSTRALIA 53.4 4626 HSBC Holdings Plc UNITED KINGDOM 54.9 4128 Credit Suisse Group SWITZERLAND 55.6 6630 Capital One Financial Corporation USA 57.3 8032 Lloyds TSB Group Plc UNITED KINGDOM 58.7 78 Capital injection33 Royal Bank of Scotland Group Plc (The) UNITED KINGDOM 59.3 96 Capital injection, asset guarantees44 Wachovia Corporation USA 62.8 100 Failed, acquired by Wells Fargo46 UBS AG SWITZERLAND 64.1 79 Capital injection48 Wells Fargo & Company USA 64.4 4751 Royal Bank of Canada RBC CANADA 65.1 4452 Banque de Montreal-Bank of Montreal CANADA 65.2 5354 Australia and New Zealand Banking Group AUSTRALIA 65.4 5457 Toronto Dominion Bank CANADA 67.9 4360 Canadian Imperial Bank of Commerce CANADA 68.2 5464 Bank of Nova Scotia (The) - CANADA 71.4 4268 Westpac Banking Corporation AUSTRALIA 74.1 3869 Washington Mutual Inc. USA 74.6 100 Failed, taken over by FDIC

* Depository funding over total assets >85% Due to extreme stress Source: BankScope and staff calculations >70% Due to other weakness

Rest of the sample

Twelve most vulnerable

Depository funding*

Regressions

Dependent Variable: Extreme Stress Price Decline >85%(1) (2) (3) (4) (5) (6)

Equity Ratio -0.182 0.259 -3.042*** 1.240 3.580** -31.80***(0.454) (0.187) (3.419) (2.025) (1.221) (10.02)

Equity Ratio<4% 0.0802 0.361**(0.0988) (0.183)

Balance Sheet Liquidity -0.541*** -0.425*** -0.382*** -1.527*** -1.694*** -1.187**(0.431) (0.377) (0.336) (0.576) (0.631) (0.538)

Depository Funding -0.326*** -0.281** -0.479*** -1.133** 0.536 -3.836***(0.224) (0.204) (0.447) (0.401) (0.629) (1.029)

Depository Funding<50%

-0.0148 0.473**(0.0224) (0.228)

Equity Ratio * Depository Funding

5.208*** 58.15***(5.480) (17.33)

Log (Asset) 0.0629*** 0.0517*** 0.0529*** 0.142 0.142 0.168(0.0574) (0.0526) (0.0516) (0.0938) (0.106) (0.105)

N 72 72 72 62 62 62R-squared 0.393 0.435 0.450 0.139 0.240 0.233

Dependent Variable: Price decline>70% Price decline (%)(7) (8) (9) (10) (11) (12)

Equity Ratio -0.907 3.685 -51.03*** 11.88 190.6** -1448***(3.692) (3.053) (18.96) (122.8) (85.48) (366.1)

Equity Ratio<4% 0.558*** 22.20***(0.125) (4.511)

Balance Sheet Liquidity -0.890 -1.151 -0.402 -33.20 -25.77 -17.73(0.611) (0.835) (0.601) (24.64) (21.94) (22.43)

Depository Funding -1.156** 1.776*** -5.543*** -51.68*** 17.66 -167.9***(0.492) (0.600) (2.152) (17.59) (17.91) (36.38)

Depository Funding<50%

0.576*** 13.07**(0.116) (4.775)

Equity Ratio * Depository Funding

87.43*** 2545***(33.46) (597.0)

Log (Asset) 0.123 0.0937 0.135 4.025 2.353 4.988*(0.0916) (0.124) (0.0953) (2.664) (2.707) (2.785)

N 62 62 62 62 62 62R-squared 0.084 0.282 0.170 0.147 0.323 0.269

Summary

• Capital– Important to have above critical minimum– Important in wholesale banks

• Balance Sheet Liquidity– Important in explaining imminent failure

• Depository Funding– Important in explaining failure– Canadian banks: outliers, ample retail deposits

• Fundamentals matter

Canadian Regulation

• Above-Basel risk weighted capital targets– 7% tier 1 (instead of 4; banks hold 10-12%)– 10% tier 2 (instead of 8)– Quality of capital: 75% of tier 1 in common equity

• Leverage ratio (“assets-to-capital multiple”)– 5%, based on tier 1+2

• IB and off-balance sheet consolidated• Direct effect (buffers) and incentive effect (focus

on core business) contained asset growth• Quality transparency

Canadian mortgage markets

• Limits– 80% LTV– 32% mortgage service-to-income– 40% total debt service-to-income

• Simplicity– 5 year max; Plain vanilla (e.g. no teaser rates)

• Incentives to repay– Interest payments not income-deductible

Summary

• Capital– Important to have above critical minimum– Important in wholesale banks

• Balance Sheet Liquidity– Important in explaining imminent failure

• Depository Funding– Important in explaining failure– Canadian banks: outliers, ample retail deposits

• Fundamentals, policies, incentives matter