By Tom Bradley

In the Economics Focus column in the October 31st Economist magazine, the question is asked, “Why are the banks so averse to raising equity?”

It’s a great question, particularly in the aftermath of last year’s worldwide banking meltdown. It has been a surprise to me that we haven’t seen more fundamental change in how the banks operate and how they fund their activities. Certainly capital ratios have improved for the Canadian banks, and the risk management committees are more vigilant than ever, but in the overall scheme of things, banking today looks almost the same as it did in 2007.

The banks still fight each other to offer 35-year floating rate mortgages with as little as 10% down. They continue to make acquisitions and push into every pocket of the financial services industry. And they are still running highly leveraged balanced sheets.

In addressing the latter, the article points out that in a world of artificially low interest rates, customer deposits and tax-deductible debt are far more attractive funding vehicles than common equity. The fact of the matter is that a bank with more equity capital will have a lower return on equity when times are good. And with explicit and implicit government guarantees in place, the banks can afford to go strictly by the numbers.

But I think the banks (Canada’s big five in particular) are missing out on a tremendous opportunity to (1) better serve the country that has allowed them to operate their cozy little oligopoly and (2) differentiate themselves from the rest of the riff raff. In an industry that is still in disarray, a major bank with a 15%+ Tier One ratio (Canadian banks range between 10% and 12%, which is above average in the global context) would carry a premium valuation and be in a better position to make opportunistic and strategic moves.

Why are the banks so averse to raising equity? Why indeed.