Canada vs US Banks The recent failure of three U.S. regional banks and the merger of Credit Suisse with UBS Group has heightened worries about the global financial system. What about Canadian banks – is the contagion going to spread to them?
One way to assess the risk is to look at short-selling activity in bank stocks. Are short-sellers ramping up their bets to an extent that would suggest they are expecting a banking crisis is on the horizon?
It doesn’t appear so. Going by the percentage of its float sold short, bearish sentiment is not escalating significantly in the Big Six banks. There is a slight trend upward, but it remains modest.
A Bloomberg News article this week pointed out that the bank with the largest short position in the world was not in Switzerland or Silicon Valley but in Canada: Toronto-Dominion Bank. It reported that short-sellers have upped their bearish bets against TD and now have roughly $3.7-billion on the line.
The implication was that we should be worried. With market capitalizations for Canadian banks down by approximately $5-billion over the past month, some concern would seem to be merited.
However, a short position could be large simply because a bank has a large number of shares trading. A more accurate gauge would be the percentage of a bank’s float that is sold short; on this basis, there would not seem to be too much reason for alarm about TD Bank. As can be seen in the chart for TD, the percentage of its float sold short has not risen much at all since January, 2022, and currently stands at a low 4 per cent.
Don’t forget that Canada was one of the few countries to get through the global financial meltdown of 2008 virtually unscathed. No banks went bankrupt. Nor were there any prolonged plunges in house prices arising from waves of mortgage defaults – unlike most other countries. Indeed, Canada’s last major banking collapse was in 1923, when Home Bank of Canada went under. Meanwhile, since 2001, more than 560 financial institutions have gone bust in the United States versus zero in Canada.
The recent implosions in U.S. regional banks, among the largest in U.S. history, resulted from a lack of diversification in assets. They had large bond portfolios that lost a great of value when interest rates shot up over the past year, and their loans to borrowers were concentrated in a few sectors. Canadian banks are considerably more diversified, with a better asset mix.
In particular, they are more reliant on residential mortgages, representing 22 per cent of their assets or twice the average proportion of banks in the United States. Residential mortgages in Canada are a relatively low-risk bank asset with low rates of default going back decades. In 2022, defaults fell to an all-time low.
Commercial real estate lending is a greater concern as interest rates climb. However, according to CPA Canada’s chief economist David-Alexandre Brassard, Canadian banks have only 2 per cent of their assets in this category, compared with 13 per cent for U.S. banks.