In the financial community, one of the big news stories right now is that HSBC Bank Canada is going to be taken over by The Royal Bank of Canada for C$13.5 billion. This move is quite significant for a number of reasons. The RBC already ranks first in the country among banks, and HSBC Canada is seventh. In other words, their merger will give birth to a banking titan.

In this article, I will look at possible reasons for this acquisition that no one is talking about, and how it may affect future trends in Canadian banking.

Reasons Behind the Merger

The key reasons behind the merger are as follows:

• The takeover will increase RBC’s domestic market share, expand their customer base, expand their branch network and enhance overall market dominance.
• HSBC is known for its global presence and experience in such fields as wealth management and international banking. Thus, this purchase will give RBC an excellent springboard and access to HSBC’s existing infrastructure and customer base.
• The merger will simplify operations, eliminate overlap, and improve the allocation of resources. For RBC, this can mean considerable cost savings and greater profitability. Besides, RBC could provide customers with more sophisticated wealth management products, mortgage insurance, and more effective international banking solutions.

All these are stated reasons behind the acquisition. Now, these are important factors for the growth of the Canadian banking industry; especially so because the competition in the banking sphere has been intensifying for quite some time. 

That being said, I don’t think these are the only reasons that motivated RBC to acquire HSBC Bank Canada. There are more important factors at play, and I’d like to focus on these factors.

The Rule of Thumb 

Business acquisitions follow a rule of thumb. Generally, when a large company acquires a small or a mid-sized company, its aim is to access a product or a service the smaller company owns, or a technology invented by the smaller company. Such acquisitions are almost always growth-oriented as the larger company sees the acquisition as a way to expand its operation or increase its customer base.

But when two very large companies merge, the merger doesn’t promise any growth, as market saturation is very normal for companies of large size. Such acquisitions are intended for cost-cutting, and lest competition eroding their shrinking profit margins.

The deal between RBC and HSBC Bank Canada doesn’t follow the previously mentioned rule of thumb, as both are very large banks, and the Canadian banking industry is heavily concentrated, implying saturating markets for both banks. We can, therefore, assume that the purpose of the deal is to reduce competition for them.

But wait, is it just a speculation? Or is there any truth behind the assumption?

In 2022, HSBC Canada’s reported profit before tax fell by $1.4 billion compared to the previous year. For RBC, 2022 was not a very profitable year. Net income fell 2% YoY and the fourth quarter revenue was flat YoY. In addition to insipid revenue figures, both banks faced intense competition from alternative financial institutions and fintech companies.

Interest Rate Fueled Competition

The Bank of Canada’s current policy rate is 5%. Below is a graph showing the history of policy rate increases over the last one and a half years.

Unlike the US Fed, the BoC believes rate hikes are not over yet, which means more hikes could be in the offing.

The uninterrupted rate hikes made the whole banking industry very competitive. For RBC, higher interest rates widened their net interest margin (NIM), but at the same time dampened loan demands as borrowing became more expensive. 

The same thing applies to HSBC Bank Canada. Both banks increased depositor’s interest rates shortly after the Bank of Canada changed its policy rates. Intensified competition in the deposit market benefits consumers with potentially higher returns on their savings. A high rate environment presents depositors with a wide range of deposit schemes to choose from, implying stiff competition for all types of lenders. 

Hence, we can safely assume that the merger intends to reduce competition. A smaller number of banking giants implies less competition among them. And consumers might find it hard to come by higher deposit interest rates.

Exposure to Systemic Risks

Larger banking entities are exposed to a greater amount of systemic risks, which means the merged entity will begin operation with growing regulatory concerns. The high policy rate environment could further increase its risk quotient. Key risk areas include 

• Size.
• Asset quality.
• Present and upcoming volatility. 

Asset quality might deteriorate in case of multiple defaults, which may appear like a far-fetched scenario at this moment but if the high rate environment persists, it might become a reality a few years down the line. There is low volatility in the Canadian market right now. At the time of writing this article, the S&P/TSX 60 VIX is 10.94, which is way below the average VIX. However, stressed assets and a jump in global volatility might increase it in the future.

Final Words

The merger will undoubtedly increase RBC’s market share, global presence, and improve the customer satisfaction rate. But I believe there are reasons to be apprehensive, and I explained these reasons in this article. If more mergers between large business/banking entities take place in the future, that will strengthen my apprehension.