In which I catch Canadian banks paying more interest to customers than US banks do

TD Bank operates on both sides of the border, yet pays more in interest on one side than the other. Source: TD

Long-time readers will know that I like to muse on the competitiveness of U.S. and Canadian banking. In my last post on the topic, I was surprised to see how Bank of Montreal's net interest margins – a measure of how much a bank is squeezing out of its customers – were far lower in Canada than the U.S. The fact that Bank of Montreal is squeezing more out of Americans than Canadians suggests that competition is stiffer north of the border than south of it.

The idea that Canadian banking is more competitive than U.S. banking goes against what I'll call the "standard view." In short, this view is that while Canadian banks are safer and better-regulated than U.S. banks, this comes at a steep price. Up here in Canada, we've ended up with a few big oligopolistic institutions capable of charging exorbitant fees and paying unnaturally low interest rates, which hurts the consumer. Meanwhile, there are many more banks in the free-wheeling U.S., and while this makes for more bank failures and runs, the public benefits from lower fees and receives higher interest rates.

Anyways, I recently stumbled on another anecdotal piece of evidence that contradicts the standard view. TD Bank operates on two sides of the border, as the screenshot at the top of this blog post shows. Yet it pays depositors a different rate, depending on what country they live in:

Data like this is why I'm slowly starting to recant my view that America's 4000 or so banks create a healthier competitive environment than Canada's sleepy big-5 banking cartel. pic.twitter.com/QdcIS564li

— John Paul Koning (@jp_koning) March 31, 2023

As the chart shows, TD Bank consistently pays higher interest rates to its Canadian depositors. Why a persistent interest rate differential? You can't blame it on central bank policy rates being higher in Canada, since over much of this time frame policy rates were higher in the U.S. Is it possible that TD has to be more competitive in Canada in order to attract deposits?

An alternative explanation for the differential is that TD's deposits are of a different character in Canada. A big chunk of TD's Canadian deposits are fixed-term deposits that mature in 12-months or more, whereas its U.S. base of fixed-term deposits is typically shorter term, usually 3-12 months. Because it costs more in interest to convince depositors to stick around for longer periods of time, could it be that it is the difference in term – and not competition – that explains why TD's interest costs are so much higher in Canada?

Not quite. Even if we compare U.S. and Canadian interest rates for the same fixed term, Canadian banks still pay more interest to depositors. In Canada, the term of art for a fixed-term deposit is a guaranteed investment certificate, or GIC. In the U.S., it's a certificate of deposit, or CD. In the chart below, I've charted out the interest rate that Canadian banks pay for 1-year GICs compared to what U.S. banks pay for a 1-year CDs.

(For more on the data, see footnote*). 

You can see that over the last few years, the big-6 Canadian banks have consistently paid more to 1-year fixed-term depositors than U.S. banks have. Again, you can't pin this on central bank policy rates being higher in Canada. 

Canadian banks not only consistently pay more interest, they are also far more responsive to central bank policy rate increases. Both nations' central banks, the Fed and the Bank of Canada, began to hike rates in lockstep with each other beginning in March 2022, starting from close to 0% and rising to 4.75% and 4.5% respectively as of today. Yet Canadian banks began to pass-off these increases months before U.S. banks did. They have also done so far more completely; the 3.0% on a 1-year GIC is far closer to central bank policy rates of 4.5%-4.75% than the 1.5% on an equivalent CD. (And by the way, I wrote about sticky U.S. deposit rates last year.)

Could it be (gasp) that Canadian banks are more competitive?

Trust me, I don't like this conclusion. I quite enjoy thrashing Canadian banks for being noncompetitive. So if you have some good counter-evidence, please send it my way.

By the way, the above data confirms an anecdote from last year. I caught Canada's largest bank, Royal Bank, paying much more to Canadian depositors than U.S.'s largest bank, Chase, pays its American depositors:

Here's a riddle for folks who like to analyze the US and Canadian financial systems.

A 1-year t-bill yields 2% in 🍁 & 🇺🇸

Canada's biggest bank, Royal, pays 1.25% on a 1-year GIC. The US's biggest bank, Chase, offers just 0.05% on a 1-year CD.

What gives? Why such a huge gap?

— John Paul Koning (@jp_koning) May 4, 2022

It's very possible that the standard view is wrong, and the tug of war between Canada's 6 nationwide heavyweights result in a more competitive price than in the U.S. where – although there are more than 4,000 banks – they are often small and regional and lack the heft to engage in high calibre competition.

If so, it appears you can have your cake and eat it too. Not only can a country have a safe and robust banking system, but that needn't come at the price of less competition.

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*A note on my data sources for this chart. Canadian data comes from the Bank of Canada, which is compiled from posted interest rates offered by the six major chartered banks in Canada. The number is the statistical mode of the rates posted, which may explain the series' choppiness. U.S. data comes from FDIC, which compiles the data from S&P Capital IQ Pro and SNL Financial Data. Certificate of deposit rates represent an average of the $10,000 and $100,000 product tiers. Averaging across dozens or hundreds of banks would explain the smoothness of the U.S. series.

There are a number of complexities that are not explained by either data source. For instance, is the Bank of Canada's GIC data made up of non-redeemable GICs only, or do they include redeemable GICs, too? As for the U.S., banks like Chase offer a "relationship rate" to customers that far exceeds the non-relationship rate. Which rate is the FDIC collecting? I've suggested in my blog post that the difference in U.S. and Canadian 1-year fixed term deposits rates could be explained by competition, but it could also come down to data artifacts like these.