By Mark Gollom

NDP Leader Jack Layton has been leading the rallying cry recently against the "big banks" with their "big" profits.

They are an easy target, too, when the public hears how these financial institutions are recording billions of dollars in record profits while they're getting dinged with a service charge when they take out cash at the ATM.

Layton's recent condemnations have focused on what he calls the greediness of Canadian banks for their initidal refusal to pass along the full central bank's interest-rate cut on to customers.

Layton accused the banks of gouging consumers to protect their fat salaries and huge profits. (On Friday, however, banks announced further cuts in their prime rates.)

But are the banks profits, as Layton suggests, "too high?"

Although profits will likely be down for 2008, Canada's six banks reported 2007 profits of a record $19.5 billion.

Eye of beholder

It's a difficult question to answer since how much profit is too much is in the eye of the beholder. But Basil Kalymon, finance professor emeritus at the Richard Ivey School of Business at the University of Western Ontario, explained what he considered "reasonable" profits.

First he said it's important to look at the rate of return, not the billions of dollars you see posted in profits.

"The absolute numbers mean absolutely nothing," he said.

An average-sized company's average return has been around five percentage points above the bond rate, he said. So if the bond rates are around 4.5 per cent, 9.5 per cent would be considered reasonable profits.

Bank returns have been 13 per cent to 15 per cent on their equity, meaning banks have over the last several years made some very healthy returns.

But Kalymon cautioned that trend may have been a cyclical phenomenon. He said it's clear that banks will not be making high returns in the near future because they're losing so much money on write-offs. As well, if the economy is about to go into a recession, banks will be faced with more defaults.

"Sometimes you have to earn a little more in the good years to make up in the lean years," he said.

"If they were making returns of that level all the time and never had down turns then it would be too high. But they do get down turns. And this is not the first down turn. They've had pretty lean years in the past. You can't look at one year and say there it is."

Prime lending rates

This leads to the recent controversy over the prime lending rates. Canadian banks will borrow and lend among themselves at a rate set by the Bank of Canada. But Canadian banks are only a very small fraction of funding sources.

Banks also borrow and lend through the interbank market. But those costs of borrowing have gone up in the current shaky economic climate over huge concerns of failing banks, Kalymon said.

Some may still argue that the banks should absorb the costs, despite the effect on their profit margins.

However, it should be noted that the beneficiaries of bank profits are average Canadians, who hold shares in bank stocks through pension funds and mutual funds. Holders of these pension funds and RRSPS receive dividends each year.

For example, bank shares make up nearly 20 per cent of the pension fund holdings of the Nova Scotia Public Service Teachers Pension Plan and 15 per cent of the Ontario Municipal Employees Retirement System.

As for top bank executives, they don't own large percentages of the companies since legislation restricts ownership by an individual or group of individuals to no more than 10 per cent. Although the top executives would have some stock and some stock options, as a percentage, it would be quite small and quite limited. (The salaries of CEOs is another issue, possible a subject for another Reality Check.)

So the reality is, while banks, like any institution, may deserve their share of knocks, some of the bank-bashing, as Kalymon puts it, is just "poorly informed."