Banks are bracing against loan losses

Canadian Bank Earnings Week is under way, and while we admit it’s not as exhilarating as Shark Week, it can teach us some valuable lessons about the murky waters of the economy.

What happened: Quarterly earnings reports for Scotiabank and BMO showed that both banks are keeping more cash aside than analysts expected to cover loans that could go sour, known as loan loss provisions, continuing a trend of caution in a risky environment. 

Why it’s happening: As the Bank of Canada continues its ‘will-they-won't-they’ approach to interest rate cuts, the current overnight rate of 5% — up from just 0.25% two years ago — has left borrowers struggling to pay off their mortgages, credit card debt, and auto loans. 

  • While Canada’s household debt-to-income ratio started to fall late last year, it’s still hovering around record highs, stoking fear in banks that some loans won’t be repaid. 

Why it matters: Higher loan loss provisions may be a plight on earnings, but they’re also a source of peace of mind. They insure against bad loans, back up risky investments, and generally ensure the banking system's stability during uncertain times (read: right now). 

  • Plus, the tide could turn soon. Canada’s top financial regulator had raised minimum loan loss requirements in December 2022 and June 2023, but held them steady in December 2023.

Bottom line: Large loan loss provisions likely took a bite out of earnings for all of the Big Six banks, but their impact should peak this year, RBC’s CEO predicted last month.—QH