Recession prep: Canada’s largest banks set aside billions

Anticipating that more Canadians will default on loans and credit card debt as the country heads into a potential recession, Canada’s six largest banks have set aside a total of more than $2.4 billion to cover potential losses.

“Unfortunately, some people can’t repay the loans they take out,” Lawrence Booth, professor of finance at the University of Toronto’s Rotman School of Management, told CTVNews.ca. “It happens periodically, but it tends to increase when we get into a recession and people lose a major source of income, such as their employment or small business income.”

Known as loan loss reserves, or PCL, the $2.49 billion in reserves was detailed in the latest first-quarter results released by Canada’s six largest banks: Royal Bank of Canada, TD Bank, Scotiabank, BMO, CIBC and National Bank.

This is a significant increase from the $373 million allocated to PCLs by six banks a year ago in the first quarter of 2022. Around the same time, in March 2022, the Bank of Canada began its attempt to moderate inflation by raising interest rates. which rose from an all-time low of 0.25 percent to 4.5 percent today, the highest since 2007.

“Currently, with the Bank of Canada raising short-term interest rates to slow the economy and bring down inflation, a downturn is expected in Q2 or Q3 this year,” Booth explained. “Therefore, banks build reserves for potential losses if a recession occurs.”

On the latest quarter’s earnings conference call, bank chiefs said higher employment and savings should help stave off a big spike in payment defaults that fell during the pandemic. Rather, they widely expected a “normalization” driven by rising interest rates and inflation, with loans and credit card debt expected to be most affected.

“Current underlying conditions, particularly high employment levels and consumer savings, are contributing to a slower-than-expected normalization of impaired PCLs,” William Bonnell, National Bank’s executive vice president of risk management, said on the March 1 earnings call. “The same factors we discussed last year — inflationary pressures, geopolitical risks and the direction and timing of interest rate changes — are still at play, all contributing to a less certain outlook.”