Canadian Banks' Lending Recovery Seen Clouded by Hot Inflation

Surging inflation and rising bond yields are set to offer a shot in the arm for Canadian banks' profit margins, which have languished during the pandemic, but an aggressive response by central banks could derail a nascent lending recovery and increase defaults, investors and analysts said, Reuters reported. Canadian banks' loan growth outside of mortgages all but disappeared during the pandemic as lockdowns and surging deposits slowed consumer and business borrowing. Although spending has increased after lockdowns were lifted, that has so far failed to translate into robust credit growth. Higher interest rates drive banks' net interest margins. But uncertainty around how persistent inflation will be and how quickly rates will rise is clouding the outlook for lending recovery into next year that investors had hoped for. "If (the Bank of Canada and U.S. Federal Reserve) raise rates too quickly, that would stifle economic growth, and loan demand will decline. ... That would be a negative for the banks and have a negative impact on profitability," said Rob Colangelo, vice president and senior credit officer at Moody's Investors Service. An aggressive response would raise loan servicing costs, raising the potential for defaults. Banks would increase bad loan provisions, which would lead to weaker profit growth. And given the recent surge in demand for variable-rate mortgages, a rapid rise in rates would make borrowers more vulnerable, potentially leading to loan losses, said Mike Driscoll, head of North American financial institutions at DBRS Morningstar. The latest data showed inflation surged to a near two-decade high of 4.7% in October. While money markets expect a hike as soon as March and five in all next year, the Bank of Canada reiterated this week that increases are not expected until the middle quarters of 2022. Read more.