The banking giants' earnings are a key indicator of what’s in store
Canada’s banking giants released their third-quarter financial results over the course of the past week, with those reports reflecting how the economy has shifted gears throughout 2022.
Lower profits due to funds set aside for potential future loan losses were the name of the game for the country’s major players, a trend that showed financial institutions are ramping up preparations for an economic downturn next year, according to an expert market analyst.
“The drivers of the lower-than-expected results really were the higher provisions for credit losses and softer capital market results,” Shilpa Mishra (pictured), managing director, capital advisory at accounting firm BDO Canada told Canadian Mortgage Professional.
“The other key data point is that the banks have now assumed that the Canadian and US economies are going to face a moderate recession in 2023. They’re preparing for that by setting this money aside and they’re being prudent in light of this uncertainty.”
Most of the country’s largest banks have sounded the alarm on potential economic difficulty ahead, with RBC becoming the first to project a mild recession moving into next year.
It said that inflation, rising interest rates and labour market shortages would bring about a “moderate” contraction in 2023 – one that would likely prove less severe than previous instances.
That said, Canadian consumers and businesses have proven hugely resilient throughout the pandemic and current inflationary period, with a “can’t stop, won’t stop” attitude prevailing despite those challenges, according to Mishra.
She described that as a “bright light” amidst economic uncertainty, helping contribute to the leading banks’ strong performances in their Canadian banking divisions in the face of significant hurdles.
The last quarter saw low unemployment and record levels of demand in the Canadian economy, factors that Mishra said had helped spur that strong performance on the consumer and business side.
“If you look at the actual results, peeling back the provisions for credit losses and the capital market results, the banks had double-digit year-over-year growth across lending, credit cards and deposits for the personal and the commercial segments,” she said.
“And putting aside provisions, current credit losses remain low because clients are demonstrating resilience despite the rising costs and economic headwinds.”
That means that while there’s higher leverage in the system because of that economic uncertainty, clients have strong liquidity as well as healthy corporate and personal balance sheets, she said, helping boost spending in those areas.
Another noteworthy trend to emerge from the top banks’ earnings results came on the deposits side, with deposit growth and spread key indicators of how well a financial institution is performing.
“What the banks said is that they continue to see that driving strong results,” Mishra said, “because they’re repricing their deposits and taking advantage of the higher spread, but in terms of their loans, they’re not able to pass the higher cost of loans onto their customers.”
What should business owners keep in mind?
Mishra identified a number of factors that business owners need to stay apprised of in the current climate, with staying on top of business performance and cash flow top of mind – ensuring that profit margin leakage can be avoided and opportunities for growth maximized.
Read next: RBC's Q3 profits slip
It’s also important to ensure the right balance of debt and equity in a company’s capital structure, she said, allowing them to keep costs under control and have capital on hand for future growth.
Passing on higher costs to customers by raising prices may be a challenging but necessary task for many businesses, she said, while seeking the advice of a professional should also be kept in mind to optimize business performance.
With 80% of a company’s profit usually deriving from around 20% of its customers and products, Mishra also recommended performing an 80/20 optimization – potentially streamlining operations by stopping sales or service to those customers that provide little or no profit – to grow margins.
“It’s really about focusing on the most profitable services and products,” she said. “It’s interesting that the banks haven’t been able to pass down the rising cost of their loans, but we do recommend businesses raise prices and pass higher costs on to consumers. And, of course, it’s good to get professional advice, because experienced advisors can provide a new perspective.”
