Canada's Big Six banks continue to deliver solid performance, but face rising risks, says a report from Fitch Ratings published on Wednesday.
The banks enjoy some of Fitch's strongest credit ratings, the report notes, underpinned by a mature economy and robust regulatory environment.
"After two years of oil and commodity price volatility and a long period of low interest rates, Canadian banks were able to deliver good profitability and only modest impacts to asset quality. Although the economy continues to face some challenges, there is little evidence that energy industry decline created a catalyst resulting in a material negative impact to Canadian bank profiles," the report says.
The rating agency expects the banks' operating environment in Canada to remain stable for the remainder of the year, supporting the banks' continued strong performance. That said, the report sees some fundamental challenges facing the banks.
For one, it says that, "credit performance is likely at an inflection point, which is reflected in the negative trend for asset quality for all Canadian banks."
The banks have enjoyed a long period of solid credit performance, the report says, which makes it difficult to assess the likely impact of an economic shock. "Canadian banks ratings would be sensitive to changes in credit performance such as impaired loans trending towards peak levels. Further, ratings are also sensitive to a severe housing correction that could lead to asset quality pressures," the report says.
"There are growing tail risks, which may emerge if there were to be a sharp increase in interest rates or weakening in the labor market," it says.
Nevertheless, absent a "broad-based shock to employment or a rapid rise in interest rates," Fitch views the risks to asset quality as "manageable".
Fitch's current outlook for Canada assumes modest GDP growth, no big jump in joblessness, and a soft landing for the housing sector.
The other notable risk for the banks stems from strategic shifts, such as growing their wealth management businesses, and foreign expansion.
"Canadian banks are focused on expanding their wealth management and, to a lesser extent, their insurance businesses," the report says.
"Wealth management is attractive given risk and return characteristics, coupled with low balance sheet usage. As wealth management in Canada is relatively mature with stable market shares among the banks, most banks are focused on international expansion," the report adds, and it "expects incremental wealth management acquisitions."
While these efforts help diversify earnings, they may also increase the banks' risk profile, the report says, and could emerge as a negative ratings driver. "Capital markets have higher intrinsic volatility, which can add incremental risk," it says.
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