Large Canadian Banks: Heading into a Challenging 2023 Operating Environment from a Position of Strength

The Canadian banking outlook for 2023 is affected by a challenging operating environment featuring muted economic growth and an increasing likelihood of a recession. Rapid and aggressive aggregate interest rate hikes of 400 basis points during 2022 have, thus far, been unable to significantly tame high inflation while materially increasing borrowing costs. As a result, disposable income is being negatively affected in Canada where high household indebtedness and still-elevated housing prices remain two key vulnerabilities in the Canadian financial system.

Key highlights include the following:

-- While macroeconomic conditions are amplifying some key vulnerabilities, DBRS Morningstar expects the overall financial impact to be manageable, as the Big Six are entering 2023 with strong asset quality, ample liquidity buffers, and sound capital levels.

-- Heavily indebted Canadian borrowers are facing increasing pressure as materially higher debt servicing costs and elevated inflation levels continue to eat into disposable income.

-- Credit quality metrics are expected to continue normalizing from unsustainably low levels. Additional interest rate hikes in 2023, a severe recession, and/or larger than expected uptick in unemployment would intensify the credit deterioration.

“The Canadian banking outlook for 2023 is affected by a challenging operating environment featuring muted economic growth and the increasing likelihood of a recession,” said Carl De Souza, Senior Vice President, North American FIG. “Given the more challenging backdrop and higher minimum CET1 regulatory requirement, we expect the Big Six to target CET1 ratios closer to 12%, while curtailing the pace of share buybacks and dividend increases after being very active on both fronts in F2022.”