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Competition for customer deposits among Canadian banks is expected to intensify with the likely onset of lower interest rates as clients divert funds parked in high-yielding fixed income products to riskier investments in search of better returns, analysts and executives say.

For banks, sticky customer deposits are a cheaper source of funding that keeps costs under check and boosts lending margins.

The big Canadian banks benefited from the $350-billion pandemic-era savings, most of which found its way into the popular Guaranteed Investment Certificates (GICs), that earn around 5 per cent interest.

Now that pot of cash is likely to seek a new home unless banks pay up to retain deposits, which will squeeze their profit margins, analysts warn. Bank of Canada governors have agreed that rate cuts should materialize this year if the economy evolves as predicted.

“It’s very likely that Canadian consumers are more demanding now than they were in the past couple of decades ago when interest rates were low,” KBW analyst Mike Rizvanovic said.

“Even in a rate-cut cycle, Canadians are maybe a bit more demanding on their money,” Rizvanovic said, noting that consumers are less likely to keep money in demand accounts that pay low interest even when rates are declining.

Debt financing is one of the most expensive form of funding for banks. While term deposits are cheaper they are still costlier than demand deposits.

Already, Canadian banks’ reliance on medium– to long-term debt and commercial paper is higher compared to their global peers. Some 36.8 per cent of large Canadian banks funding comes from debt, compared to 26.1 per cent for large U.S. banks’ and 28 per cent for European banks, according to the Bank of Canada data.

“What’s changing is that banks are being more competitive … the price competition with deposits has gotten fiercer, and that’s resulting in banks offering more competitive deposit rates, and that’s also putting upward pressure on costs,” Veritas Investment Research analyst Nigel D’Souza said.

The big banks took bold cost-cutting steps last year to preserve profits even as loan loss provisions rose. Analysts now expect earnings to decline as the banks overcome those challenges and forecast growth later in the year.

Banks are preparing to deal with a shift from maturing term deposits.

“One of the dimensions that we all struggle to predict is what’s going to happen with the C$350-billion of consumer deposits that largely sit in GICs right now,” Royal Bank of Canada CEO Dave McKay said last month.

“Some (deposits) will flow, as we expect, back into equities and back into investment products. Some will create stimulative demand.”

To be sure, the need for banks to raise more deposits is dependent on loan growth, which is currently muted.

“The question becomes … when will the loan growth volumes pick up,” Jefferies analyst John Aiken said. “This is a very squishy stage where you may actually want to pre-fund on some of that growth if you’re very optimistic and try get some market share on deposits to fund that growth,” he said.

At the end of January this year, deposit at the big five banks grew at an average rate of 2.98 per cent, one of their slowest growth rates since the pandemic era.

In Australia, a market similar to that of Canada, analysts expect competition to squeeze bank profits as pandemic-era subsidized funding comes to a close. In the US, a large part of the savings is already spent.

TD, Canada’s second-biggest bank, expects some of that deposit money to go into equities as interest rates moderate, its Canadian retail operations head Raymund Chun said. “But we’ll see and we’ll adjust accordingly,” he added.

The pressure to capture deposits could lead to product innovations similar to how telecom companies retain customers.

“As the interest rate environment shifts, we will come out with new products,” said Gillian Riley, CEO of online bank Tangerine, a unit of Bank of Nova Scotia.

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