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National Bank of Canada ’s second-quarter profit more than doubled year over year as banks enter a sweet spot of declining loan losses and increasing economic activity, but its chief executive is eyeing a new threat as concerns about inflation are rising as well.

The Montreal-based bank’s profit jumped 111 per cent year over year to $800-million, adding to a streak of outsized earnings reported by Canada’s major banks this week. Plunging provisions for credit losses – the funds set aside to cover loans that may go bad – have helped drive higher earnings as fears abate that the pandemic could create a spike in defaults. National Bank’s new second-quarter provisions were a mere $5-million, compared with $504-million a year earlier.

The bank earned $2.25 per share in the three months that ended April 30, compared with $1.01 a share in the same quarter last year. On average, analysts expected earnings per share of $1.99, according to Refinitiv.

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As economies reopen, customers are starting to borrow again, and National Bank’s personal lending increased 7 per cent from last year, while commercial loan balances rose 5 per cent. Financial markets are still busy and merger activity is hot, which propelled the bank’s capital markets division to the third-best quarter in its history, with $238-million in profit. And like its peers, National Bank has accumulated a large store of excess capital that is waiting to be deployed.

The missing piece of a “Goldilocks” scenario – where conditions are just right for banks – is a modest increase in interest rates, which would improve lending margins and help the bottom line.

But too much inflation could introduce a new set of risks, driving up loan losses as clients face higher borrowing costs, and even slowing activity in equity markets and the broader economy.

The risk “that we need to monitor very carefully is the [possibility] that Goldilocks gets overheated and that inflationary pressures start developing more in the economy, and that asset prices across different segments get to extreme levels,” said Louis Vachon, National Bank’s chief executive officer, on a Friday conference call with analysts.

As it stands, Mr. Vachon thinks overheating inflation is “a low-probability event,” and that “Goldilocks will be with us for a period of time.” Volatility in asset classes like cryptocurrency are “not a huge concern to us,” he said.

“But if it gets to a much wider spectrum of asset classes, some of which are connected to banking, or more specifically our balance sheet, then I think we would be a lot more careful.”

As a precaution, National Bank’s risk committee is having discussions about how the lender would adjust its risk policies should inflation run high. For many bankers, it is unfamiliar territory: Mr. Vachon said he is one of the last “dinosaurs” in the bank’s executive offices who worked in an inflationary environment in the 1980s.

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“It would require a bit of a change in mindset, particularly with traders and risk managers that have seen rates drop continuously for the last 25 years,” he said.

A combination of accelerating economic activity, stimulus programs from governments and central banks, and an imbalance of supply and demand for many consumer goods “is increasing the risk of inflation in certain asset classes,” said Dave McKay, CEO of Royal Bank of Canada , on a conference call this week. “Consequently, there is a higher likelihood of central banks raising their benchmark interest rates in the second half of 2022.”

A 1-percentage-point increase to benchmark rates in Canada and the U.S. would boost banks’ income from interest over the next year by an estimated $2.1-billion at Toronto-Dominion Bank , $858-million at RBC and $304-million at Bank of Montreal , according to financial disclosures.

On Thursday, Canadian Imperial Bank of Commerce CEO Victor Dodig acknowledged that “we’re all seeing the price pressures that are out there,” but said he believes that central banks will react “and things will settle down over time.”

The question is whether it will settle in the “Goldilocks” range, neither too hot nor too cold.

“If inflation becomes not just transitory but appears to be more permanent, starts impacting inflationary expectations, and that loop becomes self-reinforcing, that’s always the danger,” Mr. Vachon said in an interview.

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