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opinion

Dec. 7 will be a good day in Canadian banking.

The Bank of Canada has an opportunity to adjust its trendsetting overnight rate that day, and an increase of 0.25 to 0.5 of a percentage point is widely expected. Like flipping a switch, banks will replicate that increase in their prime lending rate and, in turn, variable-rate mortgages, lines of credit and floating rate loans.

Higher rates on these loans mean two things – increased costs for borrowers and more money for banks. “Generally, rising interest rates are positive for banks,” said Carl De Souza, senior vice-president for North American Financial Institutions at DBRS Morningstar.

But that’s not the full picture. Rising rates tend to arrive along with setbacks in the economy and financial markets that can hurt bank profits. Expect to see some evidence of this when the Big Six banks next announce financial results.

Some recent homebuyers will find rate hikes painful as mortgages go up, Bank of Canada's Carolyn Rogers says

There’s still a while to go in 2022, but it’s not too soon to declare it the year of the financial U-turn. Last year, a wide swath of the population made money through rising home prices and giddy stock markets. Stocks and housing have fallen this year, the economy is slowing, and inflation and high interest rates have returned from the past like rampaging dinosaurs.

It’s normal to feel anxious and resentful in these times, and to wonder who’s responsible. The list of those blamed so far includes the Bank of Canada, governments, supermarket chains and the big banks, who are seen by some as pocketing the higher payments their clients are forced to make as a result of rising rates for mortgages and other borrowing.

There are a few pillars of bank revenue and profitability – taking in deposits and lending out the money, advising businesses on mergers, acquisitions and other deals, and wealth management, which means selling investment products and advice. Rising rates help with the deposits and lending side of things by increasing the spread between rates charged on debt and paid on deposits.

Let’s say the Bank of Canada raises its overnight rate by 0.75 of a percentage point, which financial people express as 75 basis points. A basis point is a one-hundredth of a percentage point.

That means the banks’ prime lending rate is also going to rise by that amount, DBRS Morningstar’s Mr. De Souza said. “Are they going to funnel that full 75 basis points into deposit rates? Probably not. They’ll give a lower amount – that’s the spread.”

Banks do raise the rates they offer on deposits as borrowing costs climb, but not in nearly as predictable way as they increase borrowing costs. Mr. De Souza said deposit rates reflect how competitive a bank wants to be in attracting money to lend out. Lately, we’ve seen abysmally low rates on savings accounts yet returns from some guaranteed investment certificates have been surprisingly competitive.

The term for the difference between what a bank charges on loans and what it pays in deposit interest is net interest income. Rising rates help with net interest income these days, but other areas of banking are less positive.

Weak stock and bond markets have curtailed the investing boom of 2021, which affects the wealth management business. In the bank-dominated mutual fund business, investors redeemed a net $9-billion in September alone.

Also, a slowing economy and threat of recession negatively affects the business of advising companies on deals, share issues and more.

Even loans can be a double-edged sword for banks when rates are rising, with the risk of missed payments and defaults. Mr. De Souza said banks adjust to this risk through loan loss provisions, which are a cash reserve against a rise in defaults. But these provisions are costly. They eat into bank profits, which might otherwise be rising because of higher interest income.

Third-quarter profits for the banks were generally down, though still measured in billions of dollars. Numbers for the just-completed fourth quarter will probably look similar, a result that can be interpreted in a couple of ways. One is that the banks are making money on the backs of struggling borrowers, while the other is that the financial U-turn of 2022 affects banks along with the rest of the economy.

Two versions of reality, both true. The blame game is never as simple as it seems.

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