The big Canadian banks will take a hit from the escalating trade war, which will lead to higher credit losses and weaker earnings, says Fitch Ratings.
In a new report, the rating agency outlined the expected impact of sharply higher U.S. tariffs on the big banks — forecasting that the deteriorating economic outlook will hurt the banks’ bottom lines.
Fitch now expects Canada to go through a recession this year, with higher inflation and rising unemployment — which will translate into weaker loan volumes and credit performance and softer consumer spending.
“The initial round of U.S. tariffs is likely to have a near-term direct impact on Canadian banks’ commercial loans. Banks with greater exposure to industries vulnerable to increased tariffs, such as the industrial, agricultural, automotive, construction, energy or mining sectors, face more risks,” it said.
If the expected recession turns out to be deeper, or longer, than expected, “it will increase risks to mortgages and Canada’s housing market,” it added.
While the previous trade conflict of 2018-2019 didn’t impact the banks’ asset quality, or earnings, that “was partly because U.S. tariffs on Canadian goods were more targeted, tariff rates were lower, and the conflict was resolved in a relatively short period,” Fitch noted.
Now, it’s assuming that the effective tariff rate on Canadian imports to the U.S. in 2025 will rise to 15% from 0.1% in 2023, and that Canada will retaliate.
The looming conflict and the spike in uncertainty due to rapidly shifting U.S. policy has already “soured the business environment,” the report noted, with small business confidence hitting an all-time low in March.
The credit performance of the Canadian banks’ unsecured retail loan portfolios deteriorated in the first quarter, amid rising impairments in commercial loan books, Fitch noted.
“We expect lumpiness in the impaired loans ratio over the next few quarters as banks work to resolve these loans,” it said. “Banks typically restructure commercial loans faster than consumer loans and reduce sector exposure to quickly contain credit deterioration.”
If a more severe recession results, the banks would “face higher mortgage impairments that would take longer to resolve, especially if accompanied by a housing market downturn.”
That said, the big banks have solid balance sheets, including strong asset quality, stable funding, and “ample” capital to guard against the fallout from a recession, but the “uncertainty caused by the impending tariff-induced recession increases credit risk,” it noted.
“If impairments at Canadian banks rise to a level that results in significant losses that pressure earnings, this would not have a direct impact on rating sensitivities in the short term. However, if earnings pressure becomes structural over the long term, Canadian banks have less ratings headroom,” it concluded.