While the big banks are well-equipped to ride out the effects of heightened economic stress and uncertainty, Canada’s mid-sized banks are facing greater strains on their credit quality, according to Morningstar DBRS Inc.
In a new report, the rating agency examines the outlook for the medium-size banks, which saw asset quality deteriorate in the first half of 2025, amid ongoing financial stress in certain segments.
“Interest rate-sensitive households and businesses continued to face some repayment pressures under the weight of still-elevated interest rates,” the report said.
Against that backdrop, aggregate gross impaired loans for the mid-sized banks —including Laurentian Bank, Home Trust Co., Equitable Bank, and Fairstone Bank of Canada —rose by 12.8% in the second quarter, and the gross impaired loans ratio deteriorated by 20 basis points, DBRS said.
The rise in impaired loans was “largely driven by higher commercial impairments at Equitable and Laurentian and residential and commercial mortgages at Fairstone,” it noted.
Looking ahead, these trends are expected to continue in the second half of the year, “as tariff uncertainty persists and interest rates remain elevated.”
DBRS said that it now forecasts that impairments and credit loss provisions will peak in fiscal 2026, and impaired provisions “may increase further if macroeconomic and operating conditions deteriorate.”
In particular, the banks’ non-mortgage consumer loans — such as credit cards, unsecured lines of credit, and retail finance — along with certain commercial loan exposures, “are more likely to experience higher credit deterioration” compared with segments that have proven relatively resilient in the current credit cycle, such as residential mortgages and multi-unit commercial lending.
Additionally, the mid-sized banks face greater strain than the big banks, given the lower levels of diversification in their risk exposures by product and geography, the report said.
For instance, banks with large exposures to provinces that are likely to be hardest hit by trade turmoil are exposed to escalating trade conflict.
Despite these rising credit stresses however, DBRS also said that the banks should be able to absorb increased loan losses due to their “good balance sheet fundamentals” — including “good liquidity, stable funding, and sound capital levels.”
“While capital ratios vary by bank, [the medium-sized banks] maintain sufficient capital cushions above OSFI’s minimum regulatory thresholds, sufficient to weather an adverse operating environment and absorb potential losses,” the report said.