The rating outlook for the Canadian banking sector remains negative, Moody’s Investors Service announced on Tuesday, as the New York-based credit rating agency expects asset quality to decline amid economic weakness and high household debt levels, along with reduced expectations for taxpayer bailouts.
The outlook for the Canadian banking system remains negative “as asset quality is expected to deteriorate and the country moves to formalize regulation aimed at reducing the public cost of bank failures,” states Moody’s in a report published on Tuesday.
The asset quality at the Canadian banks will undergo a moderate decline in the next 12 to 18 months, Moody’s projects, “as low GDP growth and weakening employment fundamentals increase pressure on the ability of highly leveraged households to repay debt.”
“We anticipate a moderate decline in Canadian banks’ asset quality as they actively seek growth in higher-risk areas including credit cards and indirect auto lending,” said Moody’s senior vice president, David Beattie. “Additionally, the relaxation of covenants in commercial lending and the extension of loan terms in retail auto finance could lead to higher loan losses.”
However, Canadian banks have a low level of problem loans compared to similar banking systems, Moody’s notes in the report, adding that the banks’ solid capital positions and stable earnings will help them mitigate any increase in credit costs and withstand unexpected stress.
In addition, the banks will likely face a reduced prospect of government support given plans to formalize a bank recovery and resolution framework that would include the bail-in of creditors of systemically important institutions, the report notes.
Currently, the banks’ ratings assume a very high level of expected governmental support, but the rating agency plans to refine its assessment of the framework’s implications once the details are clarified following the federal election in October, the report states.