Big Banks in Canada expect to earn billions of dollars in added income from interest charges over the next year as central banks drive up interest rates, but the rapid pace of rate hikes could dampen the boost to profits if higher borrowing costs reduce demand for new loans. The Bank of Canada announced its second consecutive oversized increase to its policy rate on Wednesday, hiking its benchmark rate by 0.5 percentage points to 1.5 per cent, as central bankers act aggressively to tame high inflation. That is good news for chartered banks: It promises to boost the profit margins they earn from lending money at higher rates than they pay for deposits. For the past two years, banks’ net interest margins have been squeezed as central banks cut policy rates to rock-bottom levels to stimulate economies and help them rebound from COVID-19. But after the Bank of Canada hiked rates by 50 basis points for the second time since April, Canadian banks are expecting a surge in net interest income (NII) – as much as $3.5 billion combined over the coming 12 months, according to one set of estimates.
With the Bank of Canada predicting there are more rate hikes to come and saying it is “prepared to act more forcefully” if needed to cool inflation, banks’ NII could keep rising for at least the next two years. Net interest income is key to bank performance, as it typically makes up about half of a major bank’s revenue Banks tend to earn higher interest income when interest rates rise. That is partly because they can charge wider spreads between deposits and loans, but also because they earn a better rate of return on financial assets they purchase with the deposits and other funds they hold. The impact could be most obvious for banks’ mortgage balances, which have been rising at a furious pace over the last year but are expected to grow more slowly in the coming quarters. Banks are also on the cusp of an early rebound in credit card balances, which generate higher profit margins for lenders, as customers travel and dine out more with pandemic restrictions easing.