'We expect lower but still solid year-over-year earnings in the fiscal year': De Souza

Canadian Banking Outlook for 2026: A Detailed Analysis

Key Concepts:

• Big Six Banks: Refers to Canada’s largest banks – Royal Bank of Canada (RBC), Toronto-Dominion Bank (TD), Bank of Nova Scotia, Bank of Montreal, CIBC, and National Bank of Canada.
• KUSMA (formerly NAFTA): The Canada–United States–Mexico Agreement, a trade agreement governing trade between these three countries.
• PCLs (Provisions for Credit Losses): An expense set aside as an allowance for uncollectible loans. A rise in PCLs indicates anticipated credit deterioration.
• Net Interest Margin (NIM): The difference between the revenue a bank generates from its lending activities and the interest it pays out to depositors, expressed as a percentage.
• Operating Leverage: A measure of how a company uses its resources to generate revenue. Positive operating leverage means revenue is growing faster than expenses.
• Fiscal Year: A 12-month period that companies use for accounting and reporting purposes. In Canada, this typically ends on October 31st.

I. Overall Banking Sector Outlook & Macroeconomic Factors

Morningstar DBRS maintains an “unfavorable” outlook for the Canadian banking sector heading into 2026. While the baseline macroeconomic outlook has improved with stimulative fiscal and monetary policy supporting growth, significant risks create uncertainty. These risks include potential credit deterioration due to sectoral tariffs and adverse effects stemming from potential issues with the KUSMA trade agreement, including a possible US exit. Despite these headwinds, lower but still solid year-over-year earnings are expected for the fiscal year, driven by higher credit costs, slower net interest income growth, and a pullback from record capital markets revenues experienced in the previous year.

II. Impact of Trade Uncertainty (KUSMA)

The potential disruption of the KUSMA trade agreement is a major concern. If negotiations prove problematic or the US withdraws, both the Canadian and US economies could suffer. However, the banks’ diversified business models are expected to provide resilience. Carl Duza notes that even factoring in the possibility of KUSMA’s failure, the banks are still projected to have a potentially good year. This resilience is attributed to several factors:

• Interest Rate Cuts (2025): Continued rate cuts will provide some relief to borrowers.
• Diversified Business Models: The Big Six’s diversification across geography and product lines will help bolster earnings.
• US Exposure: Exposure to the more resilient US economy, particularly through capital markets and wealth management, will continue to drive revenue.
• Stable to Improving Net Interest Margins: Margins are expected to remain broadly stable or slightly improve.

III. Geopolitical Risks & Downside Risks

Geopolitical concerns, including the situations in Venezuela, Ukraine/Russia, and Gaza, are identified as additional headwinds. These conflicts could have broader global implications for growth and trade. The combination of trade uncertainty and geopolitical instability skews risks to the downside for 2026. However, optimism remains that these issues will be resolved in an orderly manner, mitigating the most severe risks. Banks are also focusing on cost discipline and undertaking restructuring programs to manage non-expense growth and achieve positive operating leverage.

IV. Artificial Intelligence (AI) & its Impact

All Canadian banks are actively exploring and deploying AI technologies. TD and RBC have quantified potential benefits:

• TD: Projects a potential $500 million in revenue uplift and $500 million in cost savings in the medium term (defined as 2029 in their recent investor day).
• RBC: Projects up to $1 billion in AI-driven enterprise value by 2027, though this figure isn’t broken down into revenue uplift versus cost efficiencies.

While tangible results are still developing, banks are maintaining significant budgets for AI investment, recognizing its importance for future productivity, efficiency, and potential revenue generation. Progress on AI implementation is expected to continue in fiscal 2026 and beyond.

V. Credit Deterioration & Provisions for Credit Losses (PCLs)

Pressures from sectoral tariffs are expected to lead to further credit deterioration for the Big Six banks in fiscal 2026. Provisions for Credit Losses (PCLs) are anticipated to potentially peak in the second half of the fiscal year, reflecting the increased risk of loan defaults.

VI. Key Arguments & Perspectives

Carl Duza presents a cautiously optimistic view. While acknowledging significant risks, he emphasizes the resilience of the Canadian banking sector due to its diversification, strong capital positions, and exposure to the US economy. He argues that the banks are well-positioned to navigate a challenging environment and maintain solid earnings, even in the face of potential trade disruptions and geopolitical instability.

VII. Notable Quotes

• Carl Duza: “The big six banks maintain very diversified business models that have proved resilient and provide earnings resilience in the face of an uncertain and potentially volatile operating environment.”
• Carl Duza: “All the banks are talking about AI…they’re projecting revenue uplift and cost savings…but there’s still time to develop here to see tangible results.”

Conclusion:

The Canadian banking sector faces a complex outlook for 2026, characterized by macroeconomic uncertainty, trade risks, and geopolitical concerns. Despite these challenges, the Big Six banks are expected to remain profitable, leveraging their diversified business models, exposure to the US economy, and investments in technologies like AI. While credit deterioration is anticipated, banks are proactively managing risks and focusing on cost discipline to maintain earnings resilience. The key takeaway is that while the environment is unfavorable, the Canadian banking sector is well-equipped to navigate the challenges and deliver solid, albeit lower, performance in the coming year.