How hard will tariffs hit the economy? Investors will be watching bank credit loss provisions for clues

Each quarter, the banks must assess the potential losses stemming from borrowers who have fallen behind on payments, then take into account any changes to their economic forecasts and whether those changes are more likely to push borrowers into default. Photo by Andrew Lahodynskyj/The Canadian Press/Postmedia files

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Investors will be keeping an eye on how much money Canada’s biggest lenders have set aside to tackle loans that may potentially go bad when they release their second-quarter results later this month.

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Some expect that amount, also referred to as provision for credit losses (PCLs), to increase due to the negative impact of United States President Donald Trump’s tariffs on the Canadian economy. Tariffs on an array of Canadian exports were imposed on March 4, and the Big Six earnings will cover the three-month period ending March 31.

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“As the Canadian banks and the markets digest a changing and challenging economic outlook, the second-quarter earnings will be another signpost as to where we are heading,” Jefferies Inc. analyst John Aiken said in a note on May 5. “We expect allowances on performing loans to increase dramatically, reflecting the deterioration in the economic outlook.”

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The banks’ quarterly results and projections often act as an economic barometer for the country, analysts say, since the sector plays a key role in the economy: it was responsible for 3.5 per cent of the country’s gross domestic product in 2023.

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Analysts made similar predictions about the Big Six increasing their PCLs ahead of first-quarter results, which were released in February for the three-month period ending Jan. 31, because the threat of Trump’s tariffs — although not yet imposed — had already started to negatively impact the economy.

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The Big Six back then did take into consideration the impact of the tariffs to a certain extent, but the PCL increases weren’t “serious,” Royal Bank of Canada analyst Darko Mihelic said in a note on May 6.

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As a result, the quarterly calls were dominated by questions about how Trump’s proposed tariffs on Canadian products might impact the economy, overshadowing to a certain extent that most of the banks comfortably beat analysts’ expectations for the quarter.

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Bank executives said they weren’t able to calculate the impact of the tariffs since there wasn’t much information.

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“It’s difficult to act on headlines and tweets,” Bank of Nova Scotia’s chief risk officer Phil Thomas said back then, referring to Trump’s inconsistent announcements.

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PCLs are a key credit metric for measuring the health of a bank’s loan book as well as the ability of households and businesses to pay their debts.

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Each quarter, the banks must assess the potential losses stemming from borrowers who have fallen behind on payments. They also take into account any changes to their economic forecasts and whether those changes are more likely to push borrowers into default in the future. If the economic picture becomes brighter, banks can release some of their PCL reserves.

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Moving ahead, banks will need to find the right balance when adding to their PCLs, analysts said, and ensure they don’t “spook” investors.