We will remember Fiscal Year 2022 for both rapidly rising inflation and unprecedented interventions by the Bank of Canada to rein it in. The central bank raised interest rates a record seven times from late 2021, boosting lending rates a total of 400 basis points.1
While rising interest rates are generally a drag on the stock market’s performance, banks work differently. For Canada’s banks—and for those who invest in them—a rising rate environment can have positive benefits for improved revenue growth and rising valuations. As we enter an era of higher overall interest rates, the potential for returns on investments in Canada’s banking sector has never been better.
How banks benefit from rising interest rates
In general, rising interest rates are good news for banks because, unlike many other types of companies, they can grow their profit margins during periods of rising interest rates.
Banks profit from two main sources of income: revenue from lending (interest-based income) and revenue from non-interest-based income like insurance and wealth management.2 Banks are asset-sensitive businesses, with the assets on their books re-pricing higher faster than their liabilities.3
As a result, in high-rate environments, the increased yields from things like commercial and residential mortgages mean that banks get a boost from their interest-based income streams. And the bigger the percentage of a bank’s income derived from interest-based sources, the more profitable that bank can be as interest rates climb.4
In fact, profitability for banks is often at its highest in a rising-rate environment coupled with a still-growing economy.5
How Canadian banks performed in 2022
Given the potential benefits of a high-rate environment for banks, how did Canada’s banking industry fair during last year’s rate increases?
If we look at the performance of Canada’s Big 6 banks as a proxy for the entire sector, we can very easily see that, overall, 2022 was a good year for Canada’s banks.
A recent report from KPMG on the full-year performance of Canada’s Big 6 banks in 2022 highlighted that, in terms of top-line growth, aggregate total revenue for the Big 6 was $194.6 billion—up 9.2% from FY 2021.6 Of this, $102 billion was net interest income (an increase of 11.3% from the previous year) and $92.6 billion was non-interest income (an increase of 5.1% from the year before).7
While there are a number of unknowns and potential headwinds for the banking sector in 2023, Geoffrey Rush, KPMG’s Financial Services National Industry Leader, says that in light of their 2022 financial results, “Canada’s 6 major banks are well positioned to deal with such economic uncertainties should they happen.”8
Investing in Canadian banks with BANK ETF
Facing an uncertain economy, banks make attractive targets for savvy investors. A great way to invest in a diverse portfolio of Canada’s largest banks, as well as Canada’s largest insurance companies, is through Evolve’s BANK ETF.
Evolve Canadian Banks and Lifecos Enhanced Yield Index Fund (TSX Ticker: BANK) provides investors with an enhanced yield from exposure to Canada’s largest banks and insurance companies through a covered call strategy applied on up to 33% of the portfolio and 25% maximum leverage. Covered call options have the potential to provide extra income and help hedge long stock positions.
For more information on BANK ETF, visit the fund page here: https://evolveetfs.com/bank/.
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