Large Canadian banks struggle with rising expenditures as inflation soars

Bank towers are seen from Bay Street in Toronto’s financial district, on Wednesday, June 16, 2010.Adrian Vikzan/The Canadian Press

Major Canadian banks are struggling to control rising costs that could eat into profits as they face pressure to continue growing revenue amid growing economic anxiety about the impact of inflation and rising interest rates.

The National Bank of Canada on Friday ended a strong second-quarter earnings season for the country’s major banks with an 11 percent increase in profits, year-over-year. The Montreal-based bank’s revenue rose 9 percent for the quarter ended April 30, with loan balances and fees rising as consumers and businesses spend more and borrow more.

But the bank’s expenses rose 8 percent as it hired staff, raised salaries and invested in technology.

Higher expenditures leave banks with little margin for error if revenue growth slows. Although banks have generated higher profits through most of the COVID-19 pandemic, and have done better than many companies in other sectors, they are not immune to the high inflation that has driven up prices.

Expenses were up 13 percent at Imperial Bank of Canada in the quarter, compared to a year earlier, and 5 percent at Toronto Dominion Bank, which included a 9 percent increase in costs in its Canadian retail banking unit.

Salaries are a major force driving up expenses, as tight labor markets that have kept many consumers financially stable also create intense competition for talent. Banks’ investments in technology to improve customer experiences and automate routine tasks, as well as increased spending on travel and marketing as economies reopen, have also made it difficult to constrain spending.

The impact of inflation is “fairly broad,” said Hrach Panossian, CIBC’s chief financial officer, in an interview. “You’re seeing effects across different categories across the bank,” and the recent pressure on bank costs “has been a little bit higher than we’d expect.”

The struggle to retain employees is adding hundreds of millions of dollars to banks’ expenses, and the pressure is felt everywhere, from executive and technical roles to employees in branches, call centers and back offices.

In mid-April, TD announced that it would give most of its non-executive employees a 3 percent pay raise in July, and RBC quickly followed suit, increasing the base pay for low-paid employees. Last week, the Bank of Montreal matched those increases, promising a 3 percent wage increase for some salary categories, according to chief financial officer Typhoon Tozon.

For TD, basic salary increases will cost an additional $290 million annually, CFO Kelvin Tran said Thursday.

Salaries and benefits will rise and inflation is high. “There are certain expenses that will naturally go up because of what is happening around us,” said Raj Viswanathan, Bank of Nova Scotia’s chief financial officer, which reported a 3 percent increase in costs for the second quarter. He predicted that those costs would rise more quickly in the coming quarters, “but we have a number of levers that we use at this bank” to control.

Mr. Panossian said CIBC has “walked the pace” on some of its planned investments, “so we’re already reacting and have the ability to respond through the rest of the year.”

For now, loan balances are growing at healthy rates even as mortgage demand is expected to cool, credit card spending picks up, commercial lending is solid, and central bank interest rate increases are boosting loan profit margins. “It’s a good combination to be able to absorb that,” Ibrahim Bunawala, an analyst at Bank of America Securities Inc., said in an interview.

But if the economy falls into a recession, as economists increasingly fear that this might happen, Mr. Poonawala said: “I don’t think … these banks have a lot of leverage to pull in terms of absolute cost reductions.”

“These are like giant ships. None of this happens overnight,” he said. “When you do it across the board [salary] increases, there is very little room for cost cuts.”

In a call with analysts on Friday, National Bank CFO Marie-Chantal Gingras said the cost increases were “linked to our business growth.” But she said the bank was looking for areas to cut as it raised salaries to keep pace with a “very competitive environment” and boosted spending in a range of areas including automation, cybersecurity and regulatory compliance.

“The team is constantly working to identify and achieve efficiencies in our expense base, particularly in an inflationary context,” she said.

National Bank earned $893 million, or $2.55 per share, in the second quarter. That compares with $801 million, or $2.25 per share, in the same period last year. On average, analysts expected earnings of $2.27 per share, according to Refinitiv.

The bank raised its quarterly dividend by 5 cents, or 6 percent, to 92 cents a share.

Profits rose across the banking sector in the second fiscal quarter, with four of the six major banks beating analyst expectations by comfortable margins.

Royal Bank of Canada had the biggest success in cost containment in the quarter, reporting just a 1 percent increase, year over year. However, the bank’s salaries were up 7 percent from the previous year, “representing roughly 40 percent of the increase in more manageable costs,” said chief financial officer Nadine Ahn. She said higher professional fees and technology costs accounted for another 30 percent of the increases, and marketing and travel 20 percent.

One reason RBC was able to rein in second-quarter costs was the weaker performance of its capital markets division, with revenue down 14 percent from last year’s high levels. CEO Dave McKay said this provides an “internal natural hedge” because it means the bank is handing out fewer bonuses to traders and investment bankers.

Over the past two years, high capital markets returns have been “a huge boon to positive operating leverage,” the industry term for revenue outweighing expenses, said Mr. Poonawala. But amid frenzied trading activity, IPOs and equity issues have fallen this year — with quarterly earnings from capital markets down 26 percent in RBC and 20 percent in BMO, for example — “you see that pain,” he said.

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