(Reuters) - Royal Bank of Canada (RY.TO) said on Wednesday it would cut its prime rate to 3.45% from 3.95% in its first reduction since July 2015, with the country’s other lenders expected to follow suit, even as the moves weigh on margins already under pressure.
Canada’s biggest lender announced the move, which will take effect on Thursday, after the Bank of Canada cut benchmark rates by 50 basis points on Wednesday to help tackle a coronavirus outbreak and said it was ready to cut again.
The central bank’s cut is “well in advance of the banks’ expectations,” said Rob Colangelo, senior vice president for credit ratings at DBRS Morningstar.
The Bank of Canada’s reduction, following a similar move by the U.S. Federal Reserve on Tuesday, will lead to margin compression at or slightly above the higher end of the 1-to-2 basis-point-per-quarter range expected by the banks at the end of fiscal 2019, Colangelo said.
The last two times the Bank of Canada lowered rates, in January and July of 2015, the banks passed on only 30 basis points of the 50-basis-point cuts. But the major banks matched the central bank’s three quarter-percentage-point increases in 2018.
“They’re choosing to err on the side of caution and put more stimulus into the economy,” said John Kinsey, portfolio manager at Caldwell Securities. “But it will squeeze them.”
The economic growth spurred by the cut would improve loan growth, but it “likely won’t be enough to offset net interest margin compression,” said Laura Lau, chief investment officer at Brompton Group.
Canadian banks are somewhat protected by their skew toward more fixed-rate loans, said Gabriel Dechaine, an analyst at National Bank Financial (NBF), contrary to the dominance of variable rates in the U.S.
“It’s not an immediate hit when the central bank cuts,” Dechaine, who expects the cuts to result in a 1% to 2% reduction in his earnings estimates for the major banks.
The decline in margins would be driven more by commercial loan portfolios, which price more frequently, Colangelo said. Banks have been growing their business loan books at double-digit rates recently.
The Fed’s rate cut would weigh more on Canadian banks’ U.S. operations, Dechaine said in a note on Tuesday. Canadian banks experienced 43 basis points of average net interest margin compression following the Fed’s three rate cuts in 2019, he said.
Reporting by Nichola Saminather in Toronto and Bharath Manjesh in Bengaluru; Editing by Shailesh Kuber, Peter Cooney and Shounak Dasgupta