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The Bank of Canada’s latest 25-basis point rate reduction may not be that bad for Canada’s biggest banks, who are attempting to preserve net interest margins by lowering prime lending rates by only 15 basis points on average, says Darko Mihelic, analyst at RBC Capital Markets.

“We believe our net interest margin expansion thesis is intact for 2016,” Mihelic said in a note to clients.

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“Specifically, we note the prime lending rate set by Canadian banks appears to have now “decoupled” from the BoC target rate (twice in a row), which suggests the banks have more autonomy on pricing than we had previously assumed for the group.”

While the banks are resisting a full “transmission” of the BoC rate to administered rates, Mihelic believes they would fully implement interest rate increases when they happen in the future.

He also would not discount the possibility of them “exceeding the BoC on the way up” with respect to its prime lending rate which is supportive net interest expansion in next year and beyond.

Mihelic added that banks with more dependence on wholesale/variable rate deposits benefit the most from a decline in the BoC rate that is not entirely matched by a decline in the prime rate.

“Although impossible to calculate with any precision, we believe generally Bank of Nova Scotia and Bank of Montreal benefit more than the other banks and Toronto Dominion Bank benefits the least,” he said.

“The reverse is true in a rising rate environment, all else equal.”

Financial Post

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