Canadian Banks and the Evolving Risk/Reward Dynamics of Tariff Uncertainty in 2025

In 2025, the Canadian banking sector is navigating a complex interplay of macroeconomic volatility and shifting trade dynamics. As U.S. tariff threats recede from their most aggressive iterations, major Canadian banks—Royal Bank of Canada (RBC), Toronto-Dominion Bank (TD), and Bank of Montreal (BMO)—are recalibrating their risk management frameworks. The result? A notable decline in loan loss provisions and improved credit quality metrics, which are reshaping profitability and long-term resilience. For investors, this evolving landscape offers both opportunities and cautionary signals.

The Credit Quality Turnaround

The most striking trend is the reduction in provisions for credit losses. TD's third-quarter 2025 provision of $971 million marked a 27% decline from $1,341 million in the same period in 2024. Similarly, BMO's provision dropped to $797 million from $906 million, while RBC's elevated but moderated provisions of $881 million reflected a cautious stance amid lingering trade uncertainties. These figures underscore a broader normalization of credit risk, driven by improved macroeconomic forecasts and disciplined underwriting.

RBC, for instance, reported a 3% quarterly reduction in gross impaired loans ($8.8 billion), attributed to accounts returning to performing status and administrative resolutions. Its allowance for credit losses (ACL) of 74 basis points of loans, though conservative, signaled a balanced approach to downside scenarios. TD's ACL-to-loans ratio fell to 0.41%, down from 0.58% in 2024, while BMO's U.S. segments saw significant credit performance improvements, partly due to reduced trade-related stress.

Tariff Uncertainty: A Receding, but Persistent Shadow

The initial fear of a U.S.-Canada trade war has abated, but its legacy remains. RBC's CEO, David McKay, noted that trade tensions continue to influence credit risk modeling, particularly in capital markets and commercial banking. BMO's CEO, Darryl White, echoed this, stating that while “the immediate threat has receded,” the bank maintains elevated provisions in sectors like real estate and agriculture, which are more exposed to cross-border trade shocks.

TD's U.S. operations, via City National, have benefited from improved credit quality, with favorable macroeconomic forecasts reducing provisions on performing loans. However, the bank's U.S. Retail segment still grapples with restructuring costs, highlighting the uneven impact of tariff uncertainty.

Profitability and Capital Resilience

The banks' ability to balance risk and reward is evident in their capital metrics. RBC's return on equity (ROE) of 17.7% in Q3 2025 outperformed its target of 16% for 2026, supported by a CET1 ratio of 13.2%. TD's CET1 ratio of 14.8% and BMO's aggressive share buybacks (BMO repurchased 30 million shares) further illustrate their confidence in capital strength.

These metrics are not just numbers; they reflect strategic foresight. RBC's focus on technology and cross-border capabilities, TD's disciplined underwriting in Canadian and U.S. markets, and BMO's proactive risk mitigation in volatile sectors all contribute to a sector-wide shift toward sustainable growth.

Investment Implications

For investors, the Canadian banking sector in 2025 presents a compelling case. The decline in loan loss provisions and improved credit quality have bolstered earnings, with RBC's Q3 net income surging 21% year-over-year to $5.4 billion. However, the sector's resilience is not uniform. Investors should prioritize banks with:
1. Robust capital buffers (e.g., RBC's 13.2% CET1 ratio).
2. Diversified portfolios (e.g., TD's U.S. and Canadian operations).
3. Proactive risk management (e.g., BMO's focus on credit migration analysis).

That said, caution is warranted. While trade tensions have eased, a severe North American recession remains a tail risk. RBC's elevated provisions in capital markets and BMO's exposure to real estate sectors suggest that the sector is not out of the woods.

Conclusion

The Canadian banking sector is at a pivotal juncture. Lower loan loss provisions and improved credit quality are reshaping profitability, but the path forward requires vigilance. For investors, the key lies in balancing optimism with prudence—targeting banks that combine strong capitalization, diversified revenue streams, and agile risk management. As the tariff uncertainty of 2025 evolves, these institutions may yet prove their mettle as pillars of a stabilizing financial sector.