Canadian bank stocks recently gave back some of the big gains they racked up over the past year. Investors who missed the huge rally are wondering if the pullback is a good opportunity to add Canadian banks to a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio focused on dividends and long-term returns.
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Bank resiliency
Heading into 2025, many analysts predicted tough times for the Canadian banks, as they braced for a wave of roughly two million mortgage renewals that would occur over the coming two years.
Canadians across the country went on a buying spree in 2020 and 2021, locking in five-year mortgage rates at record-low rate levels. Those mortgages started to become due last year, with renewal rates being 2% to 3% higher. Predictions of a massive wave of defaults, however, have proven to be way overblown.
Provisions for credit losses at the banks rose during the surge in interest rates in 2022 and 2023, but rate cuts in 2024 and 2025 helped ease the pain. The economy has held up well, meaning most people still have jobs. At the same time, the banks have been able to reduce the monthly payment hit taken by clients by extending amortizations. This actually puts a lot more profit in the coffers for the banks as the loan payments stretch out for a much longer time.
Risks
Stress is starting to show up in the alternative lenders that provided loans to people who couldn’t get funding from the big banks. Some borrowers on the fringe haven’t been able to absorb the higher rates, even as rate cuts reduced borrowing costs last year.
The recent surge in bond yields could prove to be too much for more people in 2026. The interest rate charged on fixed-rate mortgages is largely determined by yields on government bonds. Those have recently surged as markets anticipate potential increases in interest rates by central banks as they prepare to combat an anticipated jump in inflation caused by soaring oil prices. The longer the price of oil remains elevated, the higher the risk of a big jump in inflation and a slowdown in economic activity.
In the worst-case scenario, central banks will have to raise interest rates, or at least keep them at current levels for longer, leading to higher bond yields and rising mortgage rates. Rising inflation eats into people’s cash flow, and an economic downturn could trigger a jump in unemployment. This would likely drive up the default rate on loans.
The Canadian banks avoided the mortgage cliff in 2025. Things might not be the same through the end of 2026 and into 2027.
Should you buy or wait?
Investors who are of the opinion that the economy is headed for a rough ride in the coming year might want to stay on the sidelines. Investors who are focused on dividend income and think the economy will hold up, however, could start to ease into a new position on the recent pullback and look to add to the holdings if stock prices decline.
Bank of Nova Scotia (TSX: BNS), for example, currently trades near $96 compared to $105 last month.
At the current price, the dividend yield is 4.5%, so you get paid well to ride out some volatility.
The bottom line
I would probably wait to see how things pan out with the price of oil over the next few weeks before diving into bank stocks. The banks avoided a surge in defaults in 2025, but that might not be the case later this year.
