One of the more interesting stories in Canadian markets this year has been the resilience of the S&P/TSX Composite Index. The benchmark has continued setting records in August, even as Canada’s underlying economy has faced a much less convincing backdrop.
Energy and mining have contributed substantially to the rally, but financial stocks have also been important. On August 12, for example, financials helped push the TSX to another record close.
That matters because financials occupy an enormous portion of Canada’s stock market, with the Big Six banks among its largest companies. When Canadian banks perform well, they can pull a substantial portion of the index along with them.
If you’re considering adding even more bank exposure, however, I would look beyond recent performance. There are two developments I’m watching closely: a friendlier regulatory environment and increasingly demanding valuations.
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OSFI just loosened the reins
In June, the Office of the Superintendent of Financial Institutions (OSFI) lowered its Domestic Stability Buffer from 3.5% to 3.0% of risk-weighted assets, its first change since 2023. The change reduced OSFI’s supervisory common equity tier-one capital expectation for the Big Six from 11.5% to 11.0%.
That sounds technical, but the implication is straightforward. Banks make money by putting customer deposits to work. Requiring them to maintain larger capital cushions improves their ability to absorb losses, but it also means more capital sits on the sidelines instead of supporting loans and other potentially profitable activities.
Reducing the buffer gives the banks greater flexibility to deploy capital. OSFI specifically cited opportunities surrounding infrastructure, defence, resources, artificial intelligence, and changes in global trade. Canada’s largest banks were also starting from a strong position, with an average common equity tier-one ratio of 13.5% as of April 30.
For shareholders, I view that as bullish in the near term. Longer term, though, looser capital requirements always deserve some caution. Give banks more capacity to lend and take risks, and management still needs to allocate that capital intelligently.
Aggressive credit growth at the wrong point in the economic cycle can eventually produce higher loan losses. OSFI can also change the buffer again if risks increase, so I wouldn’t assume today’s more permissive environment is permanent.
Valuations matter after the rally
This is where I become more cautious. Price-to-earnings ratios are useful for many businesses, but I generally prefer price-to-book ratios when comparing banks. A bank’s balance sheet is essentially its inventory, and book value provides a useful starting point for assessing how much investors are paying for the equity supporting that business.
The Big Six currently trade at roughly an average of about 2.3 times book value, based on the latest market data. That’s not automatically expensive. A bank generating consistently high returns on equity, growing book value, and maintaining excellent credit quality deserves to trade above book value. But the higher that multiple climbs, the less margin for error you’re getting.
Canadian banks still face risks from elevated household indebtedness, mortgages resetting at higher rates, commercial real estate, and a relatively weak domestic economy. OSFI itself continues to identify household indebtedness as a vulnerability.
So, while I like the regulatory tailwind, I wouldn’t blindly chase bank stocks after their run. At today’s valuations, future returns increasingly depend on earnings and book value growing into the prices investors are already paying.
This ETF is for the most bullish Canadian bank investors.
If you have a high risk tolerance and deliberately want to overweight Canadian banks, one aggressive option is Hamilton Enhanced Canadian Bank ETF (TSX: HCAL).
HCAL starts with approximately equal exposure to the Big Six banks rather than allowing the largest institutions to dominate based on market capitalization. Then it turns the dial up.
The exchange-traded fund (ETF) uses approximately 25% cash leverage, targeting about 1.25 times the returns of its equal-weight bank index. For every $100 of investor capital, you’re effectively getting around $125 of bank exposure. Importantly, this is cash borrowing rather than the derivatives commonly used by conventional daily-reset leveraged ETFs.
That structure makes sense if your thesis is specifically that Canadian banks will continue performing well. Equal weighting spreads company-specific risk across the Big Six, while leverage amplifies your exposure to the sector. It also works both ways. If Canadian bank stocks fall, that leverage can magnify your losses as well, while borrowing costs create an additional drag.
HCAL currently charges a 0.65% management fee, pays monthly, and has a 3.35% annualized yield. Hamilton appropriately assigns it a high risk rating. For me, HCAL is something I’d treat as a deliberate satellite position rather than a portfolio core.
