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Scotiabank’s decision to change the way it accounts for future losses is the starkest example of the pressure on banks to prepare for a rainy day.

Fred Lum/The Globe and Mail

Canada’s banks are under intense pressure to prove to nervous shareholders that banks are adequately prepared to absorb loan losses when the next economic downturn arrives, according to Bank of Nova Scotia’s chief executive officer.

One day after Scotiabank abruptly announced it will add new, more pessimistic assumptions to its models for predicting losses on credit, at a cost of $150-million before tax, CEO Brian Porter revealed the bank’s move was a response to concerns from investors.

“The marketplace is really concerned about credit,” Mr. Porter said at a Toronto conference that played host to the heads of Canada’s eight largest banks on Tuesday. However, he feels they may be “overly concerned" even as the current economic cycle creeps into its later stages.

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His peers at rival banks are equally keen to demonstrate how conservative they have been in making provisions for an eventual spike upward in credit losses, in a broader effort to placate mounting unease among investors.

At Tuesday’s conference, bank CEOs also tempered expectations for earnings growth this year. And most of them appear to have reined in their ambitions for large acquisitions for the time being – Toronto-Dominion Bank is a notable exception, showing interest in mergers – preferring instead to stockpile capital and buy back shares.

Scotiabank’s decision to change the way it accounts for future losses is the starkest example of the pressure on banks to prepare for a rainy day. When a new accounting standard called IFRS 9 took effect late in 2017, Canadian banks took large one-time charges to adjust to the new rules – and Scotiabank’s was among the largest, at $600-million. But more recently, the pessimistic scenario the bank considers when calculating loan losses contained the most rosy assumptions used by any Big Six bank for the next 12 months.

Now, the bank is adding another, more pessimistic scenario to its models, which will boost its $5.1-billion allowance for credit losses by about 3 per cent, even though Mr. Porter appears skeptical about whether the change was really necessary.

“Personally, I didn’t feel this was, you know, I went along with it. But I felt investors were overly concerned about credit at this point in the cycle," Mr. Porter said at the conference. “We don’t see it in our books but you have to plan for the future, so we felt it was prudent, so we went ahead and did it."

Other banks such as Royal Bank of Canada and Bank of Montreal began building up forward-looking provisions for loan losses earlier. In the previous fiscal quarter, RBC added $41-million to its provisions on loans that are still performing, while BMO’s models incorporate some of the most pessimistic economic forecasts. But both banks are still at pains to show they have built sufficient cushions against future losses.

Since IFRS 9 was introduced, banks are forced to recognize the risks in their credit portfolios by setting aside money to cover losses even on loans that are still being paid back. But the new rules have muddied predictions for future losses, producing earnings surprises that appear to be contributing to more frequent swings in bank stocks.

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“From all the benchmarks that I can see, we’re more conservative, a little bit better than the average of our peers,” said Dave McKay, the CEO of RBC. "And we’re not cutting corners there in any shape or form.”

BMO chief executive Darryl White acknowledged that provisioning for loan losses is “an art and a science," as banks try to predict the likelihood that each of its loans may go sour. He said the bank is “reserving at the conservative end, relative to others," but added: “That doesn’t mean that we’re perfect or we’re right.”

At Canadian Imperial Bank of Commerce, executives largely dispense with the art, treating estimates for future loan losses as a mostly formulaic exercise. Provisions rise or fall as the bank’s complex models adjust to evolving economic forecasts, and CEO Victor Dodig doesn’t plan to intervene by adding any extra buffer.

“It’s business as usual in a model-driven approach and that’s the approach that we’re going to take going forward," Mr. Dodig said.

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