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Interest income accounts for more than 40% of the banking industry’s revenues, which means banks were forced to look for alternative income streams in recent years. Key streams include banking fees, as well as insurance and investment management services, reveals an outlook report on the banking industry by the Conference Board of Canada.

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Despite low rates, the industry’s profit margin improved significantly in recent years, and is expected to average about 31% over the next five years. Pre-tax profits continue to climb, and are expected to reach more than $80 billion in 2017, says the report, called “Canadian Industrial Outlook Banking.”

But, regardless of recent reports of strong-arm sales tactics to sell banking products and services, the industry’s healthy results in 2016 (profits: almost $75 billion) are mainly from the housing sector and equity markets. With those sectors expected to cool this year, banks might lean more heavily on their alternate income streams.

Securities segment grows — for now

Of the three segments that make up banking services, securities expanded fastest in recent years, with an average annual increase in GDP of 5.1% since 2011 and in revenues of 6.9%, compared with 4% average annual increases in both GDP and revenues for the industry overall.

(The other two segments of banking services are banks and credit unions, and non-depository credit intermediation.)

And the report adds that securities now account for a third of industry revenues, up 28% from five years ago.

However, the strong growth in securities revenues is tied to robust gains in North American stock markets in recent years, and that revenue is expected to slow, given the price-to-earnings ratio on the TSX stood at more than twice its 15-year average in Q3 2016.

Read: How to invest in Canadian equities

No lending, no problem

The report notes the housing market is also set to cool as it responds to new taxes and tighter lending rules, with mortgage debt subsequently forecasted to decline. In fact, for the first time in 25 years, growth in disposable income should outpace growth in consumer debt in 2017.

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Growth in private sector lending is also expected to decline, especially since business lending has now posted its longest expansion on record — 24 consecutive quarters of growth since the 2008-09 recession. This expansion cumulated in a 14% year-over-year increase in private sector loans in Q2 of 2016.

Despite the decrease in loans, banking is still expected to perform better than the Canadian economy, with GDP growth in the industry forecasted at 2.4% for 2017. (The federal budget forecasts a GDP of 1.9%.)

The healthy outlook is maintained in part by keeping costs under control. But, with low rates, slower equity growth and decreasing loans, “banks will continue to rely heavily on non-interest income to generate revenue growth,” says the report.

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Originally published on Advisor.ca
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