Why Canada’s big banks might be the next AI winners

While the buildout of artificial intelligence infrastructure continues to drive markets, some investors are starting to highlight the next potential growth area associated with the tech mega-trend: AI adopters. These companies are typically in sectors outside of tech, have huge quantities of high quality data, manual processes and large headcounts, and have their own competitive moats that are hard to disrupt with technology alone. Those traits are writ large in a group of companies that are fast becoming something of an AI darling: the Canadian big banks.

The big five Canadian banks have many of those traits that makes AI adoption seem a likely driver of better productivity and earnings overall. Add to that, Canada’s banks seem keen to adopt AI tools. The Evident AI Banking Index, which measures financial institutions’ AI adoption, puts all of the big five banks in the top 50 global adopters, with RBC ranked #3 in the world. TD is 13, BMO 19, CIBC 22, and Scotiabank 29. In a market that continues to focus on AI and its role in the future of business, it appears that Canadian banks are setting themselves up as leading adopters.

“if you’re thinking about like the equity prices in the stock market in general, I think you’re starting to see a bifurcation of a market that rewards AI winners and AI losers. And as we kind of look at the market in its totality, I think it’s fair to say at this juncture that Canadian banks are going to be AI winners,” says Brendon Sattich, Portfolio Manager, North American Equities, at RBC Global Asset Management in Toronto. “It is early days, but we’re definitely seeing business value being generated.”

Where the banks are adding AI

Sattich sees AI being adopted by the banks across a host of business lines. That includes credit underwriting, marketing, and notably in wealth management where AI is being used to try and maximize advisors’ client-facing time. Sankalp Sachdeva, Portfolio Manager and Partner at Letko Brosseau Global Investment Management in Montreal, adds that AI is now being used in the improvement of banking apps, with some banks reporting they can use AI to derive 600 insights per client. Call centers, too, are ripe for AI chatbots and other AI-powered automations. AI can also be used for fraud detection, to make the kind of monitoring work that used to require hundreds of people more streamlined.

Three of the banks, RBC, TD, and BMO, have outlined long-term targets of what to expect from AI adoption in terms of overall enterprise value. Sattich says they have committed to ongoing disclosures of performance against those targets. Sachdeva and Sattich noted that there will be a host of ROI measures applied to the banks internally and externally. Those include measures of headcount as AI allows for certain roles to be automated. On the whole, however, both PMs argue that the banks should see their AI adoption improve employee productivity, rather than see significant reductions in headcount.

“it will be very hard for them to pinpoint like the exact headcount reduction or you know, the exact revenue increase because of this one tool that, that the new employee is using. I think in the longer term what we’ll see is more revenue per employee like we have seen in the past with the other productivity improvements,” Sachdeva says. “I don’t know if you can pinpoint X number less headcount overall. But I’m sure as we grow further into the mature applications of AI and more widespread applications of AI, we’ll see higher productivity per employee.”

What AI adoption means for bank stocks

The S&P/TSX Composite Index Banks (Industry Group) is up over 30 per cent year to date and up over 60 per cent in the past 12 months. Some of that performance, Sattich and Sachdeva acknowledge, can be attributed to this AI adoption. Sattich argues, though, that it has not been the primary driver of stock performance. Canadian banks have exceeded earnings forecasts thanks to strong results in capital markets and fee income. Greater economic investment by the Federal Government, too, has driven more positivity in investor sentiment. That upward revision in earnings is the fundamental story, with AI adoption growth a more long-term driver. Sattich acknowledges, however, that bank earnings multiples are currently high relative to historic levels.

Sachdeva believes that there is a key unresolved question around whether the banks’ AI adoption has already been baked into their stock prices or not. While he also notes the high multiples that banks now carry, he believes that the AI adoption process is still so early, and many of its results are still not realized. That should give the banks runway to enjoy higher returns from AI if they can find success in their adoption.

What makes banks AI winners

While banks wealth of internal data and wide-ranging potential AI applications make them interesting as AI adopters, it’s arguably their competitive moats that make them most compelling. Sachdeva highlights how the regulated nature of their industry may prove challenging for AI implementation, but the banks’ institutional knowledge and competitive advantages in managing the regulatory burden should actually make them better protected against disruption.

Both Sachdeva and Sattich highlighted just how many competitive moats the banks have, very few of which can be disrupted by a high-tech competitor. The sheer quantity of capital required to build these banks is immense, as is their brand presence and high degree of consumer trust.

“These banks have been around for two centuries, and they have built credibility over a very long period of time,” Sachdeva says.

How advisors can frame banks’ in the AI theme

On the surface the Canadian big banks seem almost antithetical to the AI investment theme as we’ve seen it play out so far. That theme has been shaped by momentum, by high tech names, and by significant stock price volatility. The Canadian banks are known for stability. For advisors looking to explain how AI might add tailwinds to bank performance, Sachdeva is quick to emphasize that the banks should not be viewed as a pure AI play. Instead, AI is just one of the themes that are shaping bank performance, which could be positive for returns.

Sattich says that the context of AI winners and losers can help advisors frame the banks. He highlights a few metrics that advisors can lean on to assess ongoing AI adoption, including the quantity and scale of their data, the scale of their investments in AI, and the hiring of experienced and technically proficient leaders to drive these investments. He acknowledges that there may be some bifurcation within the banks themselves over time as the market identifies AI winners and losers within even this slice of the market. He highlights the importance of diligent outreach and communication by advisors to inform their client conversations on the subject.

“It’s very important for advisors, as they do outreach to their investment managers, that they just make sure that the people who are managing these funds are really keeping pace with the rate of change” Sattich says. “There’s so much information coming. So just asking good questions, making sure that they understand the AI risks and benefits of different portfolio positions, I think would be very important for an advisor when discussing with their investment managers. And then of course, they can relay that information to their clients.”