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As a CA$94B market capitalisation bank, The Bank of Nova Scotia (TSE:BNS) is well-positioned to benefit from the improving credit quality as a result of post-GFC recovery. Growth stimulates demand for loans and impacts a borrower’s ability to repay which directly affects the level of risk Bank of Nova Scotia takes on. With stricter regulations as a consequence of the recession, banks are more conservative in their lending practices, leading to more prudent levels of risky assets on the balance sheet. Since the level of risky assets held by a bank impacts its cash flow and therefore the attractiveness of its stock as an investment, I will take you through three metrics that are insightful proxies for risk. Check out our latest analysis for Bank of Nova Scotia
How Much Risk Is Too Much?
By nature, Bank of Nova Scotia is exposed to risky assets by lending to borrowers who may not be able to repay their loans. Typically, loans that are “bad” and cannot be recuperated by the bank should comprise less than 3% of its total loans. When these loans are not repaid, they are written off as expenses which comes directly out of the bank’s profit. A ratio of 0.98% indicates the bank faces relatively low chance of default and exhibits strong bad debt management.
How Good Is Bank of Nova Scotia At Forecasting Its Risks?
The ability for Bank of Nova Scotia to forecast and provision for its bad loans accurately serves as an indication for the bank’s understanding of its own level of risk. If it writes off more than 100% of the bad debt it provisioned for, then it has poorly anticipated the factors that may have contributed to a higher bad loan level which begs the question – does Bank of Nova Scotia understand its own risk?. Bank of Nova Scotia’s low bad loan to bad debt ratio of 96.14% means the bank has under-provisioned by -3.86%, indicating either an unexpected one-off occurence with defaults or poor bad debt provisioning.
How Big Is Bank of Nova Scotia’s Safety Net?
Bank of Nova Scotia operates by lending out its various forms of borrowings. Customers’ deposits tend to carry the smallest risk given the relatively stable interest rate and amount available. As a rule, a bank is considered less risky if it holds a higher level of deposits. Since Bank of Nova Scotia’s total deposit to total liabilities is within the sensible margin at 74.98% compared to other banks’ level of 50%, it shows a prudent level of the bank’s safer form of borrowing and an appropriate level of risk.
Next Steps:
The recent acquisition is expected to bring more opportunities for BNS, which in turn should lead to stronger growth. I would stay up-to-date on how this decision will affect the future of the business in terms of earnings growth and financial health. I’ve bookmarked BNS’s company page on Simply Wall St to stay informed with changes in outlook and valuation. This is also the source of data for this article. The three main sections I’d recommend you check out are: