The Canadian Press/The Canadian Press
The Canadian banking sector is facing a few big challenges that are giving investors plenty to think about: Stock prices are high, valuations are stretched and what the heck are banks supposed to do with $60-billion in spare change?
These aren’t typical challenges for the sector.
The biggest banks are lumbering behemoths with few attractive expansion prospects beyond picking off the occasional U.S. or Canadian pipsqueak.
Instead, performance generally comes from domestic economic activity, population growth, modest efficiency gains and – better sit down if your pulse is racing – a widening spread between what banks pay on deposits and earn on loans.
But this year has been far from dull for investors who signed up for the sector’s steady pace.
Share prices for the Big Six banks have rallied about 30 per cent so far in 2026, on average, even with a slight dip over the past two weeks. That’s about 2½ times the gain of the broad S&P/TSX Composite Index over the same period.
Bank of Montreal is a standout, with a gain of 40 per cent this year.
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Okay, big gains are not exactly the stuff of nightmares. But the unusual rally has pushed bank-stock valuations to curiously high levels − even more stretched than in early March, when I argued that shrugging off the concerns was a legitimate response.
Now, indifference to valuations is harder to defend.
Bank stocks traded at 15.3-times estimated earnings in early July, according to John Aiken, an analyst at Jefferies. That’s about 50 per cent above the historical average of 10.3-times earnings and well above the previous valuation peak in 2006.
Unless bank profits take off with an improving Canadian economy because of efficiency gains from artificial-intelligence tools, there could be a correction coming if the banking sector doesn’t match the market’s expectations.
But there is another concern here. Sky-high valuations make the banks’ task of distributing their excess cash to shareholders more complicated.
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Investors love the banks for their quarterly dividends. But the banks have been aggressively rewarding shareholders with share buybacks as well.
In 2025, for example, Royal Bank of Canada announced that it would repurchase up to 35 million of its own shares over a 12-month period, representing nearly 2.5 per cent of the bank’s outstanding shares.
In June, 2026, the bank announced a fresh 12-month goal: Buy up to 45-million shares or about 3.2 per cent of RBC’s total.
Buybacks can offset dilution that arises when banks issue shares to employees as part of their compensation.
They instill confidence in the stock. They are entirely flexible, in the sense that they can be curtailed – unlike quarterly dividends – without cratering the stock.
And, most importantly, buybacks can boost some profitability measures: Decreasing the share count can improve earnings per share, which can boost share prices.
Few observers questioned this use of cash when bank-stock valuations were low or even a tad stretched. But does it make sense for banks to buy their own shares at these levels?
“Given current valuations, buybacks are becoming decreasingly accretive, and we would expect activity to slow,” Mr. Aiken said in a note.
The positive impact on share prices is questionable when they are already sky-high. And if there is a correction, the money directed toward buybacks may look wasted.
But the banking sector is sitting on $60-billion – based on capital levels that are above regulatory requirements – according to Mike Rizvanovic, an analyst at Bank of Nova Scotia.
He thinks buybacks still make sense. Every buyback of 1 per cent of outstanding shares will increase earnings per share for large banks by 0.6 per cent, on average. And they may be received more warmly by investors than, say, large-scale mergers and acquisitions.
“We certainly view buybacks as a better option than letting capital levels build further, which could indicate an increased probability for large M&A deals that the market tends to be skeptical about,” Mr. Rizvanovic said in a note this week.
Excess cash is not the worst problem to have. And it underscores one of the key virtues of investing in Canadian banks for the long term: They can be enormously profitable when times are good.
But for anyone wondering if the times are a little too good and that the path forward for bank stocks could entail a few bumps, the sector’s pile of cash offers one more reason to check your risk tolerance.
Selling bank stocks is a tough call. But worrying about them is a no-brainer.