Canadian banks, despite being the envy of their global peers, will face a challenging year due to regulatory demands and a fragile global economy, according to PwC’s annual review of the banking industry.

But first the good news: PwC has reported that the big six banks continued to show strong earnings and Tier I capital growth over the past year, and indeed since the financial crisis.

These capital ratios ranged from 12% to 14.7% in spite of the soft global economy, as well as several acquisitions, and they position the banks well for upcoming regulatory changes.

“Last year Canadian banks presented solid results, primarily thanks to their strong retail banking businesses and growth in loan portfolios,” says Diane Kazarian, PwC’s Canadian financial services leader. “However, 2012 may see slowing growth in consumer credit markets and continued pressure on margins as banks battle for market share.”

Another problem for the banks is that they have few domestic investment options, so they may be forced to look abroad for growth, according to John MacKinlay, PwC’s financial services consulting leader.

“The challenge is that regulatory uncertainty makes it more difficult to form an opinion on the predictability of earnings, capital consumption and hence values,” he says. “The need for global banking institutions to recapitalize means that there’ll be interesting opportunities in the market.”

He adds, “If you can get yourself past the regulatory uncertainty, the challenge becomes one of agreeing on price [and] there are often significant differences of opinion between buyer and seller [given the economy]. This restructuring will take years to unfold and the banks have the luxury of being able to sit on the sidelines and [select] their targets.”

On the regulatory side, keys issues include uncertainty, and the cost of additional reporting and compliance. Regulatory changes will have an impact on a multitude of aspects at the banks including capital requirements, tax reporting, proprietary trading accounts and derivative transactions.

Wholesale changes to the regulatory system are being negotiated in the U.S. and Europe, affecting the way that Canadian banks function at home as well as in those countries.

The bottom line?

“The top three issues facing the banks are regulatory uncertainty, macroeconomic conditions and pressure to grow,” says Kazarian, “and when growth is challenged, cost management becomes important. However, reigning in costs is difficult when new regulatory requirements add additional layers of operational risk in systems and reporting.”

The PwC report provides an in-depth report on each of the big six banks. Visit http://www.pwc.com/ca/canadianbanks for a copy.