March 9, 2013


Title: Are Canada’s banks too generous?

Sub-title: Borrowing conditions continue to be exceptionally loose


Earlier this month, the Bank of Montreal cut its posted fixed five-year mortgage rate to 2.99 percent. The move attracted considerable attention from competitors, borrowers and government. Several other financial institutions, many of which tend to move in herd-like fashion, followed shortly thereafter.


True, banks’ posted rates are mostly a fiction, as savvy consumers can easily negotiate them down, or find more attractive options. However BMO’s latest move, which comes at a time when many believe that Canada’s housing sector is overvalued, and that many consumers are over-stretched, raises the question as to whether the banks are being overly generous in encouraging borrowing.


Jim Flaherty, Canada’s finance minister, left no doubt as to where he stood. His office quickly issued a statement warning that financial institutions not engage in “race to the bottom,” lending practices, such as those which spawned the US mortgage crisis. Flaherty has a point. After all, the average Canadian household is debt is now at 163 percent of personal disposable income, which, due to the country’s aging population, is likely an unsustainable level over the longer term. That said, blaming banks for fighting for market share, is like chiding a giraffe for eating leaves - after all, that is what they do.


Furthermore, although job creation has been strong lately (51,000 new posts were created during February according to Statistics Canada’s Labor Force Survey) Canada’s economy has continued to struggle to gain traction in recent months. Gross domestic product grew by just 0.6 per cent in the fourth quarter of last year. This comes on the heels of a tiny 0.7 per cent increase the quarter before. For 2012 as a whole, the economy grew by 1.8 per cent in real terms. With that kind of sluggishness you would think that policymakers would wants banks to boost lending to businesses and customers to get the economy moving - when they see good opportunities.


On the other hand, if governments want banks to lend less, they have plenty of tools to make it so. For example this week the Bank of Canada maintained its target rate at just 1.0 percent, and hinted that it is unlikely to change its policy anytime soon. That widely followed policy rate is a key indicator of where the central bank is guiding monetary policy.


The Canadian government too has numerous tools to reign in bank lending. Flaherty himself has made several moves in recent years to tighten borrowing requirements, in order to reduce excess leverage in the system. These include several cuts in the maximum mortgage loan amortization rate, and restrictions on home equity line of credit borrowing.

In short, if Flaherty and other government officials really wants to cut bank lending, they can easily do a lot more to make that happen than just complain about it.


In the meantime, they  should not be surprised that banks and other financial institutions are fighting to do what they do best – which is lend money.





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