TORONTO and OTTAWA — For the first time in more than a decade, Canada's Big Five banks are refusing to pass along the full extent of a central bank interest-rate cut, saying they're already feeling too much pain from a steep jump in their own borrowing costs as a result of the financial crisis. Each of the major banks announced a reduction of just a quarter of a percentage point in their prime lending rate Wednesday, after the Bank of Canada lowered its key rate by twice as much, or a half-point, to 2.5 per cent.
Although not required to move in step with the central bank, the banks have rebelled only once, in the Asian financial crisis of 1997, since Canada moved to its current regime of rate changes in 1996.
Their half measure Wednesday means the central bank will find it harder to deliver rate relief to consumers and small businesses that are most exposed to prime – the rate that banks charge their best customers for loans and that acts as the base rate for an estimated 65 per cent of Canadian business and household borrowing. Prime is now 4.5 per cent. “It makes monetary policy less effective than it otherwise would be,” said Dale Orr, chief economist at Global Insight Canada.
In lowering rates, the Bank of Canada was joining other key countries around the world in a surprise co-ordinated move early Wednesday. The United States, Britain, Europe, Switzerland, Sweden, China and Hong Kong also slashed rates in a bid to bolster the flagging global economy and instill some confidence into credit markets that have become paralyzed by fear.
Canadian banks are not the only ones holding back some of the cheaper lending costs for themselves. Australia's Big Four banks only passed along 80 of the 100 basis point cut their central bank made this week.
If the trend continues, it may require much more aggressive rate cuts by central banks to have the desired effect.
“This essentially amounts to the banks dictating the monetary policy of the nation,” said James Price, vice-president of fixed income at Blackmont Capital.
The cost banks pay to obtain money to lend to customers has soared as a result of the credit crisis, squeezing profits for lenders around the world. For instance, some Canadian banks have been losing money on variable-rate mortgages recently.
The rebellion is likely to play into the federal election. Former Liberal finance minister Ralph Goodale weighed in with his own conclusions, labelling it a “vote of no-confidence in the government.”
NDP Leader Jack Layton said he was very disappointed to see the banks “not passing on to the consumers a significant share of the reduction that has been called for and is being implemented internationally.”
“I think we need a Prime Minister that will put the bank customers first,” he said. While he would impose greater regulations on the banking industry, he stopped short of saying an NDP government would jump in and dictate interest rates.
“I think the CEOs of the banks have some explaining to do,” he said.
The Conservatives' campaign team offered up junior Tory cabinet minister James Moore to comment on the banks' move Wednesday afternoon. He declined to directly comment on the banks' behaviour, but said the Tories “believe in lower interest rates.”
Banks funding costs have been higher since the credit crunch erupted last year, but spiked dramatically in recent weeks because the financial crisis has paralyzed credit markets. Banks are scared to lend to one another, crimping the flow of money. Bankers point out that their funding costs are now tied to numerous factors other than the central bank's target interest rate.
Some Canadian banks have contemplated a break from tandem moves with the central bank since December, according to sources. They've been fearful that a public backlash would result if they were perceived to be gouging.
TD Bank was the first to announce the difficult move Wednesday, after discussions among its top executives including chief executive Ed Clark. The remaining big banks followed suit within hours.
While the central bank rate cut was not a scheduled move, many bankers were prepared for the possibility of a surprise rate cut, and senior people at various big banks had considered not cutting rates at all, sources said.
The correct decision based on economics and the current environment would have been no reduction in prime, but that would be like painting a target on the banks, said one senior banker.
Bankers say they can no longer hold off passing on higher costs to customers in other lending as well. The cost of a five-year mortgage rose 35 basis points last week. Wednesday, Bank of Montreal announced that it was increasing rates on some variable rate mortgages and home equity loans, following a similar move by TD earlier this week.
“If I had a [variable-rate] mortgage, I couldn't lock in a five-year term fast enough,” one senior big bank executive said Wednesday, suggesting he believes that rates will continue to increase.
The Bank of Canada declined to comment Wednesday. In May, Governor Mark Carney suggested to the banking senate committee that he believes monetary policy is still effective despite recent financial market turbulence, because the central bank can factor in what the commercial banks might do when it makes its interest-rate decisions.
In the current environment, the central bank might have to make, for instance, a 75-basis-point cut to achieve a 50-basis- point reduction for main-street borrowers, said Christopher Ragan, an economics professor at McGill University and a former adviser at the Bank of Canada.
With reports from Gloria Galloway, Jane Taber, Steven Chase, and Andrew Willis
© The Globe and Mail
