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Canadian Banks get help


Blog by Shaun Kimmins | November 13th, 2008


Ottawa bows to banks to keep credit flowing

Triples spending on mortgage purchases; Cuts price of loan insurance; Boosts business borrowing; Creates new lending office

From Thursday's Globe and Mail

Pressure from Canada's big banks pushed the Harper government yesterday to overhaul the terms of financial assistance programs it recently designed to keep credit flowing through the Canadian economy.
Finance Minister Jim Flaherty announced a series of measures to support the banks, but also to mitigate the unexpected harm that some of his previous measures had caused.


In an early-morning move, Ottawa tripled to $75-billion the amount of money the government will spend on a popular mortgage purchase program that allows the banks to free up extra lending capacity. At the same time, however, the government bowed to pressure from Bay Street with a sharp price cut for a loan insurance program that the banks complained had actually made matters worse. When the program was launched a few weeks ago, the banks said the fee structure was so steep that it actually boosted funding costs because their other borrowing rates rose to match the rate set by Ottawa.


These measures are not a bailout, Mr. Flaherty stressed, and could potentially generate profit of hundreds of millions of dollars for the government. "We have to expect an extended period of stress in global credit markets," the Finance Minister said after meeting in Toronto with the chief executives of most of the big banks.
He said his message to them was that private-sector lenders have to "keep on doing their job, making loans to credit-worthy people and enterprises of all sizes." But the government will step in, he said, when "markets are profoundly disrupted, so that private-sector lenders can maintain access to the funds they need to keep lending and supporting economic growth." Other stimulus measures announced yesterday included a move by Ottawa to boost the borrowing authority of the Business Development Bank of Canada to $11.5-billion from $9.7-billion, which could get more money into the hands of small- and medium-sized businesses.

The Bank of Canada also took action yesterday, setting up a new $8-billion lending facility for financial institutions that will take non-mortgage loans as collateral. That follows Tuesday's move by the Office of the Superintendent of Financial Institutions to give banks more flexibility in setting their capital levels. Last week, concerned bankers took their complaints directly to Prime Minister Stephen Harper and lobbied hard for the Conservative government to make deep cuts to rates on the loan insurance program, but yesterday they were full of praise for the government's changes.


Gerry McCaughey, chief executive of the Canadian Imperial Bank of Commerce, lauded the new programs. "Today's announcement is another example of the federal government's commitment, along with the Bank of Canada and OFSI, to ensure that Canada's financial system remains among the strongest and most competitive in the world," he said.
The banks had wanted the mortgage bond program extended, the loan insurance scheme made cheaper, the launch of a new term facility from the central bank, and changes to capital rules. "We asked for four things, and we got all four of them," said Toronto Dominion Bank chief economist Don Drummond. Bank executives were quick to defend against public perception that Ottawa's help constitutes a bailout that will have to be funded by taxpayers. "We would like to get through this crisis without government bailouts," TD Bank CEO Ed Clark told a conference in New York. While a recession in Canada seems inevitable, he said, "there have been no bailouts of the Canadian banking system."


Under the mortgage program, the government makes money because it can borrow cheaply to buy the pools of insured home loans from the banks. With those loans off their books, the banks should be able to lend money more easily — and at lower interest rates — to consumers and businesses. The moves will "further strengthen Canadian access to international credit markets," and reduce risk, said Brenda Lum, managing director of Canadian financial institutions at credit rating agency DBRS Ltd.


So far, Ottawa has made three purchases for a total of $19-billion, and it stands to make an annual profit of more than $190-million. Extrapolating that to the whole $75-billion, that would imply a potential profit of $750-million a year.
The changes in the loan insurance program were made partly because the original plan actually raised the banks' borrowing costs by putting a "floor" on the rates for bank debt. The government had designed its program like an emergency backstop, hoping financial institutions wouldn't have to use it. The insurance came with a charge of roughly 1.85 percentage points, depending on the banks' credit ratings. What Ottawa did not foresee was that market players such as pension funds decided that if that was the price the government demanded to provide security for a loan, they shouldn't take less. As a result, the cost of medium-term funding rose by nearly 30 basis points, according to one source.
The banks will now face a fee of 1.35 percentage points if they want to tap government insurance. Analysts said the mortgage bond option remains the cheaper source of funding and that the insurance program is more of a backstop and unlikely to be used unless credit markets further deteriorate. While the federal government has pulled several additional arrows out of its bank-support quiver, there are some it does not want to use.


Mr. Flaherty has been loath to consider beefing up deposit insurance coverage for retail banking customers, and he does not want Ottawa to buy any ownership stakes in the banks. Still, Ottawa is considering some other measures. At the next meeting with provincial finance ministers in December, Mr. Flaherty is to talk about possible changes to pensions, and a potential reorganization of the regulation of capital markets.

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