Carney urges banks to lend more

HEATHER SCOFFIELD

Globe and Mail Update

December 17, 2008 at 1:03 PM EST

Canada's banks should take full advantage of their relatively healthy status by expanding their lending, and resist the competitive pressure to build up capital reserves instead, Bank of Canada Governor Mark Carney says.

In comments to The Globe and Mail's editorial board on Wednesday, the governor made a point of underlining the huge amounts of help Canada's banking system has been getting from the central bank and federal government to deal with the global financial crisis.

Canada's banks are well capitalized, they have access to generous central bank term lending programs, the federal government's mortgage purchase program, as well as government loan guarantees, Mr. Carney said.

But at the same time, Canada's banks are increasing the amount of reserves they are socking away just in case something really bad happens. That doesn't make sense, Mr. Carney said.

“It is not clear to me that they need additional capital,” he said. “But what is clear to me is that there is unfilled demand for credit for worthy investment, and I'm sure that our banks will see these opportunities in the fullness of time.”

In a speech to a business audience in Toronto, Mr. Carney warned about the “paradox of thrift,” which economist John Maynard Keynes coined to refer to destructive behaviour of individuals during recessions. At an individual level, people want to save more and invest less in a recession. But collectively, this behaviour makes things worse. Banks may decide to stop lending because they fear losses, but their behaviour exacerbates the downturn.

“Of all places, Canada should be able to avoid this…paradox of thrift,” Mr. Carney told the Globe, because Canada's well capitalized banking system does not need to hoard capital to cover eventual losses.

Canada's banks should recognize their strong position as an edge over their global competitors, he added in his speech.

“The value of this virtually unique advantage of our economy should not be underestimated.”

In his speech, Mr. Carney also recognized that 2009 will be a rough year.

“Businesses are already beginning to postpone large investments, and households now hesitate over major purchases,” he said. “Partly as a consequence of financial instability, next year will be a trying one for many Canadians.”

Still, eventually, recovery will come, he said, without giving a timeline.

“It is sometimes hard to see the end of the crisis. But end it will,” he said. “The actions that policy-makers are taking will be effective. The global economy will emerge from this period of weakness.”

In order to make sure such a crisis doesn't happen again, the Bank of Canada plans to put more muscle behind its power to oversee and advise on the stability of the financial system, Mr. Carney added. The central bank already co-ordinates with other federal regulators, but it needs to assert itself more, he said.

“We will seek to identify stresses in the economy as well as the regulations and practices that have the potential for serious macroeconomic consequences,” the Governor said. “In doing so, we will want occasionally to change behaviours, conventions and even regulations to mitigate threats.”

Mr. Carney did not update his views on the economy, nor did he comment on whether governments should be putting together massive stimulus packages. The central bank has already said that Canada is in recession, but it has not published an updated detailed forecast for growth, or lack thereof.