Borrowers see red over banks’ interest policy
Mortgages just as costly despite plunging Bank of Canada rate

January 20, 2009 | By Bill Mah Journal Business Writer and Canwest News Service| Edmonton Journal

The Bank of Canada is expected to cut interest rates to a record low today to stimulate the economy, but it’s likely to stoke something else, too-growing anger from people who complain that banks are pocketing much of the savings.

Wendell Dunning, a 50-year-old Edmonton machinist for a steel company, says his longtime bank not only hasn’t passed along the break from a December interest-rate cut, it suddenly raised the rate on his personal line of credit to prime plus three percent from prime plus two.

“I went nuts,” Dunning said. “The rates are going down to encourage people to spend money and borrow to get the economy going, and they’re turning around and stealing it from us.”

Dunning is part of a backlash of people increasingly frustrated with a perceived lack of action in lowering key lending rates.

Both the Consumers’ Association of Canada and the Canadian Federation of Independent Business are fielding record numbers of complaints from people who want to know why mortgage, business and personal lending rates haven’t decreased substantially in response to the slumping economy or the falling Bank of Canada rate.

“We are getting more calls on the principals of these issues than we ever have before,” said Bruce Cran, a spokesperson for the consumers’ association.

“The government is giving them (banks) a break on the interest rate at prime level and they are not passing any of that on.”

Canadian chartered banks base their prime lending rate, sitting Monday at a historically low 3.5 per cent, on the Bank of Canada’s lending rate. Both of those rates play a key role in determining interest rates for mortgages and consumer loans.

As of last week, the posted rate for a popular five year fixed mortgage from Canada’s four biggest banks was 6.75 per cent. In January 2004, when both the Bank of Canada and the chartered Banks’ prime rates were much higher, the same mortgage was being offered at 6.35 per cent.

The Bank of Canada’s overnight lending rate is sitting at 1.5 per cent, the lowest-cost loans the banking system has seen in the past 50 years. That rate is expected to fall further today.

As the Bank of Canada’s website explains it: “the overnight rate is the interest rate at which major financial institutions borrow and lend one-day (or “overnight”) funds among themselves; the bank sets a target level for that rate. This target for the overnight rate is often referred to as the Bank of Canada’s key interest rate.”

While chartered banks have traditionally lowered or raised their interest rates based on the Bank of Canada’s rate announcements, they are not bound by law.

In December, when the central bank slashed its rate by three-quarters of a point down to 1.5 per cent, the commercial banks responded with only a half-point cut in their prime rates for the blue-chip borrowing rate, to which floating-rate consumer and business loans are directly tied.

Terry Campbell, vice-president of policy for the Canadian Bankers Association, said banks have been working to lower interest rates and have been successful in doing so through the fall.

However, he said it’s harder than ever for banks to raise funding in order to lend to businesses and consumers.

“In order to be able to lend, banks have to borrow,” Campbell said. “It’s the cost of raising these funds in the marketplace, that’s what drives the interest rates that banks charge.

“Where banks will raise their money in the marketplace is through things like the bond market and deposits. We are still cutting our costs, but we have to bear in mind the costs that we face in the marketplace.”

Five-year fixed mortgage rates from the country’s four largest banks have fallen from 7.2 per cent in October.

Campbell said the Bank of Canada’s lending rate is often misunderstood. He said the Bank of Canada’s lending rate only affects short-term loans.

“That rate serves as a signal of Bank of Canada monetary policy. It affects only really one very short-term operation and that is overnight lending. Costs to banks to raise funds are very high by historical norms.”

That explanation holds little weight for Dunning, the bank customer whose personal line of credit got more expensive.

“They’re penalizing someone like me who has an excellent credit rating and has never missed a payment, and they’re turning around and taking another percent off me,” he said after citing the banks’ profits.

Canadian banks posted profits of $19.5 billion in 2007. Earnings are not expected to be that high for 2008, although results have not yet been released.

Finn Poschmann, vice-president of research at the C.D. Howe Institute, said the chartered banks’ interest rates reflect their higher borrowing costs.

“How much the banks are actually paying in the marketplace for access to capital is what determines the rate at which they’re going to lend,” Poschmann said.

He said banks raise only a small amount of capital from the Bank of Canada. “Most of the lending that they do is supported either by deposits or raising debt on their own in the marketplace. What’s happened is that while the overnight rate is down…it doesn’t mean that longer-term money is available at such a cheap rate or is plentiful.

“There is access to mortgage credit but the rates have not been coming down on the longer-term stuff because of the availability of capital on the marketplace and terms and conditions have tightened. That’s just banks doing their job in gauging the amount of market risk that they perceive.”

Randall Morck, a professor of finance with the University of Alberta School of Business, said banks are gun-shy about loan defaults during the economic downturn.

“The banks are just as scared as everybody else because they lost a whole bunch of money too,” Morck said.

“They used to be lending money left and right and now they’re being much, much more cautious because they’re worried.

“They were reckless at a time when they should have been cautious and now they’re being cautious at a time when we wish they would be bit risk-taking.”