Canadian banks slow to pass on rate cuts

October 9 2008 by Ellen Roseman

Central banks around the world cut interest rates by half a point this week. Yet in Canada, the banks passed on only half that amount to customers. What gives?

According to this report, it was the first time in 10 years that banks did not mirror the Bank of Canada’s cuts.

BMO economist Sherry Cooper said the banks were all hoarding cash. But we keep hearing that our Canadian banks are in much better shape than their U.S. and European counterparts, since they didn’t engage in predatory mortgage lending or securitization of subprime mortgages.

So why are they failing to pass on the full rate cut when U.S. and European banks are doing so?

I thought these rate cuts were intended to be passed along to consumers. Did the central banks plan this co-ordinated action just to fatten the banks’ bottom lines? I’d like to hear what others think of the banks’ foot-dragging.

Meanwhile, a reader told me about TD Bank raising rates on its home equity line of credit program. When I asked the bank to justify this, their spokeswoman said they couldn’t continue to offer HELOCs unless they made these changes. I wonder if the banks are in more trouble than they’re saying.

I’ve reprinted the exchange below.

16 comments

  1. JP

    Oct 9 2008

    TD Bank has announced they will be introducing a new charge for clients with Home Equity Lines of Credit.

    Before, they charged the TD prime rate plus 1%. They plan on making all HELOC and Variable mortgages prime +2%

    They will effectively start charging it immediately. Are they not obligated to advise clients that they are introducing a new charge or raising an existing one?

    Changing to another bank won’t be as easy as people think, given that cash and borrowing is extremely difficult at this time.

    It’s sad that one of the largest banks has to resort to these tactics to raise capital, but I guess my TD Waterhouse account, savings account, credit cards and HELOC will have to be mismanaged by one of the other Canadian Banks.

    I urge others to do the same…

  2. Kelly Hechler, TD Bank spokeswoman

    Oct 9 2008

    Hi Ellen – the increases we announced on Monday apply only to new HELOCs and new and renewal VIRMs (variable interest rate mortgages).

    Existing contracts are not affected.

    The increase allows us to continue to offer these options to customers, while other banks are pulling them. Nothing to do with the central bank’s rate cuts.

  3. Mark

    Oct 10 2008

    It smells of gouging, plain and simple – lets see what the profits are for TD at the end of year and this will tell the full story – I suspect they’ll be quite healthy.

    Regardless, It seems to be happening everywhere now under the guise of the “financial problems” bubble, even when it makes little to no sense as in this situation. Anyone who follows the price of crude would be aware of the fact that not only is the price of gas/diesel now disproportionately high compared to the price of oil, but they’re now going in the *opposite direction* with gas actually having going *up* last night while oil fell signifigantly.

    So long as the government continues to sit back and let the gouging occur, expect to see it continue and spread – next thing you know other companies will be finding their own
    “excuses” for raising prices even when the reasoning is disconnected from reality.

  4. Jerry Hung

    Oct 10 2008

    It’s really unbelievable, we went from Prime -0.75% to Prime + 1% in a span of 2 weeks.

    I’m glad my HELOC with TD has changed to the 4.5% prime now, but I would leave immediately if they raise to Prime + 2% without my consent. Same with my variable mortgages.

    Readers online said it well: You can bet when BoC raises the overnight rate, all big 5 banks won’t hesitate to follow it fully, not just 50%.

    I wonder how BoC can “punish” banks who don’t lower the rate accordingly and take the profit spread

  5. Andy

    Oct 10 2008

    Perhaps there’s some misunderstanding about the rate the Bank of Canada changed. See below from the BoC. The target rate “affects” other rates; it doesn’t dictate them.

    From BoC:

    THE TARGET FOR THE OVERNIGHT RATE is the main tool used by the Bank of Canada to conduct monetary policy. It tells major financial institutions the average interest rate the Bank of Canada wants to see in the marketplace where they lend each other money for one day, or “overnight.”

    When the Bank changes the Target for the Overnight Rate, this change usually affects other interest rates, including mortgage rates and prime rates charged by commercial banks.

    Canada’s major financial institutions routinely borrow and lend money among themselves overnight, in order to cover their transactions during the day. Through the Large Value Transfer System (LVTS), these institutions conduct large transactions with each other electronically. At the end of the day, the financial institutions need to settle with each other. One bank may have funds left over at the end of this process, while another bank may need money.

    The trading in funds that allows all the institutions to cover their transactions is called the overnight market. The interest rate charged on those loans is called the overnight rate.

    The Bank of Canada operates a system to make sure trading in the overnight market stays within its “operating band.” This band, which is one-half of a percentage point wide, always has the Target for the Overnight Rate at its centre. For example, if the operating band is 4.25 to 4.75 per cent, the Target for the Overnight Rate would be 4.50 per cent.

    Since the institutions know that the Bank of Canada will always lend them money at the rate at the top of the band, and pay interest on deposits at the bottom, there is no reason for them to trade funds at rates outside the band. The Bank can also intervene in the overnight market at the Target rate, if the market rate is moving away from the Target.

  6. Lior

    Oct 10 2008

    Jerry: unless there are laws in place that order the banks to pass the benchmark interest rate set by the BoC to consumers who have mortgages and LOCs, the banks will continue to short the Canadian consumer.

    I just read an article in the Star today about how business owners are worried that, in light of tighter lending practices, if they’ll need to tap into their line of credit they will be turned away by their bank. A senior executive from BMO, however, reiterated in the article that the bank welcomes commercial business and that there’s no need for concern.

    So, once again the question needs to be asked: if bank executives are going in front of the media to alleviate the concerns Canadians have about the credit crisis and how they’re in such terrific shape, why then are they not passing the full interest rate cut to consumers?

    Also, in response to the spokeswoman from TD, what banks have stopped offering LOCs exactly that TD found it necessary to keep 25 basis points in its pocket?

    On a final note, it should be noted that banks in Europe routinely ignore the interest rate set by the central banks when it comes to calculating the rates for mortgages and lines of credit. They essentially pocket the difference.

  7. Cynthia

    Oct 11 2008

    Well, I for one appreciate the prime lending rate as it is tied into my student loans.

    Let it drop to 1%, if only so that I could get this debt gone. Unfortunately, banks are in the business of making money. You get dinged at every step of the banking process these days, unless you have significant funds in your account over the entire month.

  8. Lior

    Oct 12 2008

    Cynthia:

    “Unforunately, banks are in the business of making money, you get dinged at every step of the banking process these days, unless you have significant funds in your account over the entire month.”

    There are plenty of options out there to save the fees. I went with Citizens Bank and couldn’t be happier. Terrific customer service, great interest rates on saving accounts that beat all the “big” banks, and complete flexibility to administer my account over the phone or the web.

    I also get access to my money from a wide network of ATMs for no charge (virtually at every credit union in the country, HSBC and National Bank machines) and I pay no monthly fees with no minimum balance. Not to mention I also get free international debit transactions, which is a great way to save on banking fees when you travel abroad.

    Granted, there’s no “physical” branch but most people don’t need it anyway these days for their basic daily banking needs. If you do need a physical branch, then yes, you’ll need to keep a hefty minimum balance to avoid the fees.

  9. Cynthia

    Oct 12 2008

    “There are plenty of options out there to save the fees. I went with Citizens Bank and couldn’t be happier. Terrific customer service, great interest rates on saving accounts that beat all the “big” banks, and complete flexibility to administer my account over the phone or the web.”

    I was generallizing. I have recently opened a PC Financial account, so my spending will go through there.

    Several of the physical institutions you mentioned don’t exist in smaller communities. Citizens Bank, for one. We have one National Bank in a city of 165,000 people. Plenty of Credit Unions/Caisse Populaires though.

    Can’t wait until we have the option to have the $5K tax-free account. Got an email from my bank the other day. For anyone who is curious as to when it starts, it’s January 2009.

  10. Sas

    Oct 12 2008

    Along with the rate drop, recent news “Canada is buying 25 billion dollars in insured mortgage pools” troubles me. The media seems strangely quiet about this. I have a couple of concerns.

    First, why would Mr. Flaherty want to pay $25 billion and at the same time say “the mortgage pools the government is taking off the banks’ books are already insured by the government.”

    Even when the default claims happen, aren’t the banks also getting the payments from the insurance? Did he think that the default claims would be so overwhelming that the insurance can’t cover them all? Can’t the highly profitable banks and high-paid CEOs, CFOs handle such situations? After all, they are paid in millions for their smarts and skills to “manage risks”.

    Their risky practices made the banks billions in profits in the last few years. Where is the money now? Didn’t they save some for a “rainy day” like this? Don’t forget about banking fees that we’re still paying. Even the government wanted the banks to get rid of them last year!

    Secondly, these are “insured mortgages”. It means they are either low or no downpayment mortgage. They are riskier than the normal “25% downpayment mortgages”.

    I doubt that “the government stands to make a small profit from the mortgages because government borrowing costs are lower than what the assets will yield in interest”, as the minister claimed! At a time when real estate assets are dropping and the ability of borrowers to pay is diminishing, it is wishful thinking out of desperation to me.

    Don’t get me wrong. I am not against efforts to save the economy. I have money tied up and lost in this crisis, too. I just happen to think this move would benefit the big businesses more than ordinary Canadians who will end up holding the bag.

    Unlike the big and profitable banks and their highly paid executives, I pay for my own mistakes.

  11. Mike Macdonald

    Oct 12 2008

    I have a little inside experience, from a past career, in how the banks set mortgage rates. The rates are set, typically, off of the bond rates plus a margin for profit. The bond rates have typically been similar to the cost of funds for the banks.

    With the current systemic issues, the cost of funds for the banks have been extremely high and for some banks they just cannot get money at any price (think Wachovia, Washington Mutual). Because Canadian banks are sound they can get money, but it is still an expensive proposition as noted by the LIBOR rates.

    Do banks gouge…..yep! Are they gouging now….not necessarily! Their cost of funds and access to funds world wide is expensive and if they pay more, so will we.

    Will they lend to consumers at less than their own average cost of money……nope! It sucks but that does not make it gouging….this one time.

    Now if your talking mutual fund MERs, account fees, foreign exchange, credit card rates or small business loan fees, then I am with you on the gouging.

  12. Mike Macdonald

    Oct 12 2008

    SAS, re the $25B in mortgages, they are typically CMHC insured. The Canadian mortgage market has very little sub-prime and none of the non-documented crap the US has.

    Since the government backs these mortgages anyway, we already own the risk and the premiums were paid up front to CMHC (the government, thus you and I). This is a straight liquidity play, since in any kind of a normal market they sell as AAA rated paper.

    It’s a very low risk way to add liquidity and no bank is getting away with anything. The government is playing the role normally played by pension funds and large institutional investors until they come back to the markets.

    I think this was a great move and low cost. I hate to sound like a defender of our banks since they do screw us in so many ways, but again, this ain’t one of them.

  13. Lior

    Oct 12 2008

    Mike: if I understand correctly, all the mortgages that are required to be insured through CMHC are high ratio mortgages where the borrower has less than 20% equity. That means there’s a significant amount of money at risk and the premiums charged only cover a small portion of the loan amount.

    So while the government already backs these mortgages anyway against default, if market conditions continue to worsen with falling property prices as well the credit market turmoil, where the cost of lending for the banks is up significantly and they look for ways to pass on their increased costs to the consumer, we could, technically, see the borrower’s interest rate increase significantly.

    This obviously goes for both variable rate and fixed rate mortgages as well as HELOCs. Variable rates will be adjusted quicker, with TD already announcing that any new variable rate mortgages and HELOCs will now be offered at prime + 2%. Eventually, though, all the people who are renewing their fixed rate mortgages may find their new rate much higher than they can comfortably afford.

    While I don’t think that we will have it as bad as it is in the States, there’s still a real risk that if the credit crisis goes on for longer, we may see US-style defaults here as well, which will only contribute more headaches to an already fragile real estate market.

  14. Mahendrapal

    Dec 11 2008

    Will they pass on the full cut next time? Or still attempt to line their own pockets rather than helping the consumers and businesses as the central bank seems to want?

  15. Pat Murphy

    Dec 11 2008

    The banks get richer and the poor work guy gets stiffed again

  16. Jose Oliveria

    Dec 11 2008

    Hi Ellen,
    What’s even worse is Manulife One Bank. They are charging me right now prime rate of 4.25%. To me this is totally outrageous. Please help.