October 14, 2008 / 8:41 PM / 9 years ago

Canada seen poised to shore up bank lending

6 Min Read

<p>Canada's Finance Minister Jim Flaherty speaks during a news conference on Parliament Hill in Ottawa, October 9, 2008.Christopher Pike</p>

OTTAWA/TORONTO (Reuters) - The Canadian government is widely expected to offer public money within days to facilitate interbank borrowing after bailouts in other countries have put Canada's otherwise robust banks at a disadvantage.

After European banks stepped in on Monday to offer massive rescue packages to banks, Canadian Finance Minister Jim Flaherty promised to take steps to protect Canada's financial system from "unintended consequences from policy measures by other countries that would put wholesale borrowing in Canada at a competitive disadvantage".

The Bank of Canada repeated that sentiment on Tuesday, a strong signal that Ottawa has a plan in the works. Washington on Tuesday said it would take equity stakes worth US$250 billion in financial institutions, an incursion into the private sector that it called a regrettable last resort.

"Having one set of global banks with more explicit guarantees than another set of global banks obviously puts that latter set at a disadvantage and I think that's pretty obvious," said Michael Gregory, managing director and senior economist at BMO Capital Markets.

As other countries expand insurance and guarantees on bank deposits and debts along with capital injections, Canadian banks may have a tougher time competing for big chunks of short-term funding in the international market since their debt does not have the same government backing as that of other international banks.

So the onus is now on Ottawa to level the playing field.

"I suspect these (measures) are in the wings....this is something that may be announced in the next few days potentially," Gregory said.

Timing is a tricky issue for the government and it is in wait-and-see mode before making a move because banks may also benefit from the collective action by the United States and Europe, which should reduce funding costs in the interbank market.

Also, Canadians are voting on Tuesday in a general election that has focused on the global financial crisis, so the Conservative government may prefer to defer any major move that could be perceived as last-minute electioneering.

However, government officials said conditions change so swiftly in the current environment that they could not rule out an announcement later on Tuesday.

The Canadian banking system hasn't had the solvency problems seen elsewhere and was ranked the world's soundest by the World Economic Forum this month.

Indeed, the head of the Canadian Bankers Association said banks feel no need for the government to take an equity stake in their businesses, nor is there a need to increase deposit insurance limits -- both measures adopted by other Group of Seven partners.

But what banks are now wondering is: "have we got enough flexibility for our banks in terms of their funding needs?" said Nancy Hughes Anthony, president and chief executive of the

Cba.

"Is there now a level playing field, not only nationally but internationally? ... You don't want to see funding siphoned off in certain directions just because of the particular kinds of government guarantees or whatever they are."

One way Flaherty could protect banks is to expand a much-applauded plan to buy up to C$25 billion ($22 billion) in insured residential mortgages. The Conservatives like that plan because they say it is not the same as a bailout and is intended to unfreeze private-sector lending.

He could also guarantee loans from international creditors to Canadian banks, thus restoring trust between banks that lend to each other.

The government may seek the kind of bank loan guarantees offered by Germany and France on Monday, so that Canadian banks can borrow from international creditors on equal footing with their global peers.

"People are cognizant of the fact that we've got to make sure we work together," Gregory said.

"Will (the European measures) have a noticeable effect that requires the government to introduce a competing program, despite the fact that the Canadian banks don't really need it from a solvency or liquidity reason like other global banks do? We'll just have to see," he said.

Meantime, the Bank of Canada has relieved a huge amount of pressure building in money markets by expanding its liquidity operations, promising C$10 billion on Wednesday and also expanding the participants and collateral eligible to engage in these transactions.

"I think the movements of the various authorities have been commensurate with the risk in the system, so to the extent you haven't seen a capital injection in the Canadian banking system is because it's not required," said Peter Routledge, vice president and senior credit officer at Moody's.

Routledge said the predominant concern in Canada is the scarcity of short-term liquidity, and the Bank of Canada and government have responded well to that challenge through term liquidity operations and the mortgage purchase program.

"Could they do a bit more? Yes, the rate we watch is Libor, to the extent Libor stays relatively high -- and it's very high relative to historic norms -- then I would think the government would probably take more actions," he said.

($1=$1.16 Canadian)

Writing by Louise Egan; Editing by Peter Galloway

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