October 23, 2008 / 4:37 PM / 9 years ago

Canada bolsters banks, teeters on recession's edge

<p>Canadian currency in the form of twenty dollar bills are displayed in this posed photograph in Toronto, October 22, 2008.REUTERS/Mark Blinch</p>

OTTAWA (Reuters) - Canada reinforced its banking sector with loan guarantees on Thursday in a bid to mute the impact of a global financial crisis that is forecast to push the country to the edge of recession.

The move mirrors multibillion-dollar programs in the United States and Europe to restore lending confidence after a series of bank failures -- many stemming from soured investments in bad U.S. mortgages.

“The government of Canada is acting today to ensure that financial institutions in this country are not put at a competitive disadvantage when raising funds in wholesale markets to lend to consumers and businesses,” Finance Minister Jim Flaherty told reporters.

The global economic turmoil, which has slammed world markets and dragged consumer confidence to its lowest levels in decades, is expected to push Canada’s economy to the brink of recession, the Bank of Canada said Thursday.

In its quarterly report, the central bank projected the economy would shrink 0.4 percent in the fourth quarter of this year and would record zero growth in the first quarter of 2009. The technical definition of a recession is two consecutive quarters of economic contraction.

Bank of Canada Governor Mark Carney said he would not describe the economic outlook as recessionary, just sluggish, and Flaherty said he thought a recession could be avoided.

A steep weakening of the Canadian dollar could offset sliding commodities markets by helping manufacturers.

In addition, a cumulative reduction in the bank’s key interest rate of 225 basis points since last December, should start to stimulate the economy in coming months, Carney said. And Canada entered the crisis better off than other developed economies in terms of its housing and banking sectors, he said.

Despite negligible annual growth rates in 2008 and 2009 of 0.6 percent, the bank sees a full-fledged recovery in 2010 with 3.4 percent growth. Carney said he was confident of that recovery, which he said was actually milder than recoveries from previous crises.

Flaherty repeated his pledge to run the country’s 11th consecutive budget surplus this year, but said he could not promise the same for future years. In television interviews, he said the government must avoid structural deficit spending and did not rule out providing further stimulus to the Canadian economy, on top of tax cuts already announced a.

World leaders are scheduled to meet in Washington next month to address the deepening global economic gloom, with European leaders calling for an overhaul of world financial system regulation.

Finance ministers of G20 nations will meet in Brazil before the Washington meeting, and Carney said they should put in place a process for reforming the global financial system.

Canada -- which has the soundest banking system in the world according to the World Economic Forum -- could provide some lessons to other countries at the meetings, he said.

BANK GUARANTEES

Canada’s program to backstop banking lending will begin in early November and continue for at least six months, Flaherty said. He added that he hoped Canada’s banks would find the program unnecessary.

“There may be no takeup on this and ... the excellent result would be that it’s not necessary, that the banks don’t take it up,” Flaherty said.

He said the program would be offered on a commercial fee basis and would likely come at no fiscal cost.

The Canadian Bankers Association said it welcomed the new measures, even though banks were strong without them.

“Canada’s banks are well capitalized and financially sound with or without this federal government loan insurance,” said Nancy Hughes Anthony, president and chief executive of the Canadian Bankers Association.

Earlier in the month, the Canadian government announced a plan to buy up to C$25 billion ($19.9 billion) in mortgage assets from Canadian banks to help them boost liquidity and to encourage lending to consumers and businesses.

The government bought C$5 billion in mortgages in the first phase of the program October 16. A second auction of C$7 billion was held on Thursday.

Carney said signs of improvement in global and Canadian money markets in the past two weeks were encouraging but said it would be premature for the bank to declare victory and call off its extraordinary liquidity injections.

“It’s going to work. We’re seeing signs in the money market that is kind of behind the scenes and not evident to others, but it’s hugely important to how the system actually functions,” he said.

“But now is not the time to relax,” he warned.

($1=$1.27 Canadian)

Reporting by David Ljunggren, Louise Egan and Lynne Olver, writing by Richard Valdmanis; editing by Rob Wilson

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