LENDING POLICY OF BANKS IN CANADA

Presented By – Kartikay Khetarpal

Canadian Banks – An Introduction

For the fifth consecutive year the World Economic Forum has ranked Canada’s banking system as the world’s soundest. This is good news that benefits Canada and Canadians. The banking industry annually contributes tens of billions of dollars to Canada’s GDP, directly employs more than a quarter of a million Canadians and provides financing for businesses across the country, including close to $87.7 billion in credit to small businesses alone last year.

Banks represent a little more than half (58 per cent) of all lending supplied to businesses through business loans, short-term promissory notes known as bankers’ acceptances, non-residential mortgages and other lending products. Considering the financing market more broadly, including capital markets, banks represent roughly one-quarter of the total business financing marketplace.

Demand for business credit rebounding

During the recent economic downturn, many businesses reduced their borrowing because of the economic and market uncertainty. And, while banks continued to provide businesses with access to credit, businesses did not access that credit as much as they had in the past.

Business financing is now growing in response to increasingly favourable economic growth and confidence. These conditions are becoming broad-based throughout the Canadian economy.

How lending decisions are made

Bankers look at the total business package when making financing decisions and the ability to repay a loan is determined by the business plan, cash flow projections, asset base, sales and marketplace analysis and business viability.

Banks make all lending decisions on a case-bycase basis. The terms of the loan are based on the financial situation of the individual business within the context of financial market conditions more broadly.

Role of Bank of Canada

Bank of Canada is projecting Canadian economic growth to slow down in coming years. It also admits that there is some slack in the labour market. In the economic outlook, Bank of Canada governor Mark Carney stated that core inflation expected stay within 2% range till 2014. The above statements show that the bank is likely to keep it overnight target rate at the present level.

Cont..

Maintaining a super-low overnight rate comes with the risk of overheating consumer debt. As a responsible central bank it wants to keep businesses lubricated enough with accessible finance but at the same time it does not want to encourage individual to hoard cheap loans.

BOC did deliver on its promise to keep enough liquidity in the financial market. Unfortunately it cannot simply print and distribute cash to people. It has to use the existing system such as bank and other financial institutions to act as a delivery medium.

How the problem began ?

The banks started to distribute the wealth to whomever it found as “Creditworthy”.

Later it was seen that mortgage lending went up and business loan went down.

Now that the people borrowed too much and an immediate rate hike will bring the weak economy to its knees – the central bank was trapped.

Therefore we sew a rescue mission. Instead of just regulating the banks or tightening the lending policy – A decision has been made to act on both the fronts. More requirements are being put in on the banks to lend and planning to restrict CMHC from insuring every borrower. It is my view that this is a good plan if it works, at least worth a try.

Changes in Lending Policy

The Office of the Superintendent of Financial Institutions Canada (OSFI) is the primary regulator and supervisor of federally regulated deposit-taking institutions, insurance companies, and federally regulated private pension plans.

It has made every effort to rein in consumer debt levels and to reduce the risks to the financial system posed by record mortgage debt levels.  Most recently, it has asked all federally regulated banks to comply with its demand for a change and tightening in mortgage underwriting by the end of this fiscal year.  For most banks, the end of the fiscal year (2012)

TDCT first to implement changes

The first federally regulated bank to announce changes in its lending policy is TDCT (TD Canada Trust). 

Below is a summary of the changes.

Equity Lending Changes Equity lending programs have been

discontinued for salaried employees.

Maximum 65% loan to value for all applications where the borrower is self employed.

Regardless of the loan to value, or net worth, all self employed applicants must provide confirmation of business

New US Resident lending policy in Canada

. There has also been changes to the Canada-US tax treaty and this particular Bank will no longer gross up the interest rate for US Residents. Income, downpayment and credit history will have to be confirmed as usual and will be subject to the same debt servicing qualifications.

There used to be a tax treaty between the US and Canada. The Canadian Banks had to gross up the interest rate by either approx 1.48 or 1.74 and send a withholding tax down to the US IRS (Internal Revenue Service). The particular Bank that has this new program for US Residents is no longer doing that as the tax treaty is over.

Conclusion

“While banks understand the importance of providing credit businesses, they also have a responsibility to protect their depositors’ money. Banks continue to make lending decisions on a case-by-case basis, extending credit to those for whom it would be beneficial and who have the capacity to repay the loans. This prudent approach is a key reason why banks in Canada have largely avoided the financial difficulties that have plagued banks in other countries. Maintaining these sound, fundamental principles of prudent lending is important to Canada’s banking system and also in the best interest of all Canadians.”