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Are Canada's banks too generous?

Earlier this month, the Bank of Montreal cut its posted fixed five-year mortgage rate to 2.99 per cent. The move attracted considerable attention from competitors, borrowers and government. Several other financial institutions, many of which tend to move in herd-like fashion, followed shortly thereafter.

True, banks' posted rates are mostly a fiction, as savvy consumers can easily negotiate them down, or find more attractive options. However BMO's latest move, which comes at a time when many believe that Canada's housing sector is overvalued, and that many consumers are over-stretched, raises the question as to whether the banks are being overly generous in encouraging borrowing.

Avoid race to the bottom
Canada's Finance Minister Jim Flaherty leaves no doubt as to where he stands. His office quickly issued a statement warning that financial institutions not engage in "race to the bottom" lending practices, such as those that spawned the U.S. mortgage crisis.

Flaherty has a point. After all, the average Canadian household debt is now at 163 per cent of personal disposable income, which, due to the country's aging population, is likely unsustainable over the longer term. That said, blaming banks for fighting for market share is like chiding a giraffe for eating leaves--after all, this is what they do.

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Economy is sluggish
Furthermore, although job creation has been strong lately (51,000 new posts were created during February, according to Statistics Canada's Labor Force Survey) Canada's economy has continued to struggle to gain traction in recent months. Gross domestic product grew by just 0.6 per cent in the fourth quarter of last year. This comes on the heels of a tiny 0.7 per cent increase the quarter before. For 2012 as a whole, the economy grew by 1.8 per cent in real terms. With that kind of sluggishness you would think that policymakers would wants banks to boost lending to businesses and customers to get the economy moving.

Government could reign in lending
On the other hand, if governments want banks to lend less, they have plenty of tools to do that. For example, the Bank of Canada recently maintained its target rate at just 1.0 per cent, and hinted that it is unlikely to change its policy anytime soon. That widely followed policy rate is a key indicator of where the central bank is guiding monetary policy. If Canada's monetary authority truly wanted to cool borrowing, it could easily ease rates back up.

The Canadian government too has numerous tools to reign in bank lending. Flaherty himself has made several moves in recent years to tighten borrowing requirements, in order to reduce excess leverage in the system. These include several cuts in the maximum mortgage loan amortization rate, and restrictions on home equity line of credit borrowing.

In short, if Flaherty and other government officials really want to cut bank lending, they can easily make that happen, rather than just complain about it.

In the meantime, public officials should not be surprised that banks and other financial institutions are fighting to do what they do best, which is lend money.

Peter Diekmeyer is Bankrate.ca's economics columnist. He can be reached at peter@peterdiekmeyer.com

-- Posted March 18, 2013
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