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Canada’s big 5 banks cut prime, battling it out as lending rates fall

Canada's big banks followed the Bank of Canada’s interest rate cut, lowering their prime lending rates in a series of moves that reinforces the reluctance of lenders to follow the central bank in lockstep.

Toronto-Dominion Bank decreased its prime rate – the benchmark for creditworthy borrowers – to 2.7 per cent, down 0.15 percentage points. Royal Bank of Canada, Bank of Montreal Bank of Nova Scotia and Canadian Imperial Bank of Commerce followed on Wednesday evening, reducing theirs by 0.15 points to 2.70 per cent from 2.85 per cent, effective July 16, 2015. That’s a shallower reduction than the central bank’s 0.25-point cut.

This marks the second time this year that Bay Street has taken a more cautious approach to their lending rates after the central bank has slashed its benchmark in response to disappointing economic activity.

Overall, most banks have lowered their prime rates by a total of 0.3 percentage points this year, or nearly half the Bank of Canada’s total reduction of 0.50 points over the same period.

Now that the other banks have followed TD’s lead, they will have lowered their prime rates by a total of 0.25 percentage points this year, or half the Bank of Canada’s total reduction of 0.50 points over the same period.

Bank of Canada Governor Stephen Poloz appeared unconcerned by the banks’ response, noting that lending rates can be affected by many factors beyond official monetary policy.

“That’s how financial markets work,” Mr. Poloz said at a press conference. “All we’re trying to do is have an influence on [the lending rate], as opposed to determine it.”

After the Bank of Canada cut its key rate in January, also by a quarter point, the big banks were slow in responding to the surprise move.

When they did react, they took a public drubbing over their refusal to respond with an equal reduction in their prime rates, decreasing them by just 0.15 points.

However, some observers have pointed out that the Bank of Canada may not mind the muted response from the banks.

House prices have soared as borrowing costs have fallen, raising concerns that prices may be overvalued by as much as 30 per cent, according to Bank of Canada estimates. As well, Canadian indebtedness has risen to new heights, making consumers vulnerable to rising unemployment levels or an eventual ramp-up in borrowing costs.

For the banks themselves, the response to the Bank of Canada comes as they attempt to shore up profits driven by their lending activities.

Since the banks make money by lending at higher rates than their own borrowing costs, substantially lower prime rates can compress the spread, or net interest margins.

“We are in such an unusually low-interest-rate environment that the traditional rules of one-for-one [reductions in the prime rate and the Bank of Canada’s key interest rate] don’t work,” Peter Routledge, an analyst at National Bank Financial, said in an interview.

He pointed out that the net interest margin for the Canadian personal and commercial banking operations of the Big Six banks have declined to a weighted average of just 2.48 per cent from 2.73 per cent in 2010. Less than a decade ago, the margin was a far more robust 3 per cent.

Although Canadian banks have increased their overall profits over this period, their share prices have recently been struggling to keep up with the broader market, reflecting investor concerns that earnings growth is being challenged.

“We anticipate that the market’s outlook for growth will moderate further in 2016, encapsulating an even greater slowdown in loan growth and incremental margin pressures,” John Aiken, an analyst at Barclays, said in a note.

Mr. Routledge thinks the banks may also be maintaining higher prime rates, relative to the Bank of Canada’s key rate, out of concerns about credit risk.

“If the economy is slowing so much that the Bank of Canada has cut its policy rate in half” – to 0.5 per cent from 1 per cent in January – “maybe households in particular are not as creditworthy as consensus believes,” he said.

“If that’s the case, you want to put in a little more spread for taking credit risk.”

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