Carney to banks: Lend , don't hoard

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Bank of Canada Governor implores big five to help lift economy out of recession by freeing up money for business instead of building cushions to guard against losses

TORONTO - Mark Carney is pointing a finger at the country's big banks for hoarding capital against a rainy day instead of doling out more loans, a choice the Governor of the Bank of Canada says is damaging the economy.

The public admonishment is an unusual move for a central bank governor, but Mr. Carney has recently decided to advocate more publicly for certain government policies and bank behaviours.

While he has a direct line of communication with the chief executives of the big banks, his message hasn't been embraced. The banks have been racing to bolster their capital cushion, increasing the amount of money they hold to protect against potential loan losses.

"It is not clear to me that they need additional capital buffers," he said of the banks during a meeting with the editorial board of The Globe and Mail. "What is clear to me is that there is unfilled demand for credit for worthy investments, and I'm sure that our banks will see
these opportunities in the fullness of time."

Federal Finance Minister Jim Flaherty says he and his provincial and territorial counterparts agree infrastructure projects must happen quickly to boost the economy.

The banks are tightening up just as many businesses are having trouble securing loans. The crimped corporate-credit environment could spur layoffs or closures and exacerbate pain in the economy precisely as the country is dragged into its first recession in nearly two decades.

Worries about companies' struggles to get loans emerged as one of the biggest risks to the economy at a meeting between Finance Minister Jim Flaherty and his provincial counterparts yesterday in Saskatoon.

"There was a feeling they could do more to get credit to business," Gregory Selinger, Manitoba's Finance Minister, said of the banks.

Ontario Premier Dalton McGuinty also criticized Canada's big banks for not doing more to help cash-starved businesses. "One of the ways they can help is to make sure there is not an undue constraint on access to credit," he said. "Businesses need to continue to operate lines of
credit."

Banks refused to respond to Mr. Carney's remarks yesterday, and the Canadian Bankers Association declined comment.

Banks are required to hold capital, or funds, to protect their depositors in the event that they lose money on bad loans. Canada's banking regulator requires banks to keep the ratio of their most solid capital, known as Tier 1 capital, to their loans and investments above 7 per cent. Global rules require only 4 per cent. The riskier a bank's lending, the more capital it has to hold.

In the wake of the September collapse of Lehman Brothers Holdings Inc., investors, analysts and regulators placed greater emphasis on the importance of capital cushions, which help to protect banks from financial hits such as soured loans and writedowns. Market pressure has
created what some analysts have deemed to be the new minimum acceptable ratio of 9 per cent in Canada, and the big banks all now have ratios ranging from 9.1 per cent to 10.5 per cent.

Three of the big five have taken the extraordinary step of issuing common shares in recent weeks. Earlier this week, Bank of Montreal CEO Bill Downe referred to his bank's move as "prudent." At least one bank chief has acknowledged some doubts about opting to raise capital. When Toronto-Dominion Bank CEO Ed Clark decided to raise capital late last month, he felt it was not in his bank's best interest. But he also felt pressure to bow to the market's whim, he said in an interview at the time.

What Mr. Carney advocates is almost a Keynesian approach to banking, in which a buildup of capital in good times is used to fund lending in bad times. The argument is that it's similar to the government practice of using deficit spending to prime the pump in a recession.

In a speech to a business audience in Toronto, Mr. Carney warned about the "paradox of thrift," which economist John Maynard Keynes coined to refer to destructive behaviour of individuals during a recession. At an individual level, people want to save more and invest less in a
recession. But collectively, this makes things worse. Banks may decide to stop lending because they fear losses, but their behaviour exacerbates the downturn.

"Of all places, Canada should be able to avoid this ... paradox of thrift," Mr. Carney told The Globe, because Canada's well-capitalized banking system does not need to hoard capital to cover eventual losses.

The Canadian banks are well positioned to heed critics such as Mr. Carney, since they all have capital levels well above the minimum requirements and access to relatively inexpensive government funding.

Even Canada's banking regulator, Julie Dickson, who has been prodding banks to conserve capital, now says it's "not the time to raise capital requirements across the board."

Former Bank of Canada governor David Dodge recently called on the bank, regulators and the Finance Department to band together and "lean against the wind" by combatting policies that could exacerbate the economic downturn.

As the financial crisis has gathered steam, officials around the world have identified policies that threaten to make the situation worse, ranging from accounting rules that cause the banks to take writedowns quarterly, to the regulations that cause employment insurance premiums
to rise when job losses loom.

In the future, banks should be required to build up capital buffers when the economy is good, Mr. Carney said.

With reports from Boyd Erman and Karen Howlett in Toronto, Heather
Scoffield in Ottawa and Kevin Carmichael in Saskatoon