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OTTAWA — The global credit crunch is taking a toll on Canadian banks’ balance sheets, and has prompted lenders to curtail their credit, the Bank of Canada says.
“Canadian financial institutions are facing substantially increased funding needs,” the central bank said in its first full tally of the damage done by the recent financial turmoil.
Canadian banks have been forced to hold high amounts of commercial paper of questionable value in their inventories, the central bank pointed out.
Plus, corporate borrowers are calling on their banks to come through with funding arranged under pre-committed lines of credit, now that some market sources of funding are not as accessible.
The Canadian banks are solvent enough to handle it, the central bank said, but they are reacting by tightening up credit conditions.
Banks are raising the price of credit for both companies and households, and they’re also cracking down on the terms of credit for business loans, the central bank said. For example, in addition to raising short-term credit rates, banks are also increasing covenants on new loans, or reducing the number of new loans, the central bank said.
In its quarterly outlook, the central bank recognized that it is difficult to say exactly how much effect the tighter credit conditions will have. But eventually, households and businesses will feel the pinch.
“In this base-case outlook, the tightening of credit conditions is tempering the momentum in household spending,” the Monetary Policy Report stated. “The tightening of credit conditions is also expected to lead some businesses to postpone some capital spending into 2009.”
Still, by the time the effects of tighter credit conditions trickle through the economy, the end result will be fairly mild — similar to the central bank raising its key interest rate by a quarter of a percentage point.
Given the tighter credit conditions, as well as a steep appreciation of the Canadian dollar and a slowdown in the U.S. economy, the central bank also indicated that its key interest rate will remain on hold if everything stays the same, even though the economy is in overdrive.
“The anticipated slowing in the U.S. economy, combined with the stronger Canadian dollar and modestly tighter credit conditions, more than offset the momentum in domestic demand, bringing aggregate demand and supply back into balance,” the report states.
The Bank of Canada has not raised its key rate since July. Back then, the central bank had indicated that interest rates would have to move higher, to chill the hot Canadian economy.
But August and September brought a few major surprises to the bank’s outlook: the financial turmoil that has led to tighter credit conditions; a worse-than-expected downturn in the U.S. housing sector; and a Canadian dollar that soared well beyond the bank’s assumptions.
The central bank suggested the currency’s heights are unjustified by economic fundamentals.
“The magnitude of the recent appreciation appears to have been stronger than historical experience would have suggested,” the report states.
Now, the real-estate-fuelled consumer spending machine that has been the driving force behind growth in Canada is still chugging along, but the export sector is taking a major blow, the central bank said.
Exports are projected to grow by just 0.2 per cent in 2008 (down from earlier projections of 0.9 per cent), and since imports are robust, the trade sector will shave a full percentage point off of Canada’s growth next year, the central bank said.
It expects the Canadian economy to perform well below its potential in 2008, growing by just 2.3 per cent, after 2.6 per cent this year.
The forecast for 2007 did not change much from July, mainly because the first half of the year proved to be much stronger than anticipated, making up for the sudden weakness appearing in the second half of the year. But momentum going into 2008 is much lower than thought in July.