Pay more attention to banks

Canadian households are deep in debt and the banks couldn't be happier. All the major banks increased their dividends last week because their loan business is booming. Car sales have remained strong. Home appliances are flying out the door. University classrooms are bulging with indebted students. How long can this go on?

Finance Minister Jim Flaherty and Bank of Canada governor Mark Carney have been worrying aloud for a couple of years about what happens when interest rates rise and deeply indebted families can no longer afford their loan payments.

Mr. Flaherty has tightened mortgage-lending rules. Both authorities have warned families to tailor their debt load to the likelihood interest rates will increase sooner or later.

But the low price of credit speaks louder than the cautionary remarks.

Statistics Canada found in June the debts of Canadian households had risen to 152 per cent of household income in the second quarter of this year from 150.5 per cent in the first quarter.

Twenty-five years ago, household debt generally averaged about 60 per cent of household income. Last week, the agency estimated the debts of Canadian households had risen to $93 billion in the second quarter of this year.

Mortgage borrowing had slowed down but consumer credit increased sharply.

Survey results suggest the households with the largest debts also have the highest incomes, the best education and the best levels of financial literacy. Banks are happiest to lend to families that will be able to pay and keep on paying.

The banks are also endlessly inventive in packaging debt in bright, shiny wrappers. CIBC, for example, announced last week it has rolled out in British Columbia and Alberta its new Home Power Plan -- a traditional mortgage and a line of credit to give clients a long-term borrowing solution resulting in a deeper, longer-term relationship with CIBC.

Experience suggests a period of credit expansion is likely to be followed by a period of what is politely called de-leveraging -- when lenders call in their loans and crank up the interest rates, and when borrowers tighten their belts and reduce their debts.

The U.S. credit market is still working its way through such a phase now, as are Ireland, Greece, Spain, Portugal and Italy.

It is possible Canada will enjoy endless credit expansion and never undergo de-leveraging, but that seems unlikely.

When that day comes, the Canadian banks that are now raising their dividends may find they have a whole lot of loan customers who cannot pay. If one of those banks, or several of them, run into deep enough difficulties, Mr. Flaherty and Mr. Carney may have to decide whether to organize a bailout or let a Canadian bank fail. They may then wish Canada had more banks and were not so dependent on the Big Five, which, for practical purposes, are simply too big to fail.

During these days of easy credit, federal policy should foster the growth of more banks to limit the failure risk each one represents. Purchase of ING Canada by Scotiabank, Canada's second-largest bank, will tend to concentrate risk. Mr. Flaherty and Mr. Carney should aim to spread it, not concentrate it.

Republished from the Winnipeg Free Press print edition September 5, 2012 A10