Canadian banks will pass along only part of a central bank rate cut to borrowers, with Toronto-Dominion Bank being the first to announce on Wednesday it will lower its prime lending rate by 25 basis points to 4.50 percent.
That is only half of the 50 point cut in administered rates made by the Bank of Canada earlier on Wednesday, when it acted with other central banks to lower key lending rates in an attempt to shore up investor confidence and ease the effects of the global credit crunch.
The Bank of Canada dropped its overnight rate target to 2.5 percent.
Canadian Imperial Bank of Commerce, Royal Bank of Canada and Bank of Nova Scotia said they would make the same reductions as Toronto-Dominion, bringing their prime rates to 4.50 percent from 4.75 percent, effective Thursday. Other banks were likely to follow suit, based on past patterns.
The prime rate influences borrowing rates on other consumer and business loans.
“There’s certainly no rule that states that they have to cut their rates in lockstep with the Bank of Canada,” said Steve Foerster, a finance professor at the University of Western Ontario’s Ivey School of Business.
“I think we’re in unusual times right now, and their costs have been going up.”
TD, Canada’s second-largest bank, said that it would be “challenging” to fully match the half-percentage point cut because funding costs have risen in the industry. It called the smaller cut “a balanced move.”
The banks should be able to increase their lending margins, as the rates that they pay on their clients’ deposits will likely drop more than the rates they charge on loans, Blackmont Capital analyst Brad Smith said.
“Funding for banks has been largely decoupled from administered central bank rates, that’s particularly evident in the U.S.,” Smith said. The Canadian banks’ decision to only partly implement the central bank’s rate cut reflect that reality, he said.
Tim Hockey, president of Toronto-Dominion’s TD Canada Trust unit, said that all financial institutions have been watching key lending rates very closely.
“Continuing market turmoil has steadily driven up the cost of borrowing for financial institutions,” he said in a statement. “This makes it challenging to match the Bank of Canada rate cut at this time.”
Economists at National Bank Financial said on Wednesday that the liquidity squeeze has intensified over the last few weeks in the Canadian banking system, just as it has in other countries.
A key barometer of the cost of funds for Canadian banks is the one-month bankers’ acceptance (BA) rate, which has been rising in 2008, while prime rates have been falling since last year, NBF noted in a commentary.
That means the spread between the prime rate and BA rate, which has historically been about 1.65 percentage points, has narrowed to 1.16, NBF said.
Central bank actions, market reaction and the competitive landscape will all be considered when setting future rates, TD Bank’s Hockey said.