Credit Cards

What Is The Cost To Canadians When The Banks Are Issued Credit Downgrades?

By: Justin Leung on February 4, 2013

Should Canada be worried that the five big banks have been placed on ‘credit watch?’ Economists agree that the banks are unlikely to collapse as Lehman Brothers did in the US, but caution that the downgrades could affect lending rates across the country.  In turn, higher rates will inevitably increase the costs of mortgages, lines of credit, and credit cards for the average Canadian.

The downgrade was issued by Moody’s Corporation, a research and financial firm that provides credit ratings and risk assessments for the global financial market.  Canada’s banking system has been praised for five years as the most fiscally responsible structure in the entire world, but Moody’s believes the banks are vulnerable to record household debts and an overvalued housing market.

However, Canada’s banks are more complicated than most citizens understand.  The five major branches maintain operations in other countries as well – TD and CIBC for example, both have major financial institutions in New York State.  These foreign operations leave the banks, and in turn Canada, vulnerable to risks or crises that occur in these other markets, which many analysts say contributed to Moody’s decision to downgrade.  The ongoing debt solvency problem in Europe is particularly distressing for global financial centres, including Canadian lenders.

If the banks lose money in foreign markets, new money will be raised by charging Canadians higher lending rates or banking fees to keep operations stable in these other markets.  The Bank of Canada could even authorize an increase in the prime rate, which would allow other banks to charge higher rates for mortgages and interest on lines of credit and credit cards.  The country’s interest rates already have nowhere to go but up, and the Bank of Canada has repeatedly cautioned that rates won’t remain near record lows forever.  Any number of risks could justify a rate hike, and thousands of indebted households will be unable to manage their payments if the hike is sooner – and larger – than economists have forecast.

The complexity of the banking system combined with the credit downgrade imposed by Moody’s could cost Canadians more money than they expect.