David Macdonald appeared as an expert witness before the federal Finance Committee June 18, to discuss banking and the government's response to COVID-19. This is a copy of his prepared remarks.
Thank you Mr. Chair and I’d like to thank the Committee for their invitation to speak to you today.
The banking sector in Canada occupies a privileged position within the Canadian economy. The concentrated sector contains few competitors and little outside competition. Its central role in providing credit to businesses and households means that extraordinary tools are deployed to ensure that credit continues to flow. The protected nature of the Canadian banking sector has led to extraordinary profits to its shareholders and tremendous bonuses being paid to its executives. However, in a time of great need for many Canadians, it is time for more to be asked of this sector—not only for the good of Canadians but also the good of our economy.
It’s worth taking stock of the approximately $750 billion promised in support for the banks. By my count $679 billion of this amount has been deployed. The reduction in the banks’ domestic stability buffer has provided them with an extra $300 billion. The Bank of Canada was initially scheduled to spend $300 billion, although its balance sheet has now expanded to $373 billion as of last Wednesday. Almost half of that expansion is due to the increase in its repurchase agreements. On the other hand, the mortgage purchase program at CMHC has managed to buy almost no mortgages, spending only $6 billion of its $150 billion budget with the last two purchases buying essentially no mortgages. This is almost the opposite of the utilization during the great recession where the IMPP (Insured Mortgage Purchase Program) was much more important.
In any event, these interventions alone benefited the banks either directly in that they were the counterparties to the transactions, or indirectly in supporting the prices of assets the banks own. Showing the federal government has the banks’ back no doubt further ingrains in shareholders an implicit understanding that Canadian banks are too big to fail with the resulting pricing in of that guarantee in both bank borrowing costs and stock valuations.
The lowering of the domestic stability buffer from 2.25% to only 1% of risk weighted could free up as much as $300 billion in assets for other purposes. OSFI (the Office of the Superintendent of Financial Institutions) would prefer if those purposes were to provide further loans to businesses or households. However, this assumes that the banks can find households and businesses who are both credit worthy and are willing to take on another $300 billion in debt in the middle of the worst labour market since 1936. For context, if all this was loaned out as mortgages it would increase residential mortgage debt by 25%. That $300 billion could be used for other purposes, much less desirable than lending as within these large organizations money is fungible. For instance, it could be used to pay out shareholders and executives or it could be used to cover loan losses.
Thankfully, OSFI has explicitly barred banks from continuing with any existing share-buyback programs. Their position on both dividend payments and executive bonuses is much more permissive. These payments cannot be increased, but they can be maintained. Interestingly Royal Bank, TD and CIBC had already announced their annual dividend increases prior to the new OSFI rules, meaning that they will be allowed to increase their payout to shareholders despite these rules. Bad timing has meant that the Bank of Nova Scotia and Bank of Montreal are the only ones who won’t be able to increase their dividends in 2020. In the first quarter of 2020, the banks paid out $5 billion in dividends and the are on track to pay out $22 billion to shareholders throughout the year. In other words, 7% to 10% of the gain from the change in the stability buffer could still be paid out to shareholders despite the OSFI rules as they stand today.
Also, senior executives will not be able to increase their total pay above where it stood in previous years. Given ever-increasing executive pay in Canada, this is hardly a stringent restriction. In fact, in 2018 the top executives at Canada’s big banks raked in $173 million in bonuses across only 31 people. If this is the pay bar they have to fit under given extraordinary government support for the sector, it likely won’t cause them any difficulty.
I would recommend that this Committee examine other international approaches like those in the EU and the UK, and suspend bank dividends and executive bonuses for the period of extraordinary government interventions.
A Bank of Canada study released earlier this month supported the government’s move to encourage banks to provide 6month deferrals on mortgages. It found that the deferral of mortgages is an important way to keep Canadians who’ve temporarily lost work in their homes and reduce the likelihood of a downward spiral of lost housing and net worth through a rushed sale. With 14% of all mortgage now in deferral, this has been a lifeline to the 4.8 million Canadians who’ve lost their jobs or hours since February.
Banks are better off if borrowers repay loans rather than having to foreclose on their assets. It is worth mentioning that this deferral program is made much cheaper through OSFI’s allowing banks not to have to increase their capital requirement due to non-performing loans, potentially a very substantial cost for banks given that between 12% (TD) to 18% (RBC) of mortgage loans are presently in deferral depending on the bank.
I’d encourage this Committee to get more value from this OSFI rule change in favour of everyday Canadians who’ve lost their jobs. In particular I’d encourage the Committee to require banks not charge interest and other penalties over the deferral period on mortgages, but also on higher interest products like credit cards and lines of credit. I’d also suggest that even though the percentage of mortgages in deferral will likely decrease by September, it certainly won’t be zero. I’d recommend the Committee consider extending the deferral period until the end of 2020. Furthermore, many Canadians simply won’t get their jobs back by then and will be forced to sell their houses. Mortgages, particularly fixed rates ones, carry substantial penalties for early repayment. The committee should consider limiting or eliminating these pre-payment penalties allowing Canadians to more easily get out of houses they can no longer afford.