Retail lending rates still hovering near crisis levels

Bank profits are back to normal, but the cost of borrowing in some cases is stuck in a financial crisis time warp.

Stellar is the word to describe the financial results the banks have been announcing in recent weeks. Royal Bank of Canada had a record first quarter, while Toronto-Dominion Bank joined National Bank of Canada as the first big banks to announce post-crisis dividend increases. That's a sure sign that worries about bank financial stability have dissipated.

"It's been pretty good for the banks here, in the U.S. and abroad," said Queen's University finance professor Louis Gagnon. "The banks have been making an awful lot of money."

Strong stock markets and improving economic conditions have helped, but so have borrowing costs that were raised during the crisis and have either been left untouched or adjusted down only partly. Banks say the costs they incur in raising money to lend out have still not returned to pre-crisis levels, but the fact remains that profits have.

It's all very frustrating for borrowers, but there's hope. Competitive forces are pushing rates lower and the more customers resist paying off-the-rack rates, the more pressure there will be for borrowing costs to fall.

Pre-crisis, you could set up a line of credit secured by your home at the prime rate, which is a key reference rate for consumer lending. As the financial crisis froze up the global financial system, most banks raised the cost of home-equity lines of credit to prime plus one percentage point. The move reflected the higher costs the banks themselves had to pay for money to lend to customers.

Though it's rarely talked about now, the banks found another way to juice their revenues from borrowing. As the Bank of Canada made a big cut in its trendsetting bank rate back in December, 2008, the banks chose not to make the customary identical cut in their prime rates. The central bank slashed the overnight rate by three-quarters of a percentage point, the banks cut their prime by half a point.

Bank of Canada data for the past 10 years indicates the spread between the prime rate and the overnight rate is still higher than average right now. That means all lending products where rates are linked to prime are affected, including lines of credit and variable-rate mortgages.

The increase in line-of-credit rates has generated a large and continuing number of complaints to this column. One in particular asked the question of whether the premiums built into borrowing costs "will become permanent (just like what happened with the income tax)."

The banks insist they're still paying higher costs, so customers are as well.

Toronto-Dominion Bank said it last adjusted its "variance" (spread over the prime rate) for home-equity lines of credit in November, 2009. What about putting things back where they were? "We have no current plans to change the variance on LOC rates," the bank said in an e-mail response to questions. "Generally, our rates are related to cost of funds, which remain at elevated levels."

Bank of Nova Scotia, which last adjusted its rates for home-equity credit lines in mid-2009, noted that its cost of funds has come down but remains at higher levels than were the norm before 2008.

Prof. Gagnon said the banks have fairly described the financial environment they're dealing with right now. "There is still a measure of uncertainty," he said. "There's a bit of a tension, but it's dissipating by the day."

You can see evidence of a return to normal in the pricing of five-year fixed rate mortgages, a popular option right now. Prior to the financial crisis, the average spread between Government of Canada five-year bonds and posted five-year mortgage rates was 2.4 percentage points. The spread today is 2.8 points, down from 3.6 in late 2007.

Same goes with variable-rate mortgages, which pre-crisis could be had with a discount of as much as 0.9 of a percentage point to a full point off prime. The rate surge to prime plus one in 2008, and now has receded to roughly prime minus 0.75 at best.

Prof. Gagnon believes the same competitive pressures that have forced banks to lower mortgage costs will eventually play out in lines of credit. "None of the players have started blinking yet, but it will invariably happen. They all want to grab market share."

How borrowing costs today compare to before and during the financial crisis, which began in 2007 and lasted well into 2009 (all numbers expressed in percentage points).

*Royal Bank of Canada has a home equity line of credit at prime + 0.50 for new clients and says it has not raised the cost above prime for existing clients.

**Average spread between posted rates and five-year Government of Canada bond yields.