Variable Rates Might Not Follow Prime

If you have a variable rate mortgage you won't like the sound of this.

TD says there's a chance the big banks may not lower their prime rates the next time the Bank of Canada (BoC) lowers the overnight rate.

The reason is that banks' cost of borrowing has increased considerably thanks to the subprime crisis.  Banks are looking for any way possible to preserve profit margins.  Keeping prime rate at 6.00% would add a juicy 1/4% to their rate spreads (assuming the BoC lowered rates 1/4%).

While not unprecedented, this would certainly be an unusual scenario.  For almost 10 years, banks have lowered their prime rates every time the BoC has lowered its overnight rate.  The prime-BoC spread has been a steady 1.75% the whole time.

The underlying problem is that prime rate determines 65% of all business and consumer interest rates, either directly or indirectly.  Unless the banks lower their prime rates, the Bank of Canada's own rate cut would have much less power to stimulate our economy.

Many are upset by this prospect, and some have even accused the banks of colluding to set rates.

In reality, though, the chance of banks defying the Bank of Canada are rather small.  Banks don't want to threaten their relationship with the BoC...or lose business if competitors break ranks and match the BoC's rate cut. 

Indeed, the chances of banks flouting the BoC are greatest if their cost of borrowing increases further before the BoC's next meeting.  Most likely, however, banks will make do with lowering prime but keeping their discounts off prime stingy.

The Bank of Canada meets next on January 22, and is expected to cut rates 1/4%.

Comments

[Traciatim]

Nothing like making up for their mistakes by sticking it to Mr Joe Median. You didn't think the banks would cover their own mistakes did you?

I'm thinking that TD, who has declared several times that their exposure is either incredibly low or non-existent, will lower their rate anyway. If one bank does, the others will have to fall in line or lose business.

This time last year I couldn't have cared less what the economy and the banking system was doing. After a year of watching what's going on, I realized maybe it's best just to ignore it. The USA released that inflation was over 4% yet are still cutting rates, we're following suit. If they keep going this route I'll be paying $154 for my tea in the morning instead of $1.54.

[Al R]

I'd be really surprised if the banks went this route, especially since their cost of borrowing has gone down in recent weeks, and they'd get absolutely crucified in the court of public opinion.

Bad idea - especially when they're still holding out hope that the federal government will allow mergers sometime in the future.

At least that's what I hope, since I have a vested interest in prime dropping. ;-)

[Michael_S]

What? The bbbBillions in yearly profit isn't enough? Give me a break. It's collusion, it's price gouging, it's whatever you want to call it.
It's a scam by the richest players in town.

[Stephen]

If the comercial banks allow to seek their profit interest, then it will defeat the purpose of BoC stimulate efforts. In fact, there is nothing to be stimulated if comercial banks not match the lowering.

If there ever happens, the BoC will need to find another channels to get this lower rate out to regular Canadian.

As for the comercial bank, I will be the first to take business else where: Mortgage, Saving and Investment - all together.