Flaherty Suggests Banks Self-Regulate More

Banks need to control their own lending and not rely on the government to do it for them.

Jim-FlahertyThat’s essentially what Finance Minister Jim Flaherty told Bloomberg News yesterday.

The primary responsibility for prudence in lending practices rests with the financial institutions,” he said.

Just as importantly, individuals “need to take responsibility for what they do and exercise common sense in terms of taking on debt.”

It’s refreshing that sensibility is making headlines in Canada’s often emotional debt debate.

Banks are completely capable of underwriting prudently on their own. Moreover, banks by nature fear defaults. Mortgage defaults occur in plain view. They can’t be hidden and they are untolerated in Canada’s highly scrutinized and regulated mortgage market.

Imagine what would happen if, for example, BMO’s mortgage arrears were double other banks (e.g.  0.90% vs. the 0.45% industry average). There’d be investor outrage, a huge hit to BMO’s market cap, and major heat from regulators. It makes absolutely no difference if these defaults are insured or not; the government and investors demand that banks lend wisely.

Flaherty’s stance contrasts noticeably with the hopes of CEOs like TD’s Ed Clark, who advocates more government rule making in the mortgage market.

Flaherty told Bloomberg: “Banks are responsible for their own business practices and what I find odd from time to time is when a bank executive asks me to tighten lending rules.

Market Share - Words on Pie Chart GraphMany find it just as odd that big bankers don’t want to do the right thing unless all the banks do it at once! Although, from the standpoint of preserving market share that’s understandable.

It seems to me that’s the primary responsibility of the financial institutions and not the government,” says Flaherty.

Here’s more from Jim Flaherty on the potential for new mortgage restrictions in 2011:

  • We continue to watch carefully.”
  • We have a regulatory role and if we need to tighten the rules because the banks don’t — and it is necessary to do so — we would.
  • A lot of this demand is because of very low interest rates, so it’s not surprising that some people are taking advantage of that.”
  • “…people have bought more expensive houses than they need to have because they could afford to, because interest rates are low.”
  • Part of it is rational in the sense that people can carry more debt when interest rates are very low.”
  • Our concern is at the moment as interest rates go up—which they inevitably will—we want people to be able to afford their obligations.”
  • We want to encourage thrift. We want to encourage people in the residential mortgage world to not buy more house than they can afford.
  • Flaherty says he’s also concerned about “the home-equity loan market, which has grown significantly.”
  • If we go back a generation, I think most of our parents viewed the house as something to be paid off. It was the first way that they built up equity. I think it would be preferable if we did more of that and less of buying as much house as one can possibly afford based on how much the bank will lend a person.”
  • I find it just strange that I get some of the financial institutions telling me to mind my own business on regulatory matters — and then we have some worries about the level of consumer debt, and the banks are saying the government needs to move in and tighten standards.”

New-Mortgage-Qualification-RulesFlaherty won’t say whether any rule changes will be made in 2011, but he said he’ll carefully evaluate the economic implications. The most serious of these implications would be harmful effects on employment and job creation.

Our sense is that it’s better than 50/50 that some kind of rule changes are coming. There’s major political pressure out there. At the least, this might prompt token rule changes if nothing else.

On the other hand, patience is prudence when tinkering with a $1 trillion mortgage market. International Monetary Fund (IMF) Canadian Analyst, Charles Kramer, says: “At this point, the appropriate thing to do is wait and see how the credit cycle matures.” But he says we need to keep ready to curtail mortgage lending “a bit more if it doesn’t decelerate.”

It’s important to remember that rising rates will crimp affordability. That in turn will self-moderate housing and borrowing, and this will all happen without any government intervention whatsoever.

The concern is that adding new rules on top of a natural cyclical correction could cool housing too much. Kramer makes a judicious point about waiting (perhaps 2-4 quarters) before dishing out new lending restrictions.



Sources: Bloomberg, Toronto Sun, Vancouver Sun, Financial Post


Rob McLister, CMT


  1. self regulation does not work. it was lack of public regulation that brought us into our worst recession since the great depression.
    banks need to be regulated by democratically elected governments, rather, then those self interested _____ who sit at the top making handsome profits off of working people
    [Edited. Kindly refrain from derogatory comments. Further such posts will be deleted in whole without notice. Thanks for your understanding.]

  2. In defense of the bankers, if you’re the CEO of the only bank in the country that’s not taking certain risks that are currently making big profits you won’t last long. Losing market share is one thing but being less profitable than your competition brings rapid change.
    The other problem with this is commonly seen in investing; if a big risk comes due but you were just copying everyone else you can claim “no one knew this would happen”, and sometimes it actually works.
    Leaving aside what anyone may think of current rules, if 4 out of 5 major banks are doing something that’s too risky the 5th one may know better but they get the best outcome (for the executives) by following the others.

  3. You got it Richard. There’s safety in packs.
    Mind you, TD can still go with the flow to an extent, while simultaneously being more selective with approvals. That is fully within their power regardless of government guidelines.
    Nonetheless, your comment on their motivation remains largely dead on.

  4. I disagree. Its just politics. Flaherty knows the banks don’t control their marginal lending criteria when there’s CMHC insurance.
    Put yourself in the banker’s shoes. You are told that riskier mortgages are insured. Wouldn’t you lend every penny you have following the CMHC’s guideline? It’s naive to expect otherwise. If you don’t lend, somebody else will — for a risk-free profit.
    I do agree with you and Kramer that it’s probably too late to implement restrictions. You’re supposed to be conservative before a bubble is built — not after. Restrictions now could be the catalyst that pops the bubble.
    That of course assumes we’re in a bubble, which I, a nameless comment-writer, firmly believe.

  5. Hi Former,
    Thanks for the note. Totally agree that banks take more risk and lend at lower interest rates because they can rely on insurance. (Which is part of the purpose of government-backed default insurance.)
    I also agree with you and Richard that banks are motivated to maximize profitable lending. The keyword is profitable.
    The question is, how much more risk do they take with default insurers behind them? Based on the only objective statistics we have, the answer is, not much.
    We have to remember, there are capital costs, expenses, opportunity costs, and shareholder risks involved with writing bad mortgages. Insurance does not compensate lenders for these things. Depending on the extent of it, bad underwriting can cost more in the end than it’s worth. We did a CMHC piece that discussed this a while back.

  6. The question is, how much more risk do they take with default insurers behind them?
    ZERO more risk! Underwriting standards are the same for insured verses non-insured conventional mortgages. The regulators and the banks board of directors would never accept it or anything that contravenes the Bank or C.U. Act.
    As for the reason Bank executives act in packs, it is simply because if a loan portfolio is off the charts, there’s a lot of explaining to do to the board, shareholders, regulators and board committees. Bankers never take risks that can’t be easily quantified!

  7. Flaherty obviously has a short memory. We only have to look south to see what happens when the banks decide what is risky & what is not. CMHC & Genworth are now having a hangover from when they insured mortgages up to 100% LTV. Default rates are up right now. Canadian’s will buy as much as they can & borrow as much as they can. The banks are more then willing to lend as much as they can. Banks are in the business of lending money. Flaherty is talking about the fox guarding the hen house. There has to be a balance between capitalism & government control. If Flaherty is concern about Canadian debt he should look at the worse of them all credit cards fallowed by HELOC & refinancing.

  8. > what I find odd from time to time is when a bank executive asks me to tighten lending rules.
    Banks are responsible but as has already been mentioned, they need to be responsible together which is why some banks are asking for government intervention. Not rocket science IMHO.

  9. We all know what self regulation means, it means going through the economic nightmare we all have been going through for the last 2 years. Self regulation means the 2nd coming of the great depression.
    Banks cannot self-regulate themselves, just like alcoholics cannot self regulate themselves, and both need strong government oversight – because the public interest is at stake.

  10. Good to see the finance Minister being proactive and passing the buck. Now if anything happens he can just say that it wasn’t his job to control bank lending. He’s a step ahead. Kick the can down the road…

  11. Nice try, Dim Jim.
    You can’t be all rah-rah with press releases and political grand-standing when you loosen the CMHC rules, and then pretend that you’re not in charge when the industry calls on you to correct some of your decisions.
    Also — Flaherty still refers to his decision-making/leadership in tightening the regulations in April… so why is it different this time?

  12. Flaherty is a hypocrite, he had no problem loosening the lending rules creating 35 and 40 year mortgages when it was clear that the market was peaking and he needed a way to keep the market hot and prevent it from finding it’s natural price level. Now he says it’s not his job to cool things off ? No wonder Garth Turner goes after him with a vengence, he’s full of contradictions.
    People and banks can not control themselves when money has never been available like this in history. It’s already too late anyhow,too many people are maxed out and it takes only a small percentage to crash a market.
    As per the credit card counsellors on CTV last week, they have seen the effects of this cheap money 3 years ago with most people coming in with 5 and 6 credit cards maxed out on top of a mortgage.
    Enough bombs already have the fuse lit, just a matter of time,like in a few months when the next flood of listings hit the market.
    Please spare me the replies about “working hard” etc, I have all my life based on responsible borrowing and budgeting and I know this market is on the cusp of a major hit and Flaherty knows it’s too late to do anything about it, thus blame the banks.

  13. Wages drive house values, credit and emotion drive prices.
    Its a bubble people waiting to implode. Take a look at prices to income ratios or prices to rental returns. Why cant people see the obvious.

  14. There are few parallels between the American and Canadian housing risk besides debt levels and housing prices. The US market crashed for reasons that don’t exist here. I think almost everyone knows that so it’s silly to try and scare people with US comparisons.
    To your second point, default rates are not up in any meaningful way. Where did you hear that?
    I do agree that unsecured credit card debt is a far worse hazard than mortgages.

  15. It’s different because you have to draw the line somewhere. If the government kills affordability with more rules, the housing, and potentially the economy, will come crashing down. That benefits nobody. Like Rob said, I fully believe rising rates on their own will cool the market.

  16. You can’t call a bubble in advance. They said Google stock was a bubble at $300 a share. It was “obvious” at the time. Now it’s at $600.

  17. what about pet.com? Try giving some balance to your observations. It’s a hard sell to compare a house to Google. A house doubling in price and a company like Google doubling in price is very different. Google actually did something to result in the stock doubling, what has your house done for you to double in price?

  18. The price of a house and the price of Google are not so different. They’re both based on supply and demand. If demand is there and supply is limited, prices will increase in either case. One person’s opinion of value is inconsequential if market forces are contradictory. Home prices have always had highs and lows and always will. Just because we’re at a high doesn’t mean it’s a bubble. Prices can easily correct naturally without any catastrophe.

  19. Google has 320M shares outstanding… not exactly a supply/demand argument there.
    However, one could look at the fundamentals:
    Google is currently priced with a 24-to-1 P/E ratio. This is about the same as Yahoo’s or Oracle’s P/E.
    So, assuming that a company like Google will be valued at 24x its earnings, the earnings would need to double for the stock price to double.
    With a house, the “earnings” are based on the rent you could charge for that home: rents have stayed flat relative to incomes, but house prices have skyrocketed… hence the “bubble” label tied to today’s housing market – especially in Vancouver and parts of Toronto.

  20. You are right if you actually have equity in your house. It’s a lot like going to the casino. If you have lots of money and you lose some no big deal, but if you’re playing with money you don’t have you’re screwed.

  21. The bubble controversy is way overplayed. There are only 5-10 markets out of 100s across the country that are overextended. Note that when the last supposed “bubble” burst in 1989 home prices fell 25% in Toronto. In some areas prices fell 30-40%. Wads of people had put down only 10%. That means negative equity of 15-30%. Yet, life moved on and people kept paying their mortgages.

  22. Is this guy OK? or is he smoking something he shouldn’t?
    Har Har Har!! I couldn’t get over this for hours! Do we ever learn? Isn’t this like recruiting a bunch of thieves into The Neighborhood Watch program?…….. Hey Mr. Flaherty if I remember correctly we elected you to err…. “regulate”….. slacking off on your job now, are ya?

  23. Jim Flaherty is not blaming banks. He’s just saying that government’s role is not to restrict mortgage choices for the majority of responsible Canadians. Lenders have incentives to be cautious and can restrict lending themselves. Also remember that it is a very small minority that are at risk. In other words, very few people would not pay their mortgage if rates went up 2-3 pct. This has been proven time and again by the research.

Your email address will not be published. Required fields are marked *