It is the banks’ earnings season, when Canada’s major financial institutions report results for their first quarter. Analysts expect the banks to show a major slowdown in mortgage lending, with worse portended for the rest of 2023.
Good. In fact, it should get worse. Much worse.
For the sake of the future of the economy, banks should be weaned off housing and lend more to businesses – and governments and regulators should encourage competition and adjust rules to help make that happen.
First, some numbers. Canadian banks have gorged on mortgages. According to investment firm Keefe, Bruyette & Woods, 44 per cent of the loan book of the average Big Six bank last quarter was real estate secured lending. It ranged from 33 per cent (Bank of Montreal) to 53 per cent (CIBC).
This has the effect of crowding out other types of lending. Only 13 per cent of the assets of chartered banks were business loans, according to Bank of Canada data from December. And small and medium-sized enterprises (SMEs) received a tiny share of that small slice: 12 per cent of business loans in Canada went to SMEs, according to 2020 data from the OECD. The OECD average is 44 per cent.
There is no mystery why mortgage lending is so attractive – it’s safe. Canadians have a reputation for making their mortgage payments, come hell or high water, with less than 0.2 per cent of mortgages in arrears last year. And if homeowners don’t make their payments, no problem. A third of bank mortgages are insured by the Canada Mortgage and Housing Corp., so the government can pick up the tab.
In fact, the government is already picking up the tab in another way: Small businesses turned away from commercial lending are often encouraged to apply for loans at the Business Development Bank of Canada. BDC does valuable work, but as a Crown corporation, it means too much of the risk of supporting entrepreneurs is foisted on taxpayers.
This isn’t necessarily a problem for the banks. But it is a problem for the Canadian economy. Existing real estate is a non-productive asset because it doesn’t create jobs or new innovations. And Canada badly needs to become more productive. Since 2015, we have lagged behind other developed countries in business investment per worker, suggesting less prosperity for workers and corporations in the years to come.
Lack of financing is not the only reason for Canada’s low productivity, but it is an important one. And there are some ways the government and regulators can nudge things along.
Number one will be ensuring the successful launch of Canada’s open-banking regime, which is the term for a system that allows consumers and entrepreneurs more control over their financial data. That in turn makes it easier to switch lenders and use new digital tools, which will encourage the growth of innovative financial-technology companies and boost competition among lenders.
But the open-banking system has been slow to launch. The Liberals’ 2021 platform promised an open-banking system in place by early 2023, a deadline that will not be met as working groups are still designing the system. This should be a priority for the Finance Department to get done this year.
Another idea would be to address interest rates. The top reason small businesses cited for not applying for loans was because interest rates were too high, according to Statistics Canada’s most recent survey on business conditions, with the problem particularly acute for the smallest enterprises. Again, the problem is worse in Canada: Research from the C.D. Howe Institute shows the average interest-rate spread between small and large businesses was 2.48 percentage points here, compared with 1.17 points in Britain and 0.42 points in the United States.
Small businesses are riskier borrowers and so operational costs are higher to assess those loans compared with mortgages. C.D. Howe researchers suggest one way to rebalance that would be if CMHC adjusted its premiums on insured mortgages based on the creditworthiness of the applicants. That would make the costs of assessing mortgage applications more dynamic within the banks, and may encourage a shifting of internal resources to commercial loans.
There are no easy answers. But Canada’s obsession with real estate has been bad for the economy and an unproductive use of capital. Banks are not the cause of the problem, but they have certainly helped it. And now they can play an important role in building a Canadian economy that is about more than just houses.