Strong economy helps Canadian banks deal with third-world debt
A booming economy has increased domestic profits for Canadian banks and helped them plan for loan losses to third world countries. The big Canadian chartered banks have been announcing increases for reserves to guard against possible defaults by third world countries. The announcements made in recent weeks cover the period ending July 31. Loan loss reserves for bad third world debt have gone from 15 percent to 35 percent of the amount loaned or higher. The moves followed similar actions by big banks in the United States.
The top five Canadian chartered banks - which do about 84 percent of the banking business in Canada - have all increased their reserves. This has resulted in some fairly heavy losses for the banks: The Royal Bank of Canada is setting aside reserves of C$800 million (US$600 million); the Bank of Montreal, C$753 million; the Bank of Nova Scotia, C$693 million; Toronto-Dominion Bank, C$575 million; and Canadian Imperial Bank of Commerce, C$450 million.
The chief executive officers of at least two banks said the losses would make no difference in dividends. ``Substantially increasing the general provision [for reserves] in no way alters the bank's overall strategic direction or dividend policy,'' said Royal Bank chairman Allan Taylor.
``While this will reduce capital and reserves, the bank's capital base has been continuously strengthened by earnings,'' said Cedric Ritchie, chairman of the Bank of Nova Scotia. ``The provision can therefore be absorbed without impairing the bank's operations or its dividend policy.''
The stock market bought that, as bank shares rose following the announcement. Credit rating agencies such as Moody's in New York have so far not changed their ratings for the big Canadian banks.
One reason is that the losses are tax deductible. ``The banks are taking a bath,'' said opposition member of Parliament Michael Cassidy. ``But close to 50 percent of the cost of this is being taken by the taxpayers.'' Mr. Cassidy, finance critic for the socialist New Democratic Party predicted the banks ``are not going to pay any tax at all for the 1987 tax year.''
The reserves for third world loans have been cushioned by domestic profits. Banks report that profits on mortgages and consumer loans are up. There have also been increased service charges.
``It can be assumed that there must have been a considerable cost to the Canadian economy and to Canadian consumers,'' said a Senate report on third world debt problems published earlier this year. The report cited ``increased charges to bank customers through wider spreads in interest rates and higher service charges.''
The move by the Canadian banks follows similar loan loss provisions in the US. And the Canadian banks are also moving to convert some third world debt into third world equity, by taking positions in foreign companies as a way of taking payment on loans. The Bank of Nova Scotia, for example, will buy a 40 percent stake in Consolidated Bank and Trust Corporation in the Philippines. The Bank of Montreal has said it will convert US$100 million worth of debt in Brazil into shares of Brazilian companies.
Converting debt to equity means a change of the rules which govern Canadian banks, a move already taken in the US by the Federal Reserve Board. ``I would not discourage banks to convert,'' said Michael Mackenzie, the federal superintendent of financial institutions. ``I hope some of it happens.''