This is a note to banks and credit unions in Canada.
We want our umbrellas back!
When I started my banking career back in September of 1987, an elderly gentleman asked me why I got into banking.
I gave him the usual answers; steady income, job stability, recession-proof, and ability to advance my career. The typical stuff of a young, maybe a bit naive, guy just starting his career.
He then asked me, “do you know what banks are good for?”
Not sure where he was going with this, I replied, “no, what?”
He said, “when it's sunny outside, banks run around and give everybody an umbrella, but when it starts to rain, they come knocking on your door to ask for the umbrella back.”
I didn’t really understand what he meant until I was a few years into my career. And, I’m having to talk about this now because we’re all having to endure a banking system where our umbrella has been taken away.
The Two Umbrellas
We’ve lost two umbrellas in the last eight years.
Before we get into when these events happened, let’s do a quick overview of how banks make their money (remember, they are here to make a profit after all).
Banks make their money on the spread—difference—between the interest rates they charge people and the interest rates they pay people, i.e. The Bank of Canada. The larger the spread, the great the profit. Of course, there are other ways of making money in the banking system, but this is a primary driver.
The easiest way to look at the spread differential is looking at a 5-year fixed rate mortgage versus what the bank is paying on a 5-year fixed Guaranteed Investment Certificate (GIC).
For example, the bank is charging the borrower (homeowner) 5.69% and paying the investor of the GIC 4% for the same 5-year term. Their spread would be 5.69% - 4% for 1.69%.
There are other factors, but the concept is the same.
For variable rate mortgages, it would be the difference that the bank pays the Bank of Canada (BoC) versus what the borrower is being charged.
Our first umbrella was taken away in January 2015, when the Bank of Canada reduced prime by 0.25% on January 20.
On January 28, the banks only shared 0.15% with their customer base, so they didn’t share the full savings of the rate drop. Meaning they kept .10% of the spread for profit.
The perspective was that the margins were so low at the time, they just couldn’t pass along the savings.
Our second umbrella was taken away from us in July 2015. The Bank of Canada, again, dropped prime by another 0.25% on July 14.
On July 24, the banks reduced their prime rate to their customer base by 0.15%, keeping the 0.10% again, using the excuse that margins were so narrow that they needed to keep this difference.
Now, as a former banker, I can understand the logic of keeping a higher spread. It makes sense to me due to the margins being pinched.
Having said that, this isn’t the case today.
The Prime rate—the rate being charged by Banks and Credit Unions charges their consumers—is set at 5.45%, with another increase of 0.50% that took effect on October 26, 2022. This increase is going to push up Prime to 5.95%.
However, the banks are lending with each other at 3.25%, to 3.75% after October 26.
Something to note is that the drops in Prime took 8 – 10 days before the banks passed along the savings to Canadians. Conversely, when Prime has been trending up, all the banks and credit unions reacted within 24 hours, with no week delay on the way up.
“When it's sunny outside, banks run around and give everybody an umbrella, but when it starts to rain, they come knocking on your door to ask for the umbrella back.”
Why This Is Important
The reason this is important to all of us Canadians is that nearly all of us have products that are tied to the Prime rate, and we have all been negatively affected.
If you have a variable rate mortgage, Home Equity Lines of Credit (HELOC) or unsecured lines of credit, interest costs for all these products have gone up.
This cuts directly into your monthly cash flow.
Let’s go through an example.
Mortgage Balance | $400,000 |
Amortization | 25 Years |
Prime Rate (after Oct 26) | 5.95% |
Variable Rate (Prime - 0.90%) | 5.05% |
Monthly Payment | $2,337.82 |
Interest Paid Over 5 Years | $94,576.71 |
If you have a $400,000 mortgage outstanding balance, 25-year amortization, the Prime you are being charged once prime goes up by 0.75%, prime becomes 6.20%, and your variable rate mortgage is 5.30% (Prime - 0.90%).
If the Banks and Credit Unions gave us our umbrella back, the 0.20%, how would that affect your payment? (Assuming all other factors remain the same.)
Mortgage Balance | $400,000 |
Amortization | 25 Years |
Prime Rate (after Oct 26) | 5.75% |
Variable Rate (Prime - 0.90%) | 4.85% |
Monthly Payment | $2,292.38 |
Interest Paid Over 5 Years | $90,732.75 |
The impact to you is the combination of monthly cash savings and interest over the five-year period.
You would be saying $45.44 per month. At 60 months, that’s a total savings of $2,726.40.
The interest savings to you over this period is $3,8844 for a combined savings of $6,579.40.
This is equivalent to monthly savings over the 60 months of $109.66.
Now if you have an unsecured line of credit with a balance outstanding of $20,000, usually priced at Prime plus 3%, your borrow rate is 8.45%, going to be 9.20% after October 26.
The impact isn’t as great from an interest cost perspective over the course of the year, but these products usually have an interest-only payment or a 2% balance payment depending on the lender.
This in effect bumps your monthly payment charge or extends the time to payout the product.
It’s Time For Our Umbrellas Back
Given the current economic climate—especially given the potential for a government-induced recession—on behalf of all Canadians, I’m asking for the banks and credit unions of our country to give us our umbrellas back.
And I believe I shouldn't be the only one.
I believe every single Canadian who has a variable rate mortgage or unsecured line of credit to demand that 20 basis points (0.20%) because the spreads are no longer the difference between 1.25% and 2.85%.
The spreads are now at 5.45% to 6.2%, and the product rates they're paying us are 4% or less. So they're back up to normal returns of spreads.
And in today's environment, with inflation the way it is and people's costs soaring out of control, our Canadian financial institutions, in good faith should just give us what they took away.
But my experience over the years of being in the banks is that they're not going to. So we have to go ask for it.
If you'd like to call me and discuss this further, I'd love to have that conversation with you.
And if necessary, I would be more than happy to do a financial analysis of your current situation to see if there's any way we could help you manage your cash flow or put you into a better position so we can drop your overall cash outflow and maintain your standard of living.