The flow of credit in the Canadian economy is slowing. This is the effect of much higher interest rates—as engineered by the Bank of Canada—but the other component that could amplify the slowdown is more restrictive bank lending due to their lower risk appetites, concerns about clients’ creditworthiness, and regulatory supervision.
Oxford Economics (OE) says that tightening lending standards often provide warning signs for a recession. With respect to the United States, OE predicts the net percent of banks tightening standards for lending to small firms should hit 60 percent.
“Business investment is sensitive to changes in lending standards and real interest rates. It’s also often the first economic indicator to drop ahead of recession, followed by consumer spending,” said Ryan Sweet, OE’s chief U.S. economist, in an April 14 note.
Fitch bank analyst Mark Narron told The Epoch Times that Canadian banking has not been impacted by the U.S. banking malaise based on anecdotal evidence, but adds that it’s too early to say what’s happening with bank underwriting. Bank earnings season, which doesn’t come until May, will be telling, he added.
While two factors influencing the flow of credit in the economy are the increase in interest rates and changes to lending standards, Narron says the former is primarily creating a demand problem.
“Our view continues to be a slowdown in the economy as a result of the interest rate hikes. What is it going to impact? It’s demand for credit, not supply of credit,” Narron said.
The Bank of Canada noted in its April monetary policy report that consumer spending on big-ticket items is going to take a hit.
Waiting Game
What has manifested so far in Canada is a rise in corporate bond credit spreads—the incremental interest rate above the rate on risk-free Government of Canada bonds that a company has to pay to borrow in the capital markets.
Credit spreads generally widen during periods of uncertainty, as was the case with the U.S. banking turmoil of mid-March. Higher credit spreads feed into reduced investment spending and hiring decisions. They effectively work like another rate hike.
RBC senior economist Josh Nye said the Bank of Canada’s senior loan officer survey, to be released on May 12, will be key to see the extent to which lending conditions have become more restrictive.
“It’s safe to assume we’ll see some further tightening in that regard [fees and spreads], though the extent is uncertain. In any case, we think tightening in Canadian banks’ lending standards will be less than in the U.S. given the latter’s more direct exposure to banking turmoil,” he said in an April 12 note.
