Canadian Banks In For Possible Ratings Cuts

Canada's banks have been warned of potential ratings cutsCanadian banks are learning they are not immune to the problems plaguing the global financial industry. In a surprise announcement last week, Moody’s Investor Service says it is placing the long-term rating of six Canadian banks on review for a possible downgrade.

The rating agency says the record high levels of consumer debt in Canada and the sky high housing prices are indicating Canadians banks are more vulnerable and could be a downside risk to the Canadian economy.

Which Banks are Affected?

Exposure to the sluggish U.S. economy has put six Canadian banks under possible review by the agency. They are Bank of Montreal, Bank of Nova Scotia, Caisse Centrale Desjardins, CIBC, National Bank of Canada and Toronto-Dominion Bank. Noticeably absent is Royal Bank of Canada – that’s because Moody’s already downgraded its longer term rating by two notches in June of this year.

What is the Purpose of Ratings?

The purpose of Moody’s ratings is to provide investors with a simple system of gradation by which future relative creditworthiness of securities may be gauged. The system of rating securities was developed by John Moody in 1909.

So Why are Canadians Banks Under Scrutiny Now?

Canadians banks survived the financial crisis of 2008 with little damage to their stocks and with no government-funded bailout.  Now, Moody’s says although Canada’s economy is on track for  growth between two per cent and three per cent in 2013, the downside risks have increased.

Along with our reliance on the U.S. economy, which continues to suffer, Canada is also affected by the ongoing crisis in Europe and a slowdown in the emerging markets. All this affected one of Canada’s biggest industries: oil and other natural resources.

 What Would a Downgrade Mean?

If the downgrade came for every bank under review, the effect on the market would be minimal. The worst scenario would be some banks being considered weak while others still strong and benefiting form the stellar Canadian banking reputation. If a downgrade comes to only some of the banks, the stock of those financial intuitions will be affected. If you’re invested in any of the banks under review, it’s in your best interest to watch what Moody’s has to say in the near future.

Are Canadian Banks Still Considered Strong?

Compared to banks in Europe and the U.S., yes. But if the rating agency shows a lot of concern, it could mean Canadian banks may not be held in the highest regard as they have been for the last several years.

 What About Interest Rates?

This news comes on the heels of yet another announcement by the Bank of Canada that rates will remain the same for the foreseeable future. BoC Governor Mark Carney added his all-too-common warning that Canadians should stop taking on too much debt and start dealing with the loans the already have. If the majority of Canadian banks had their long-term rating downgraded, it could tie the Bank’s hand when it comes to lending. On top of this, housing prices have left the banks more vulnerable to downside risks to the Canadian economy than in the past.

Finally here are my five tips for anyone worried about the Canadian Banking system being pummeled by a bad rating.

1. Canadian banks are still considered the strongest in the world

2. Rating agencies in the United States don’t have the best track record; they were the ones that rated junk bonds triple AAA before the housing crisis.

3. Very long-term Canadian banks will do fine; it’s the short-term risk investors should worry about.

4. We are not immune to the financial debt crisis in Europe and sluggish growth in the U.S.

5. We need them, as a country of only 30 million we need the outside world to survive and keep our economy on track.

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