If my salary goes down, I consume less. If I consume less, the business around the corner sells less and could close. If it closes, the owner of the building no longer collects the rent and may not pay his [prêt hypothécaire]. If the bank no longer collects its [remboursements hypothécaires]to whom is she accountable?
Gilles Burns
This question of the great consumption cycle and its direct and indirect impacts is particularly relevant in the context where recent interest rate hikes can stifle economic activity and contribute to increasing the risk of default.
Banks obviously take risks by lending money, which is desirable for society: institutions must be willing to take certain risks.
There are also mechanisms or safeguards to ensure that bankers make the most informed decisions possible.
Predict losses
A bank forecasts potential defaults periodically in its financial statements and makes provisions for loan losses in advance for all types of loans. She can also decide to reverse the provisions in time if she realizes that there have not been as many defects as she anticipated.
Typically, banks will “overprovision” losses and find themselves in a reversal situation by indicating that things went better than they expected because, for example, the government came to the rescue by helping companies .
You should know that Canadian banks have a reputation for being very cautious. This is how the system manages to hold its own.
The banks are cautious because the government is vigilant. The last thing you want is a destabilization of the financial system, either reputationally or financially (losses).
Caution is also called for because banks have shareholders. The latter hold shares in particular because the dividend paid is constant. Bank managers manage in such a way as to avoid at all costs having to reduce the dividend, which requires prudence in risk management.
Reducing the dividend would undermine the relationship of trust between a banking institution and its shareholders, hence the observable “overfunding” in the industry, one might say.
The manager of a financial institution must report to the risk management committee of the board of directors. The latter is there to ensure prudence and sound management of the organization’s assets. This is where managers ensure that the bank is properly “provisioned”. There are also ongoing conversations with the Office of the Superintendent of Financial Institutions Canada, the Department of Finance, as well as with shareholders to ensure the proper management of operations.
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