How Stable are Canadian Banks?

With Canadian banks being praised throughout the world for their stability and soundness in the face of a worldwide financial crisis, it might seem churlish to raise pointed questions about their health. Yet there are a few questions that I think at least need to be considered.

The question of the health of the banking sector first arose for me with the Harper government's Extraordinary Financing Framework introduced in the January budget. This initiative has earmarked $200-billion largely for the purchase of bank assets. This is an astronomical sum even if, as the government claims, the assets purchased will be performing assets and that there will be no cost (it is thus not a fiscal matter) and perhaps even a profit.

The question this raises for me is why, if the banks are so healthy, do they need this amount of backing, particularly at a time when they do not seem particularly anxious to lend? Could it be that their balance sheets include assets whose value is at risk or uncertain? And is the government set to purchase (or have they already purchased) assets that might be a good deal less stellar than we have been led to believe?

In his column today in the Globe and Mail, Jim Stanford, economist for the CAW, strongly suggested that balance sheets are less than they seem, stating:

Believe me, if Canada's banks were truly stable, Ottawa wouldn't have pumped $200-billion into the system.

In another column in today's Globe, Fabrice Taylor reminded readers that whatever press the banks are getting, markets aren't buying it, as reflected in share prices. So what is on those balance sheets? And surely more important, how are they being valued?

It turns out that last October the accounting rules for banks were substantially altered by the Canada Accounting Standards Board. These changes allowed banks to reclassify many investments to which fair value or mark-to-market accounting rules had applied. And these changes were backdated to July 1, 2008, to allow their effects to be reflected in the fourth quarter earnings which now look so favorable.

What does this mean? It means that assets for which there is little or no market (many of which have been termed "toxic assets") can now be re-evaluated or removed from balance sheets, making the banks appear healthier than they really are. As Hugh Anderson of the Financial Post noted last fall,

It's quite possible that such reclassifications will enable banks to report substantial net income boosts from reversing previous writedowns. Simultaneously, assets off the balance sheets will grow.

So I have two questions. First, to what extent are these changes reflected in the banks surprisingly rosy outlook? And second, what is our government buying with its $200-billion?