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Central bank poised to boost lending

TORONTO and OTTAWA -- The Bank of Canada is planning a safety net for money market mutual funds and the Finance Department is moving toward guaranteeing loans between banks as Canadian policy makers develop a broader range of measures to support the financial system.

The central bank yesterday laid out a package of plans to increase the amount of cash available to lenders, including boosting today's purchase from the banks of securities to $10-billion from $4-billion.

The Bank of Canada also broadened the list of participants in such actions, which are normally reserved for a select group of financial institutions such as the big banks, to include "other money market participants" that sources said will likely include pension funds and mutual funds.

The moves are part of Canada's commitment to the Group of Seven nations' efforts to flood the market with extra cash to loosen credit conditions. The goal is to restore lending, which has frozen up throughout the financial system, while staving off further crises.

The situation in Canada isn't as grave as in the United States, which has already set out a plan to backstop money market funds.

But sources said the central bank wants to be ready should Canadian money market funds or pension funds need to raise money in a hurry.

The plan, to be set out Friday, would allow mutual funds and pension funds that hold short-term assets such as commercial paper to turn to the Bank of Canada for cash should the markets for those assets disappear.

"You have a mechanism that for all we know probably won't be used," said Michael Gregory, senior economist at BMO Nesbitt Burns. "That's like a lot of the things that Canada is going to be doing - shoring up what perhaps doesn't need to be shored up, but [doing it] for the sake of a global response to a global problem."

The moves come at the same time as the government considers guaranteeing short-term debts of Canadian banks, and perhaps raising the upper limit for the guarantee on customer deposits from its current level of $100,000. Finance Minister Jim Flaherty this week signalled that a move on debt guarantees is in the offing, and many in the market expect an announcement soon to keep Canada in line with other countries such as Germany, Britain and the United States.

"Canadian banks are still standing head and shoulders above others in terms of solvency and those kinds of issues, but the fact of the matter is you can't have one jurisdiction just standing by while everybody else's jurisdiction does things that are for the benefit of their financial institutions," said Nancy Hughes Anthony, head of the Canadian Bankers Association.

However, any federal government action is likely to be complicated by this week's election. For example, raising the deposit guarantee would normally require approval from Parliament, which has been dissolved. As a result, there are discussions taking place about finding another way, one source said.

Canadian banks aren't at any serious risk of defaulting on debts, but they risk losing access to credit markets that will favour institutions in countries that have guaranteed bank debts.

The issue is similar when it comes to deposit insurance, with a fear that customers will transfer funds to banks in the U.S. where the guarantee has been raised.

"I think Canada should look closely to what others are doing and not allow much of a gap to show between our measures and theirs," said former federal finance minister John Manley, who is also a director of Canadian Imperial Bank of Commerce.

"You can't have Canadian banks having to access capital at significantly higher rates than foreign banks and still hope to see the Canadian economy have access to the credit it needs."

In a panic, the soundness of Canada's banks would become moot, said Ian Lee, the director of the MBA program at Carleton University's business school and a former banker.

Prof. Lee said that if he was in his old job as a loan manager, he would be worried about losing small-business clients to U.S. banks because it's relatively easy to cross the border and set up an account.

"The government is going to be boxed in to providing some kind of assistance in light of the plans launched in the U.K. and the U.S.," Prof. Lee said.

Analysts insist the costs of these moves to the Canadian government will likely be minimal.

"If the banks are as safe as everyone says they are, then it's not going to make a huge amount of difference to the government's finances," said David Laidler, a professor emeritus of economics at the University of Western Ontario and a former Bank of Canada adviser.

The plans already in place around the globe are already beginning to thaw credit markets.

© 2007 The Globe and Mail. All rights reserved.

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