In early October, banks began charging premiums above prime rate for variable-rate mortgages and lines of credit. But, the increases only affected new customers. Existing customers were safe.

Then, a few days later the Bank of Canada lowered rates and Manulife stopped tying it’s popular “One” mortgage to prime. That move affected all of their customers and created a mini-firestorm for their PR department. Angry customers quickly lashed out online.

Now, according to the Globe & Mail, BMO is sending letters to existing customers with lines of credit to tell them their interest rate will be rising by 1%. The increase is due to escalating capital costs says the bank, and reportedly affects customers who got lines of credit before October 15.

Is this a trend? Will other banks follow this move? Craig Fehr, an analyst with Edward Jones, thinks they might.

Fehr says, “I think we’ll see the rest of the competitors follow suit in some fashion…I think this is going to be the first of many product lines that will get repriced.”

National Bank analyst, Robert Sedran, explains why: “Since the banks depend on deposits for much of their funding, if you reduce prime without being able to reduce deposit rates by the same amount, the margin gets squeezed…Increasing the borrower’s spread to prime restores some of that lost profitability. You could see more of that behaviour if interest rates continue to fall.”

With economists expecting the Bank of Canada to cut rates 1/2% on Tuesday, all eyes will be on the banks to see how they’ll react. If the BoC’s key lending rate drops 1/2% but the banks cut prime only 1/4%, it may create quite a ruckus.

Regarding the line of credit rate increases, most lenders are already at prime + 1.00% for new business. Customers who got lines of credit before October 2008, however, are still generally paying prime rate. As a bank, it’s almost a no win situation, with essentially two scenarios: a) Hold rates, thus giving up profits or operating at a loss; or b) Raise rates and risk losing customers to lower-cost competitors.

In this day and age, with bank shareholders so unrelenting and loyalty to lenders so minimal, scenario B is probably the most likely outcome.

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Source of quotes and BMO news: Globe & Mail (Hats off to the Globe for an excellent story)