* Finance Minister Flaherty calls for prudent lending
* Discourages U.S.-style "race to the bottom" by banks
* Banks worried about lending crunch; profits still strong
By Louise Egan
OTTAWA, March 4 (Reuters) - Canadian Finance Minister Jim Flaherty warned the country's banks on Monday not to engage in the kind of risky lending that led to the U.S. housing crisis, after Bank of Montreal cut a popular mortgage rate back to a near-record low.
Record-high household debt, fueled partly by ultra-low borrowing costs, remains a nagging concern for Flaherty even as Canada's once-hot housing market starts to cool.
"As I have said repeatedly before, my expectation is that banks will engage in prudent lending - not the type of 'race to the bottom' practices that led to a mortgage crisis in the United States," Flaherty said in an emailed statement.
The stern words followed an announcement by Bank of Montreal , the country's fourth-largest lender, that it is lowering the rate on its five-year fixed-rate mortgage to 2.99 percent from 3.09 percent. The rate is only for mortgages to be paid back in 25 years or less.
BMO had dropped the rate to 2.99 percent for a period in 2012. Commentators said this was the lowest-ever rate advertised by major Canadian bank for that type of mortgage.
Spurred on by the BMO move, some lenders went even further, bringing mortgage rates down to their lowest on record.
When some markets showed signs of overvalued housing and overbuilding, Flaherty responded by tightening the rules on government-insured mortgages for the fourth time in four years. The government took other administrative steps to cool a market it feared might overheat.
The central bank has kept its benchmark overnight lending target at 1.0 percent since September 2010, although central Bank of Canada chief Mark Carney has been signaling plans to hike rates for the past several months.
Both Carney and Flaherty have warned consumers to watch their debt load and prepare for a return to normal interest rates.
The message appears to be getting through, with data showing household credit is growing at a slower pace. Other data showed home prices fell for the fifth month in a row in January from December and existing home sales declined from a year earlier.
Forecasters in a Reuters poll published last week predicted a soft landing for the housing market.
For their part, the banks have fretted that a period of deleveraging by Canadian consumers would lead to a slowdown in lending.
However, three top banks posted stronger-than-expected quarterly profits last week, relying on other factors to offset the lending crunch.
BMO's core quarterly profit also topped expectations, and the bank reported steady loan growth of 9 percent, although the effect of low rates all but negated that.
BMO said on Monday that its new low rate would help save borrowers money by locking in for five years, a period in which other rates will most likely go up.
"Longer-term rates, such as five-year mortgages, can start moving higher well in advance of any action by the Bank of Canada," said Doug Porter, chief economist at BMO Capital Markets.
Shares of BMO were unchanged at C$64.08 in midday trading.