The Bank of Canada has issued another sobering reminder that having the strongest economy and soundest financial system in the Group of Seven might not be enough to shield Canada from Europe’s debt problems should the crisis worsen.
Canada’s financial system is more vulnerable than six months ago, the central bank said Monday in a semi-annual review, because of potential fallout from Europe, “severe tensions” in global markets and fears that global trade imbalances won’t be narrowed soon enough for private demand in emerging markets to replace spending by consumers and governments in countries that need to get their balance sheets in order.
Policy makers said Canada’s system continues to function well and has actually strengthened since their last assessment in late 2009. However, they reiterated concerns about household debt Canadians have built up amid historically low borrowing costs, and outlined how Canada’s economy could fall victim to fiscal troubles in advanced nations or asset bubbles in emerging markets, if responses to either led to a sharp drop in bank lending or demand.
“Many aspects of the Canadian macrofinancial environment have improved since last December, with the economic recovery proceeding as expected and conditions in Canada’s financial system generally strengthening,” the central bank’s governing council said in its report. Still, members warned near-term risks to Canada have increased because of “heightened concerns that worldwide fiscal strains have the potential to cause tensions in interbank funding markets, to derail the global economic recovery, or to trigger a disorderly resolution of global imbalances.’’ The level of risk has increased in three of five categories that policy makers look at for their review: funding and liquidity; the so-called imbalances in the global economy that exacerbated the financial crisis of 2008; and the current economic outlook.
Canadian banks’ capital levels – and the quality of what they possess – have improved since December, the central bank said, while risks posed by household balance sheets remain roughly unchanged even as households’ financial vulnerability to economic shocks is growing. The rising debt-to-income ratio among Canadians, which Bank of Canada Governor Mark Carney has warned about for several months, could pose a risk to banks and the economy as a whole, should borrowers default on their loans and force banks to hold back on extending credit.
Measures being taken by European governments to cut deficits must be sufficient to keep investors satisfied that the problems are being addressed, the central bank said, while warning that economic and political constraints could complicate those efforts and lead to another period of severe stress in markets.
Also, sweeping new rules that Group of 20 policy makers are crafting for the financial sector could have unintended consequences or cause challenges for banks as they transition to whatever regime is approved, the central banks said.
The Bank of Canada’s report gives fresh incentive for Prime Minister Stephen Harper to press his case on a range of issues at the Group of 20 leaders’ summit in Toronto this week, since it puts into focus why Canada has a deep interest in ensuring the world comes out of the meeting a little further along a path to sustainable and balanced growth, as well as to global financial rules which force banks to take fewer risks that might harm various economies.
