Canada's banking watchdog fears that ultra-low interest rates are forcing banks to take undue risks in order to maintain profits.
Julie Dickson relayed her fears in a speech during which she said she wouldn't seek a second term as the head of the Office of the Superintendent of Financial Institutions and will step down from the post next year.
With Bank of Canada Governor Mark Carney set to take the top job at the Bank of England, Ms. Dickson's departure means the country is losing two key figures who are credited with successfully steering it through the financial crisis.
Until then, she is closely watching banks' net interest margins – the difference between the rates at which they borrow and lend money.
With interest rates so low, margins are slim for such products as mortgages and Ms. Dickson is worried this could convince the banks to loosen their lending standards.
Ms. Dickson is also worried about interest rate risk – something every bank is exposed to. At some point, the Bank of Canada will raise its benchmark rate, and she worries the fallout will be "very painful," particularly for banks that have lent to overleveraged consumers.
"The longer the low-interest-rate environment persists, the more interest rate risk can be built up," she said.
The central bank has kept interest rates at 1 per cent or less since early 2009 to help stimulate economic growth. Canadians have taken advantage of the easy money by amassing sky-high debts and stoking fears of a housing bubble by driving up real estate prices.
The Bank of Canada's Mr. Carney touched on the same topic in his final speech on Tuesday. "We cannot grow indefinitely by relying on Canadian households increasing their borrowing relative to income," he said, suggesting that the banks and the Canadian economy must figure out a way to grow without depending on more debt.
Although Ms. Dickson has sounded the alarm about low interest rates before, her past comments pertained to their effects on pension plans and insurance companies. Now she argues that "a sustained low-interest-rate environment, especially combined with a flat yield curve, affects the banking sector as well, largely through squeezing net interest margins, which negatively affects revenues."
Such concerns have long been on the banks' radars. Declining margins were the hot topic during the second-quarter earnings season two years ago, and Tim Hockey, head of Canadian retail banking at Toronto-Dominion Bank, said slimmer profits were resulting "in fighting over the growth opportunities in Canada."
This competition is what worries Ms. Dixon. "This environment can provide incentives for banks to increase their earnings asset base by trying to gain market share, a zero sum game, increase fee income activities, reduce expenses, enter new markets, and by increasing the proportion of higher-yielding assets both in the lending and investment portfolios. Of more concern, products and businesses that are overreliant on low financing costs tend to grow and borrowers are strongly incented to increase leverage."
Banks must also be cautious of interest rates. "No one can predict when, or how fast, rates will start to climb," Ms. Dickson said.
However, they might have some time to come up with a solution to steer them away from any doom. The Bank of Canada is not expected to raise its benchmark interest rate from 1 per cent until late next year or early 2015.
Ms. Dickson's coming departure from OSFI adds her to a growing list of prominent financial sector people who are leaving their posts within the next year. Both Bank of Nova Scotia and Toronto-Dominion Bank will soon get new chief executive officers, and Jim Leech, the head of the Ontario Teachers' Pension Plan, is also retiring.
In Ottawa, Canada Mortgage and Housing Corp. will also get a new CEO in the near future and a new chairman was just named.