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IMFSurvey Magazine: Policy

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A man walks past a bank in Toronto, Canada: the country’s six largest banks dominate the financial sector (photo: Mark Blinch/Reuters)

A man walks past a bank in Toronto, Canada: the country’s six largest banks dominate the financial sector (photo: Mark Blinch/Reuters)

FINANCIAL SECTOR ASSESSMENT PROGRAM

Canadian Banks Safe and Sound, Housing Poses Risks

IMF Survey

February 3, 2014

  • Six banks dominate with 93% of total assets
  • Stress tests show banks are resilient, well capitalized
  • Single body needed for ‘bird’s eye view’ of financial risks

If Canada’s banking system were a person, a suitor could introduce it to their parents: stable, resilient, prudently regulated, and rich. Similar to other advanced economy commodity-exporting countries, Canadian banks have been among the most profitable since 2008.

The country’s housing market is a potential risk to financial stability; but the country’s government backed mortgage insurance scheme would cushion any initial blow dealt by a crisis, according to the IMF’s latest assessment of the country’s financial sector.

The report says the household debt-to income ratio has surged in recent years, in large part related to high house prices in some areas, and this makes the economy more vulnerable in the event of a shock. Mortgages and consumer loans secured by real estate represent the single largest asset group for Canadian banks. One third of all non-performing loans are mortgages.

The IMF also released its annual check-up of Canada’s economy, which is expected to grow 2¼ percent in 2014.

Reduce risk to taxpayers

The government has taken steps to impose limits on government-backed mortgage insurance, and the IMF said the government could do more to limit the risk to taxpayers. Two measures in particular would help:

• Give the main financial supervisor full regulatory authority over the government’s housing mortgage insurance body

• Provide common guidelines for mortgage insurance

Six federally-regulated banks hold 93 percent of bank assets—a relatively high concentration in comparison to countries such as the United Kingdom.

The federal authorities regulate the majority of the financial sector, though a significant segment comes under provincial regulations. The IMF said the framework for regulation and oversight is current with international standards, and is well coordinated across the different federal oversight bodies. But Canada lacks a single regulator to keep an eye on risks to the financial system as a whole.

“The Canadian financial system has performed remarkably well over the years. This reflects a combination of a conservative approach to banking, effective regulation and supervision by a regulator which keeps close to its market, and good coordination between the federal authorities. Our recommendations aim at ‘future-proofing’ the system, rather than suggesting any fundamental changes. One of the gaps that we identify is that no entity or forum has the mandate or membership that can allow for a complete, bird’s eye view of the system to cover all institutions and markets across the federal and provincial remit,” said Aditya Narain, an assistant director in the IMF’s Monetary and Capital Markets Department and head of the team that conducted the assessment.

Main risks

Canada’s financial sector is large and dominated by a few players. The country’s financial system has assets worth five times the size of Canada’s GDP.

Other potential risks identified by the IMF include:

• Weaker growth in emerging markets could lead to lower commodity prices

• Financial stress in Europe could lead to higher bank funding coasts and a decline in bank earnings

• A disorderly end to unconventional central bank policies in the United States could mean losses on bond portfolios

Canada is one of the major 25 financial centers that must undergo a regular review of its financial health as part of the IMF’s surveillance. The global economic crisis laid bare the devastating economic consequences a financial crisis in one country can have on the global economy. Since 2010 countries with financial sectors that have the greatest impact on global financial stability have been required to undergo in-depth reviews of their financial health every five years.

Key reforms

In its assessment of the financial system, the IMF recommended the government enact a series of reforms, including the following:

• Collect more data on a regular basis from the financial sector to help regulators spot trouble on the horizon

• Include big deposit takers regulated at the federal and provincial level in a regular, common stress testing exercise and increase federal-provincial coordination on crisis management plans

• Fix shortcomings in identifying risks and enforcement in securities regulation

• Provide a clear mandate to a single entity to take a bird’s eye view of the risks to the overall financial system

Canada’s last financial assessment was in 2008. The IMF said the authorities have taken steps since then to address its earlier recommendations. In the coming years the government should gradually reduce its role in providing mortgage insurance.



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