## EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS ## Source details **Canonical URL:** [EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1429.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1429.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1429.pdf.json) --- ### Background and Macroeconomic Outlook - Growth has averaged above-potential 2.2 percent over the first three quarters of 2013. - Growth is expected to accelerate to about 2¼ percent in 2014, up from 1.7 percent in 2013. - Unemployment rate will converge to its natural rate (close to 6½ percent) over the medium term. - Headline CPI inflation is expected to pick up in 2014, approaching the Bank of Canada’s target rate of 2 percent (y/y) by end-2015. - Current account deficit is expected to remain broadly stable at about 3¼ percent of GDP in 2014, and to gradually decline to 2½ percent over the medium term. - Canada’s financial system assets total about 500 percent of GDP. - Six federally-regulated banks (D-SIBs) hold 93 percent of bank assets. - As of end-2012, about half of the total Can$3 trillion (165 percent of GDP) credit to households and non-financial corporations was provided by the banks. - Non-domestic operations of the six D-SIBs accounted for 28 percent of net income in 2012. ### Overall Stability Assessment and Key Risks - Canada’s financial system successfully navigated the global financial crisis; major financial institutions are resilient to credit, liquidity, and contagion risks in a severe stress scenario. - Elevated house prices and high household debt remain an area of concern despite substantial government-guaranteed mortgage insurance. - Mortgages and consumer loans secured by real estate represent the single largest exposure of banks. - Among life insurers, solvency has somewhat eroded, mainly because of policies with guaranteed benefits in a low interest rate environment. - The financial system is large and dominated by a handful of players; concentration can make market entry difficult for newcomers. - The federal system of safety nets is credible, but there is no single body with an explicit mandate to take a comprehensive view of systemic risks or to undertake crisis preparedness. ### Stress Tests: Summary Findings - Stress tests demonstrate resilience of major banks and insurance companies to credit, liquidity, and contagion risks from a severe stress scenario. - Even in the severe stress scenario, recapitalization needs of banks remain manageable. - Solvency ratios of the life insurance majors remain above the regulatory minima in the severe stress scenario. ### Regulatory and Supervisory Framework: Strengths and Gaps - Canada is among the first advanced economies to adopt the Basel III capital standard and to adopt a Domestic Systemically Important Bank (D-SIB) framework. - OSFI has a clear mandate and is empowered to take a range of actions, and applies a “close touch” risk-based supervisory approach. - Legal delineation between prudential responsibilities of OSFI and the Minister could be improved to better protect OSFI’s operational independence. - Notification and reporting obligations for banks could be strengthened. - In the insurance sector, there is scope for a more consistent regime of group-wide supervision, including prudential and market conduct requirements; OSFI should have authority to take supervisory measures at the holding company level. - Provincial securities regulators have made progress on harmonization, but gaps remain in enforcement, risk identification and timely policy making. ### Safety Nets and Crisis Preparedness - The operational capacity of CDIC is well developed. - CDIC’s operational independence, resolution powers, and ex-ante funding should be bolstered. - Legal and institutional arrangements for resolving federal financial institutions are robust and well articulated but untested recently. - Multiple fora exist for federal stakeholders in a crisis, but no single body has the mandate for crisis preparedness or comprehensive systemic risk monitoring. - Cooperation between federal and provincial authorities in ongoing supervision and crisis preparedness should be improved, especially for financial groups spanning federal and provincial boundaries and for institutions and markets deemed systemic. ### Key Recommendations (summary) - Expand financial sector data collection and dissemination with a view to enhancing coverage, regularity, and availability of time-series to facilitate analysis. — Short term - Reduce the government’s exposure to mortgage insurance gradually. — Long term - Augment OSFI’s top-down stress testing framework for banks with risk-sensitive concepts of key credit risk input parameters and econometric, model-based approaches using longer time series. — Short term - Include major regulated entities at federal and provincial level in a regular, common stress testing exercise, involving collaboration between relevant federal and provincial authorities. — Short term - Equip OSFI with powers to make its own enforceable rules by administrative means; amend legislation on statutory decisions to give OSFI sole decision-making authority on prudential criteria. — Medium term - Replace certain informal and ad hoc reporting requirements by FRFIs with more formal requirements. — Medium term - Adopt a transparent and consistent regulatory regime for group-wide insurance supervision; give OSFI the authority to take supervisory measures at the holding company level. — Medium term - Address shortcomings in risk identification and enforcement in securities regulation. — Short term - Enhance supervisory cooperation among federal and provincial supervisors and subject all systemically significant financial institutions to intensive supervision. — Short term - Provide a clear mandate to an entity (i) to monitor systemic risk to facilitate macro-prudential oversight, and (ii) to carry out system-wide crisis preparedness. — Short term - Increase the ex-ante funding of CDIC and enhance its data collection and analysis of depositor profiles. — Medium term Note: Short term – within 12 months; Medium term 1-3 years; Long term – over 3 years ### Shadow banking and non-bank intermediation - Financial intermediation outside the traditional banking system is estimated at 40 percent of GDP. - Components include government-insured mortgage securitization, private-label securitization (ABCP and ABS), repos (predominantly in government securities), money market mutual funds (MMMFs), bankers’ acceptances, and commercial paper. - In all these segments, banks (and other regulated institutions) play a prominent role. - Over 70 percent of government-insured mortgage securitization (about 60 percent of total “shadow banking”) is issued by the six largest banks, which also sponsor most of the outstanding ABS/ABCP. ### Securities intermediation and asset management (as of December 2012) - 1,498 active firms registered to carry out investment activities; 1,365 headquartered in Canada. - Bank-owned asset management subsidiaries control about 60 percent of AUM of the top 10 asset management firms, and 27 percent of the sector’s total AUM. - Mutual fund industry: shift from equity funds to balanced and fixed income funds since the GFC. - MMMF industry: more limited in size; declined as investors reacted to lower yields; predominantly bank-owned; use stable NAVs but have no direct link to the payment system. ### Debt and equity markets (end-2012) - Nominal value of outstanding debt securities: about Can$2.1 trillion (115 percent of GDP); corporate bonds accounted for a third, half of which were issued by financial corporations. - Corporate bond issuance has continued to increase since 2008; issuance of money market instruments declined following the financial crisis. - Securitization markets are beginning to recover; non-bank ABCP industry has not restarted following its collapse in 2007. - Equities market: total market capitalization of nearly Can$2.1 trillion (115 percent of GDP); TSX and TSXV have over 3,800 listed companies; TMX Group is the eighth largest exchange group worldwide by market capitalization. - Derivatives markets are modest in size; OTC derivatives market is concentrated amongst the Big Six Canadian banks. ### Occupational pension funds - Sector accounts for about 13 percent of total financial sector assets; membership about 6 million. - Public-sector trusteed pension plans account for 70 percent of total assets. - Less than 5 percent of occupational pension plans are defined contribution (DC) plans; transition from defined benefit toward DC is slowly taking place. - Sector’s assets are diversified: Canadian debt securities and shares (about one-third each); remainder in private equity, real estate, and infrastructure. ### Banking sector — key statistics and assessments - Asset composition: well-diversified and stable; share of consumer loans has risen as business loans declined; sharp increase in share of insured mortgages reflects IFRS implementation in November 2011. - Funding: dominated by individual and other deposits; deposits almost equally split between demand/notice deposits and fixed-term deposits; around half of ‘other deposits’ comprises deposits from non-financial corporates. - Capital and regulatory posture: - Average capital adequacy ratio for domestic banks was over 12 percent at end-Q1 2013. - OSFI adopted Basel III capital standard on an “all in” basis from January 2013. - OSFI implementing a surcharge for D-SIBs setting an “all-in” Tier 1 common equity (CET1) target of 8 percent of risk weighted assets commencing January 1, 2016. - Major banks’ publicly-reported CET1 ratios at end-Q3 2013 ranged between 8.6–10.7 percent. - Asset quality and provisioning: - Non-performing loans (NPLs): 0.6 percent of loans as of Q2 2013. - Provisioning ratio: 93 percent of NPLs as of Q2 2013, mostly general provisions. - Non-performing business loans account for around half of the NPLs; non-performing mortgage loans account for 1/3 of total NPLs. - Profitability and business mix: - Profitability remains strong despite narrowing interest rate margins. - On average, 20 percent of banks’ earnings rely on capital markets (wholesale banking) and 13 percent on wealth management. - Personal and commercial business income generation varies from about 30 to 70 percent across banks. - Non-Canadian retail and commercial business has shown the largest (percentage) increase in net income, while domestic business provides the largest dollar-increase. - Income volatility: highest for U.S. operations over the last five years, with negative net income in 2009. ### Insurance sector — key points - Life & Health (L&H): - Performance dampened by the global financial crisis; L&H FRIs re-pricing products, removing or weakening guarantees, transferring more risks to policyholders. - Profitability has been declining in absence of growth. - Property & Casualty (P&C): - Much smaller, writes almost exclusively domestic risks with motor insurance dominant; operating results strong but declining investment returns have led to focus on underwriting discipline. - Solvency: - Solvency ratios for both sectors reported well above the regulatory minimum. - Solvency position of the L&H industry had eroded since 2010 but improved in recent quarters. - Insurance exposures to low interest rates: - Life insurers have significant exposure via permanent life insurance and long-term policies with guaranteed rates; exposures were built up through U.S. operations. - Canadian accounting and regulatory standards require assumed reinvestment rates to take increasing account of current market rates; capital ratios declined as rates fell. - Companies have responded by changing pricing and business mix rather than increasing investment risk. - Recommendation: consider development of macro-prudential tools for insurance, including market-wide stress tests and possible limits on higher risk business or additional buffers such as countercyclical capital requirements. ### Housing sector and mortgage insurance - Indicators (house price-to-rent ratio, house price-to-income ratio) suggest house prices are elevated in some markets. - Residential investment as a share of GDP is at a two-decade high. - House completions have outpaced household formation for the past 10 years or so. - Household debt-to-income ratio has surged. - Government-backed mortgage insurance covers some three-fifths of outstanding mortgage credit and all high LTV loans, creating material government exposure to financial system risks. - Recent policy measures: prohibited use of insured mortgages in covered bonds, imposed ceilings on CMHC-sponsored securitization programs, announced plans to prohibit use of insured mortgages in non-CMHC-sponsored securitization and gradually limit insurance of low-ratio mortgages to those used in CMHC securitizations. - Further measures suggested: - Extend OSFI formal powers over CMHC’s commercial operations. - OSFI developing a guideline on mortgage insurers’ underwriting practices; ensure consistency of capital charges between mortgage lending and mortgage insurance. - Longer-term structural options: gradually increase market share of private mortgage insurers while keeping the government’s 10 percent deductible; change mortgage insurance product to involve more risk sharing; re-examine long-run need for extensive government-backed mortgage insurance. ### Stress testing — design, scenarios and key results - Scope and participants: - Tests covered all major banks and life insurance companies and the largest mortgage insurer. - Largest banks constitute over 90 percent of banking assets. - Life insurance companies tested had a combined 76 percent market share. - The largest mortgage insurer, CMHC, has a 70 percent market share. - Tests conducted on consolidated data as of October 2012, restated for solvency stress tests to reflect Basel III calculation. - Scenarios (five-year horizon): - Baseline: reflects IMF World Economic Outlook projections as of February 2013. - Hypothetical adverse: model-driven simulation of a severe crisis outside Canada producing a cumulative decline in real GDP over a three-year period representing the most severe recession in at least the last 35 years; GDP growth rate returns to positive levels after three years of recession. - Bank solvency stress test findings: - Assessed CET1 ratios using the “all-in” methodology against an OSFI supervisory “all-in” threshold of 7 percent introduced in January 2013. - Most banks will fall below the OSFI supervisory threshold by 2015 with recapitalization needs peaking in 2016 under the IMF approach, at up to 30 percent of 2012 gross income or 150 percent of 2012 net income (corresponding to 2.5 percent of 2015 nominal GDP). - The system-wide CET1 ratio would fall by 2.5 percentage points in 2015 relative to the base year or 5.5 percentage points relative to the baseline scenario under the most conservative assumptions. - Under this approach, four banks would fall below the Basel regulatory minimum for the first time in 2016, mainly due to the introduction of the D-SIB surcharge. - Single-factor analysis suggests interest rate risk in the banking book and market risk in the trading book would not entail large losses. - Methodological notes: - The “all-in” methodology does not include Basel III phase-ins; including phase-ins would raise average CET1 ratios of the Big Six by about 400 basis points. - The all-in CET1 threshold includes 2019 Basel III regulatory minimum (4.5 percent) and capital conservation buffer (2.5 percent); an additional surcharge of one percent for the six D-SIBs is assumed from 2016. - Recapitalization needs peak in 2016 under the IMF approach and were five times smaller under the authorities’ approach. ### Liquidity stress tests and network effects - Aggregate finding: banks could endure a liquidity shock characterized by withdrawal of funds and haircuts on liquid assets similar to emerging standards without central bank support (baseline liquidity scenario). - Reliance on unsecured wholesale funding poses more risks under severe unsecured wholesale market disruption (adverse liquidity scenario). - Interbank exposures to other Canadian financial institutions and non-Canadian bank counterparties are small; spillover risk is quite low. - Marginal impact of network effect on CET1 ranges between 21 and 29 basis points. - MFRAF results: - Funding liquidity risk and network effects further deteriorate banks’ capital positions. - Cumulative marginal impact of funding liquidity risk and network effects on the Big Six over two years is around 30 basis points in the baseline scenario with one bank falling below the regulatory threshold. - Cumulative marginal impact is 230 basis points in the adverse scenario with four banks falling below the regulatory CET1 threshold. - Including liquidity risk and network effects shifts the loss distribution to the right, implying greater average losses and higher probability of higher losses. ### Life insurance, mortgage insurance stress test results - Life insurers: - Adverse scenario: lower equity prices, higher credit spreads and low interest rates. - Three large life insurance companies show robust results; solvency ratios remain well above the supervisory target of 150 percent (MCCSR). - Aggregate MCCSR ratios decline from 215 percent in 2012 to 199 percent in 2015, stabilizing thereafter. - Net income remains positive under the adverse scenario each year and at end-2017 is 15 percent higher than in 2012. - Key drivers: share price declines and unfavorable policyholder lapse rates; lower risk-free interest rates less pronounced due to substantial reserves. - Mortgage insurance: - Capital adequacy of the largest mortgage insurance provider remains above regulatory requirements under stress. - In the adverse scenario, MCT drops sharply from 2012 to 2014 but remains above the minimum regulatory level of 100 percent; improves starting in 2015. ### Recommended enhancements to stress testing framework - Address data gaps by collecting longer time series of granular data on a greater range of items. - Use econometric, model-based approaches for forecasting income statement and balance sheet items. - Incorporate economic concepts in the determination of credit risk input parameters. - Subject all major federal and provincial entities to common stress testing frameworks. - Establish a liquidity stress testing framework which incorporates Basel III metrics. - Embed the MFRAF framework in a macroeconomic model to allow simulation of stress scenarios and calculation of their impact within one framework while accounting for feedback loops. - Insurance sector: provide comprehensive assumptions for macro stress tests, strengthen analytical validation against supervisory data, and explore roll out of top-down stress tests. ### Financial sector oversight — summary findings - Prudential supervision and regulation of banking, insurance, and securities industries are effective and generally in compliance with international standards, though some gaps remain. - OSFI: very effective banking supervision; risk-based, conservative, “close touch” approach; strong cadre of supervisors. - Areas for improvement across sectors: formalize information flows and reporting, strengthen legal protection for OSFI operational independence, improve group-wide supervision for insurance, strengthen securities enforcement and risk identification, and augment provincial supervisory capacity. ### Enforcement, regulatory governance, and macroprudential measures - Enforcement remains a key challenge, especially in connection with criminal offenses; results mixed and visible in only some larger provinces. - Securities regulators should improve timeliness of decision making; current consensus-based governance may affect timeliness. - Coordination with the federal government is necessary for identification of systemic risk and criminal enforcement. - Macroprudential measures since 2008 include four rounds of tightening mortgage insurance (reduced maximum amortization to 25 years for high LTV loans; 5 percent minimum down payment for owner-occupied properties; maximum total debt service ratio of 44 percent; tightened LTV on refinancing and non-owner-occupied purchases; withdrawal of government insurance on lines of credit secured by homes). - Econometric evidence suggests measures adopted since 2010 were effective in curbing mortgage credit growth and moderating house prices spike. - Institutional gaps: no single body with mandate for macroprudential oversight; no one mandated to collect and analyze system-wide data across federal, provincial and unregulated entities and markets. ### Systemic oversight committees and safety nets - Multiple committees exist (FISC, SAC, HOA, CSA SRC) with varying memberships and mandates; only FISC is statutory. - Federal safety net is well established and credible; Minister of Finance is the financial stability “gatekeeper” with broad intervention powers. - Provincial safety nets are functionally independent and heterogeneous; some need substantial improvements; provincial deposit insurance practices vary widely and ex-ante funding is relatively low. - Crisis preparedness: several committees engage in oversight but no single body has an assigned mandate for system-wide crisis preparedness or to trigger crisis actions; assigning such a mandate recommended. - Resolution frameworks and BoC liquidity: federal legal and institutional arrangements for resolving institutions are robust; OSFI and CDIC advanced in recovery and resolution planning for D-SIBs; authorities plan to introduce a bail-in regime for systemically important banks. - BoC has a strong emergency liquidity framework; removing the legal prohibition to take mortgages as collateral would increase flexibility. ### CDIC operational capacity and recommendations - CDIC operational capacity is well developed. - Recommended enhancements: - Bolster operational independence, resolution powers and ex-ante funding. - Allow greater CDIC independence in applying resolution tools while maintaining governmental approval where public funds are involved. - Empower CDIC to require group continuity of essential services and to terminate contracts. - Extend powers to temporarily stay early termination rights to a broader range of resolution tools. - Consider introducing some form of depositor preference. - To achieve targeted 100 basis points minimum coverage in a reasonable timeframe, increase premiums paid by financial institutions. - Simplify rules for eligibility for deposit insurance of complex deposit products. ### Appendix I — Financial sector structure (calendar year end-2012) - Total financial sector assets: 9,119,921 Millions Can$ representing 100% of sector assets and 501% of GDP. - Sector breakdown (Millions Can$; % Total Assets; % GDP): - Banks: 3,849,384 — 42% of total assets — 212% of GDP - Domestic banks: 3,663,491 - Foreign subsidiaries and branches: 185,893 - Trust and mortgage loan companies 1/: 49,495 — 1% — 3% of GDP - Credit unions, caisses populaires, central credit unions: 352,326 — 4% — 19% of GDP - Credit unions and caisses populaires: 297,607 - Central credit unions 2/: 54,719 - of which: Federally regulated: 23,116 - Non-depository credit intermediation 3/: 84,872 — 1% — 5% of GDP - Life insurers and segregated funds 4/: 1,009,617 — 11% — 55% of GDP - of which: Federally regulated: 958,763 - Provincially chartered 2/: 50,854 - Mutual funds: 1,133,091 — 12% — 62% of GDP - Property and casualty insurance 5/: 427,411 — 5% — 23% of GDP - of which: Federally regulated (including mortgage insurers) 6/: 415,261 - Provincially chartered 2/: 12,150 - Trusteed pension plans: 1,189,781 — 13% — 65% of GDP - of which: Federally regulated private pension plans 7/: 142,000 - Provincially regulated: 1,047,781 - Financial government business enterprises: 158,545 — 2% — 9% of GDP - of which: Federal: 79,596 - Provincial: 78,949 - Other (excluding monetary authorities): 865,400 — 9% — 48% of GDP - Issuers of asset-backed securities 8/: 122,756 - Other private financial institutions 9/: 742,644 *Source: EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS, IMF Financial Sector Assessment Program Update (Canada); IMF staff report content unit _cr1429.* ### EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS ______________________________________ 6 ### EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS ### Background and Macroeconomic Outlook - Growth has averaged above-potential 2.2 percent over the first three quarters of 2013. - Growth is expected to accelerate to about 2¼ percent in 2014, up from 1.7 percent in 2013. - Unemployment rate will converge to its natural rate (close to 6½ percent) over the medium term. - Headline CPI inflation is expected to pick up in 2014, approaching the Bank of Canada’s target rate of 2 percent (y/y) by end-2015. - Current account deficit is expected to remain broadly stable at about 3¼ percent of GDP in 2014, and to gradually decline to 2½ percent over the medium term. - Canada’s financial system assets total about 500 percent of GDP. - Six federally-regulated banks (D-SIBs) hold 93 percent of bank assets. - As of end-2012, about half of the total Can$3 trillion (165 percent of GDP) credit to households and non-financial corporations was provided by the banks. - Non-domestic operations of the six D-SIBs accounted for 28 percent of net income in 2012. ### Overall Stability Assessment and Key Risks - Canada’s financial system successfully navigated the global financial crisis; major financial institutions are resilient to credit, liquidity, and contagion risks in a severe stress scenario. - Elevated house prices and high household debt remain an area of concern despite substantial government-guaranteed mortgage insurance. - Mortgages and consumer loans secured by real estate represent the single largest exposure of banks. - Among life insurers, solvency has somewhat eroded, mainly because of policies with guaranteed benefits in a low interest rate environment. - The financial system is large and dominated by a handful of players; concentration can make market entry difficult for newcomers. - The federal system of safety nets is credible, but there is no single body with an explicit mandate to take a comprehensive view of systemic risks or to undertake crisis preparedness. ### Stress Tests: Summary Findings - Stress tests demonstrate resilience of major banks and insurance companies to credit, liquidity, and contagion risks from a severe stress scenario. - Even in the severe stress scenario, recapitalization needs of banks remain manageable. - Solvency ratios of the life insurance majors remain above the regulatory minima in the severe stress scenario. ### Regulatory and Supervisory Framework: Strengths and Gaps - Canada is among the first advanced economies to adopt the Basel III capital standard and to adopt a Domestic Systemically Important Bank (D-SIB) framework. - OSFI has a clear mandate and is empowered to take a range of actions, and applies a “close touch” risk-based supervisory approach. - Legal delineation between prudential responsibilities of OSFI and the Minister could be improved to better protect OSFI’s operational independence. - Notification and reporting obligations for banks could be strengthened. - In the insurance sector, there is scope for a more consistent regime of group-wide supervision, including prudential and market conduct requirements; OSFI should have authority to take supervisory measures at the holding company level. - Provincial securities regulators have made progress on harmonization, but gaps remain in enforcement, risk identification and timely policy making. ### Safety Nets and Crisis Preparedness - The operational capacity of CDIC is well developed. - CDIC’s operational independence, resolution powers, and ex-ante funding should be bolstered. - Legal and institutional arrangements for resolving federal financial institutions are robust and well articulated but untested recently. - Multiple fora exist for federal stakeholders in a crisis, but no single body has the mandate for crisis preparedness or comprehensive systemic risk monitoring. - Cooperation between federal and provincial authorities in ongoing supervision and crisis preparedness should be improved, especially for financial groups spanning federal and provincial boundaries and for institutions and markets deemed systemic. ### Key Recommendations (Table 1: 2013 FSAP Update—Key Recommendations) - Expand financial sector data collection and dissemination with a view to enhancing coverage, regularity, and availability of time-series to facilitate analysis. Para 56; BCP 28; ICP 20; IOSCO 6,7 — Short term - Reduce the government’s exposure to mortgage insurance gradually. Para 25 — Long term - Augment OSFI’s top-down stress testing framework for banks with risk-sensitive concepts of key credit risk input parameters and econometric, model-based approaches using longer time series. Para 37 — Short term - Include major regulated entities at federal and provincial level in a regular, common stress testing exercise, which would involve a degree of collaboration between relevant federal and provincial authorities. Para 37 — Short term - Equip OSFI with powers to make its own enforceable rules by administrative means, supplementing the use of guidelines and government regulations; amend legislation on statutory decisions to give OSFI sole decision-making authority on prudential criteria. Para 41, 47; BCP 1, 2; ICP 1, 2 — Medium term - Replace certain informal and ad hoc reporting requirements by FRFIs with more formal requirements. Para 40; BCP 9, 12, 19, 20; ICP 6, 9 — Medium term - Adopt a transparent and consistent regulatory regime for group-wide insurance supervision; give OSFI the authority to take supervisory measures at the level of the holding company. Para 44 — Medium term - Address shortcomings in risk identification and enforcement in securities regulation. Para 51 — Short term - Enhance supervisory cooperation among federal and provincial supervisors (Para 42, 44; BCP 3; ICP 3) and subject all systemically significant financial institutions to intensive supervision. Para 24; Box 3 — Short term - Provide a clear mandate to an entity (i) to monitor systemic risk to facilitate macro-prudential oversight, and (ii) to carry out system-wide crisis preparedness. Para 56, 58 — Short term - Increase the ex-ante funding of CDIC and enhance its data collection and analysis of depositor profiles. Para 60 — Medium term Note: Short term – within 12 months; Medium term 1-3 years; Long term – over 3 years *Source: EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS, IMF Financial Sector Assessment Program Update (Canada).* ### 6. Financial intermediation outside the traditional banking system is estimated at ### 6. Financial intermediation outside the traditional banking system is estimated at 40 percent of GDP (Figure 6) ### Shadow banking and non-bank intermediation - Financial intermediation outside the traditional banking system is estimated at 40 percent of GDP. - Components of “shadow banking” include: - government-insured mortgage securitization, - private-label securitization (ABCP and ABS), - repos (predominantly in government securities), - money market mutual funds (MMMFs), - bankers’ acceptances, - commercial paper. - In all these segments, banks (and other regulated institutions) play a prominent role. - Over 70 percent of government-insured mortgage securitization (about 60 percent of total “shadow banking”) is issued by the six largest banks, which also sponsor most of the outstanding ABS/ABCP. ### Securities intermediation and asset management - As of December 2012: - 1,498 active firms registered to carry out investment activities, - 1,365 of those were headquartered in Canada. - Bank-owned subsidiaries’ market positions: - Bank-owned asset management subsidiaries control about 60 percent of AUM of the top 10 asset management firms, - and 27 percent of the sector’s total AUM. - Mutual fund industry trends since the GFC: - shift from equity funds to balanced and fixed income funds. - MMMF industry: - more limited in size, - experienced a decline of assets as investors reacted to lower yields paid by MMMFs relative to alternatives such as high-interest savings accounts. - MMMFs in Canada are predominantly bank-owned; they use stable NAVs but have no direct link to the payment system. ### Debt and equity markets - Nominal value of outstanding debt securities at end-2012: about Can$2.1 trillion (115 percent of GDP). - Corporate bonds accounted for a third of this, of which half were issued by financial corporations. - Market issuance trends: - Corporate bond issuance in Canada has continued to increase since 2008. - Issuance of money market instruments (commercial paper and bankers’ acceptances) declined following the financial crisis. - Securitization: - Securitization markets as a whole are beginning to recover, - non-bank ABCP industry has not restarted following its collapse in 2007. - Equities market at end-2012: - total market capitalization of nearly Can$2.1 trillion (115 percent of GDP). - TSX and TSXV (owned and operated by the TMX Group) have over 3,800 listed companies. - TMX Group is the eighth largest exchange group worldwide by market capitalization. - Majority of the largest listed companies operate in the financial sector or extractive industries. - Derivatives markets: - Derivatives markets are modest in size. - The over-the-counter (OTC) derivatives market is concentrated amongst the Big Six Canadian banks. ### Occupational pension funds - Occupational pension funds sector accounts for about 13 percent of total financial sector assets. - Membership: about 6 million. - Public-sector trusteed pension plans account for 70 percent of total assets. - Plan types and assets: - Less than 5 percent of occupational pension plans are defined contribution (DC) plans, although a transition from defined benefit toward DC is slowly taking place. - Sector’s assets are diversified across Canadian debt securities and shares (about one-third each) and the remainder across investments in private equity, real estate, and infrastructure. ### Overall stability assessment — Banking sector - Asset composition and trends: - Canadian banks’ assets are well-diversified and stable in composition. - Share of consumer loans has risen as that of business loans has declined. - Sharp increase in share of insured mortgages reflects IFRS implementation in November 2011 (bringing most securitized mortgages back on balance sheet). - Funding: - Bank funding is dominated by individual and other deposits. - Deposits are almost equally split between demand/notice deposits and fixed-term deposits, and include both retail and ‘other’ deposits. - Around half of ‘other deposits’ comprises deposits from non-financial corporates considered stable and relationship-driven. - Capital and regulatory posture: - Average capital adequacy ratio for domestic banks was over 12 percent at end-Q1 2013. - OSFI adopted Basel III capital standard on an “all in” basis from January 2013. - OSFI is implementing a surcharge for D-SIBs setting an “all-in” Tier 1 common equity (CET1) target of 8 percent of risk weighted assets commencing January 1, 2016. - Major banks’ publicly-reported CET1 ratios at end-Q3 2013 ranged between 8.6–10.7 percent. - Asset quality and provisioning: - Non-performing loans (NPLs): 0.6 percent of loans as of Q2 2013. - Provisioning ratio: 93 percent of NPLs as of Q2 2013, mostly in the form of general provisions. - Non-performing business loans account for around half of the NPLs; non-performing mortgage loans account for 1/3 of the total NPLs. - Profitability and business mix: - Profitability remains strong despite narrowing interest rate margins. - Canadian banks were among the most profitable during the post-2008 period, especially the D-SIBs. - On average, 20 percent of banks’ earnings rely on capital markets (wholesale banking) and 13 percent on wealth management. - Personal and commercial business income generation varies from about 30 to 70 percent across banks. - Non-Canadian retail and commercial business has shown the largest (percentage) increase in net income, while domestic business provides the largest dollar-increase. - Income volatility: - Over the last five years, income volatility has been highest for U.S. operations, with negative net income in 2009. - Income contribution from operations in the Caribbean and Latin America has been stable on aggregate. ### Insurance sector - Life & Health (L&H) industry: - Performance dampened by the global financial crisis and ongoing volatility. - L&H FRIs have been re-pricing products, removing or weakening guarantees, and transferring more risks to policyholders. - Profitability has been declining in absence of growth. - Property & Casualty (P&C) industry: - Much smaller and writes almost exclusively domestic risks, with motor insurance dominant. - Growth modest; operating results strong but declining investment returns have led to focus on underwriting discipline. - Solvency: - Solvency ratios for both sectors are reported well above the regulatory minimum. - Solvency position of the L&H industry had eroded since 2010 but has improved in recent quarters. - Insurance sector exposures to low interest rates (Box 1 highlights): - Life insurers have significant exposure via permanent life insurance and long-term policies with guaranteed rates; exposures were built up through U.S. operations (with subsequent retrenchment). - Canadian accounting and regulatory standards require assumed reinvestment rates to take increasing account of current market rates; capital ratios declined as rates fell. - Companies have responded by changing pricing and business mix rather than increasing investment risk. - Insurers would gain from gradually rising interest rates, though longer run impacts on business models remain unclear. - OSFI’s capital regime redesign is influenced by anticipated IFRS4 revisions. - Recommendation: consider development of macro-prudential tools for insurance, including market-wide stress tests and possible limits on higher risk business or additional buffers such as countercyclical capital requirements. ### Housing sector and mortgage insurance - Housing vulnerabilities: - Indicators (house price-to-rent ratio, house price-to-income ratio) suggest house prices are elevated in some markets. - Residential investment as a share of GDP is at a two-decade high. - House completions have outpaced household formation for the past 10 years or so. - Household debt-to-income ratio has surged. - Mortgages and consumer loans secured by real estate represent the single largest asset group for Canadian banks. - Government-backed mortgage insurance: - Covers some three-fifths of outstanding mortgage credit and all high LTV loans. - This mitigates first-round effects on the financial system but means government exposure to financial system risks is material. - Recent policy measures: - Government prohibited use of insured mortgages in covered bonds and imposed ceilings on CMHC-sponsored securitization programs. - Announced plans to prohibit use of insured mortgages in non-CMHC-sponsored securitization and gradually limit insurance of low-ratio mortgages to those used in CMHC securitizations. - Further measures suggested: - Prudential supervision of CMHC: - OSFI’s authority is limited; extending formal powers over CMHC’s commercial operations would place CMHC on an equal regulatory footing with other financial institutions and improve supervision. - Mortgage insurance guideline: - OSFI developing a guideline on mortgage insurers’ underwriting practices; ensuring consistency of capital charges between mortgage lending and mortgage insurance is important. - Longer-term structural options: - Gradually increase market share of private mortgage insurers while keeping the government’s 10 percent deductible in the event of insolvency. - Change mortgage insurance product to involve more risk sharing (as in Hong Kong SAR). - Re-examine long-run need for extensive government-backed mortgage insurance; Australia privatized a similar system in 1998. ### Stress tests — design and results - Scope and participants: - Stress tests covered all major banks and life insurance companies and the largest mortgage insurer. - Largest banks constitute over 90 percent of banking assets. - Life insurance companies tested had a combined 76 percent market share. - The largest mortgage insurer, CMHC, has a 70 percent market share. - Tests conducted on consolidated data as of October 2012, restated for solvency stress tests to reflect Basel III calculation. - Scenarios (two scenarios over a five-year horizon): - Baseline scenario: reflects IMF World Economic Outlook projections as of February 2013. - Hypothetical stress scenario: model-driven simulation of a severe crisis outside Canada producing a cumulative decline in real GDP over a three-year period representing the most severe recession in at least the last 35 years; GDP growth rate returns to positive levels after three years of recession. - Bank solvency stress test findings: - Solvency stress test assessed banks’ CET1 ratios using the “all-in” methodology against an OSFI supervisory “all-in” threshold of 7 percent introduced in January 2013. - Most banks will fall below the OSFI supervisory threshold by 2015 with recapitalization needs peaking in 2016 under the IMF approach, at up to 30 percent of 2012 gross income or 150 percent of 2012 net income (corresponding to 2.5 percent of 2015 nominal GDP). - The system-wide CET1 ratio would fall by 2.5 percentage points in 2015 relative to the base year or 5.5 percentage points relative to the baseline scenario under the most conservative assumptions. - Under this approach, four banks would fall below the Basel regulatory minimum for the first time in 2016, mainly due to the introduction of the D-SIB surcharge. - Analysis of single factor shocks suggests interest rate risk shocks in the banking book and market risk shocks in the trading book would not entail large losses. - Additional notes on methodologies and comparisons: - The “all-in” methodology does not include Basel III phase-ins; including phase-ins would raise average CET1 ratios of the Big Six by about 400 basis points. - The all-in CET1 threshold includes 2019 Basel III regulatory minimum (4.5 percent) and capital conservation buffer (2.5 percent); an additional surcharge of one percent for the six D-SIBs is assumed from 2016. - Recapitalization needs to bring banks to the regulatory threshold also peak in 2016 under the IMF approach and were five times smaller under the authorities’ approach. - While only one bank would face the same challenge in the OSFI ToD stress test, no bank would hit the regulatory minimum under the BU approach. *Source: _cr1429 - 6. Financial intermediation outside the traditional banking system is estimated at (IMF staff text provided).* ### 29. Liquidity stress tests results suggest banks could generally withstand severe ### _cr1429 - 29. Liquidity stress tests results suggest banks could generally withstand severe ### Liquidity stress test findings - On aggregate, banks would be able to endure a liquidity shock as characterized by withdrawal of funds and haircuts on liquid assets similar to emerging standards without support from the central bank (the baseline liquidity scenario). - Reliance on unsecured wholesale funding (operational and nonoperational deposits from non-financial corporates in particular) poses more risks for all banks in a scenario characterized by more severe disruptions in the unsecured wholesale markets (the adverse liquidity scenario). ### Interbank exposures and spillover risk - Interbank exposures and those to other Canadian financial institutions and non-Canadian bank counterparties are small, keeping spillover risk quite low. - Any contagion effects arising outside of the major Canadian banks would be limited. - The marginal impact of the network effect on CET1 is rather small and ranges between 21 and 29 basis points. ### MFRAF exercise and combined capital impact - The MFRAF exercise shows an effective systemic-risk monitoring framework needs comprehensive consideration of banks’ capital, funding profiles and financial interconnections. - When funding liquidity risk and network effects are taken into account, banks face further deterioration in their capital position. - Comparing the system-wide CET1 between the base year and stress year 3 in the credit module and liquidity and network module: - The cumulative marginal impact of funding liquidity risk and network effects on the capital position of the Big Six over the two years is around 30 basis points in the baseline scenario with one bank falling below the regulatory threshold. - The cumulative marginal impact is 230 basis points in the adverse scenario with four banks falling below the regulatory CET1 threshold. - Including liquidity risk and network effects shifts the first mode of the loss distribution to the right, implying greater average losses and a higher probability of higher losses. ### Life insurance stress test results - The stress test for life insurers follows assumptions comparable to the bank stress test; the adverse scenario included mainly variations of market variables (lower equity prices, higher credit spreads and low interest rates). - The three large life insurance companies show quite robust results in the stress test. - Even in the adverse scenario, solvency ratios of all companies remain well above the supervisory target of 150 percent, based on the Minimum Continuing Capital and Surplus Requirement (MCCSR). - On aggregate, total MCCSR ratios decline from 215 percent in 2012 to 199 percent in 2015, stabilizing thereafter. - The variation of results is low. - Net income remains positive under the adverse scenario in each year of the projection horizon and is expected to recover quickly from its lows in 2013. - At the end of the projection horizon in 2017, net income is 15 percent higher than in 2012. - Key drivers of the adverse scenario impact: - Share price declines and unfavorable changes in policyholders’ lapse rates add most to the overall impact on insurers’ capital and net income in the first year of the adverse scenario. - The effect of lower risk-free interest rates in the first years of the projection horizon is less pronounced because companies have already built up substantial reserves. - Exchange rate movements included in the adverse scenario have a negligible effect on solvency ratios and net income given the close currency matching of assets and liabilities. ### Mortgage insurance stress test results - The capital adequacy of the largest mortgage insurance provider remains above the regulatory requirements under a stress scenario using similar assumptions as those for banks and life insurers. - In the adverse scenario, capital adequacy, based on the Minimum Capital Test (MCT), drops sharply from 2012 to 2014, but remains above the minimum regulatory level of 100 percent. - Starting in 2015, capital adequacy improves gradually. ### Next steps and recommended enhancements to stress testing framework - Address data gaps by collecting longer time series of granular data on a greater range of items. - Use econometric, model-based approaches for forecasting income statement and balance sheet items. - Incorporate economic concepts in the determination of credit risk input parameters. - Subject all major federal and provincial entities to common stress testing frameworks. - Establish a liquidity stress testing framework which incorporates Basel III metrics. - Embed the MFRAF framework in a macroeconomic model to allow simulation of stress scenarios and calculation of their impact within one framework while taking into account feedback loops between the financial system and the real economy. - In the insurance sector: - Provide a comprehensive set of assumptions for macro stress tests to all participating insurance firms. - Strengthen the analytical approach in validating stress test results against supervisory data. - Explore the potential roll out of top-down stress tests. ### Financial sector oversight — summary findings - The FSAP mission found prudential supervision and regulation of the banking, insurance, and securities industries to be effective and generally in compliance with international standards, though some gaps remain to be addressed. - The Canadian financial sector was able to withstand the global financial crisis much better than financial systems in other developed countries. - OSFI has a reputation for being a strong and effective regulator but vulnerabilities were identified in staffing, supervisory follow-up, group supervision, coordination and the potential for political considerations to override prudential concerns under various statutes. ### Banking supervision (OSFI) - OSFI’s supervision of the Canadian banking system was found to be very effective with a high level of compliance with the Basel Core Principles for Effective Banking Supervision (BCPs). - OSFI applies a risk-based and conservative approach; when an institution has a material weakness it is subject to increased supervision. - OSFI’s “close touch” supervision engages boards and management regularly and emphasizes board accountability for risk appetite and oversight. - OSFI has a strong cadre of highly trained and experienced supervisors; communication between OSFI senior staff and banks is frequent and open. - Areas for improvement: - The informal approach to information flows is vulnerable to staff turnover and may not work well under stress. - Reporting and notification obligations (for example, related party transactions and large exposures) could be made more formal or more frequent. - The Bank Act provides the Minister of Finance authority to override OSFI prudential judgments; the supervisory framework would be stronger if legislation limited overrides to extraordinary circumstances with full public disclosure. - Relationships with provincial regulators could be strengthened to enhance two-way communications and protocols for sharing supervisory information. ### Insurance supervision - OSFI’s supervision of federally regulated insurers (FRIs) has a high level of observance with the ICPs and robust prudential supervision. - OSFI’s risk-based approach supports structured supervisory risk assessments and timely intervention. - Areas for improvement: - Effectiveness and transparency of group supervision approaches could be improved; OSFI should work with the DoF and Provinces to formulate a clear and consistent regulatory regime for group-wide supervision including material non-regulated entities. - There are gaps and inconsistencies in application of solvency regimes for L&H and P&C businesses at group and solo levels. - Scope for strengthening requirements on FRIs’ investments, particularly for complex or less transparent instruments. - Conduct of Business (COB) regimes across provinces are being harmonized but supervisory resources need augmentation. - Legal capacity and operational autonomy of supervisors should be strengthened so supervisors can issue legally enforceable rules and reduce potential political interference; laws should be updated to separate prudential decisions from national interest considerations and require public disclosure in certain circumstances. ### Securities regulation - The framework exhibits a high level of implementation of the IOSCO principles; provincial securities regulatory agencies have broad powers. - The Canadian Securities Administrators (CSA) have achieved a high degree of harmonization across provinces. - Remaining challenges in risk identification that require additional coordination, resources, data collection and on-the-ground work: - Stronger coordination across different regulatory authorities and SROs to obtain a full view of risks. - Additional capacity in specialized areas to address increased market complexity. - More robust use of quantitative analysis for identification and monitoring of systemic risks and to enrich risk discussions. - Additional on-site inspections to detect poor practices, conduct problems, and weaknesses in internal controls and risk management. *Source: IMF Financial Sector Assessment Program chapter on Canada (content unit _cr1429).* ### 50. Enforcement remains another key challenge, especially in connection with criminal ### _cr1429 - 50. Enforcement remains another key challenge, especially in connection with criminal ### Enforcement and Criminal Sanctions - Enforcement remains a key challenge, especially in connection with criminal offenses. - Despite several efforts to improve criminal enforcement, results are mixed and are visible in only some of the larger provinces. - The SROs have taken important steps to ensure that they have in place strong enforcement strategies, in particular in connection with compliance reviews. - It is important that such efforts continue. ### Regulatory Governance and Timeliness of Decision Making - Securities regulators should continue to take steps to ensure timely decision making in policy formulation. - Current governance arrangements are based on a consensus building approach across several entities, which might affect timeliness of decision making. - Addressing these challenges requires a concerted effort by the provinces and, given functions noted by the Supreme Court, also by the federal government. - Coordination with the federal government would be necessary in the areas of: - identification of systemic risk, and - criminal enforcement. - The recent agreement in principle to establish a cooperative capital markets regulator to which the provinces and the federal government would delegate their functions is cited as a practical way forward that could also bring efficiency gains. ### Box 3 — Supervisory Intensity and Effectiveness (key findings) - Canadian banks entered the global financial crisis with a solid funding base and high risk-based capital levels and recovered quickly from initial episodes of turbulence in funding markets. - Contributory factors included: - a strong economy and conservative federal fiscal stance that enabled the government to credibly stand behind back-stopping arrangements, - a government-backed mortgage finance system that mitigates risks in the financial sector, - and the intensity and effectiveness of the supervisory framework influencing industry behavior. - Supervisory processes and outcomes align with key FSB Recommendations on Supervisory Intensity and Effectiveness. - OSFI’s mandate focuses exclusively on protecting the savings of depositors and policyholders of FRFIs. - OSFI practices and characteristics: - required high quality capital in the banks, - early adoption of international standards, - skepticism regarding riskier capital market instruments, - de facto operational independence though de jure part of government with formal head the Minister of Finance, - reliance on regulatory “guidelines” that can be issued promptly, - sunset clause in banking legislation providing periodic opportunity to update the framework every five years, - principles-based supervisory approach practicing “close touch” supervision, - emphasizes accountability of board of directors and management, - adequately resourced and has built supervisory capacity including by hiring experienced professionals from the industry. - Federal-level collaboration requires sharing of supervisory information among members on a confidential basis to facilitate more informed federal policies. - The financial system is relatively concentrated, profitable, conservatively run, and benefits from effective supervision; mergers among big banks have been discouraged. - Provincial deposit takers that become large enough to pose systemic risks should be subject to the same level of rigorous supervision and regulation as other major depository institutions in Canada. - Challenges for provincial supervisors: - some large credit unions regulated at the provincial level require provincial supervisors to have standalone capacity to effectively supervise them and for provinces to have fiscal resources to backstop depositors and resolve nonviable ones, - wide dispersion of supervisory talent across provinces makes it challenging for all provincial supervisors to acquire needed breadth and depth of experience, - greater collaboration across federal and provincial agencies could help ensure supervision remains intense and effective across all systemic institutions. - Note: The cooperative capital markets regulator—a joint federal and provincial initiative—was announced on September 19, 2013, initially involving the federal government, British Columbia and Ontario. ### Macroprudential Measures (2008–2012 and onward) - The Canadian authorities have taken several macro-prudential measures since 2008 to support the long-term stability of the housing and mortgage markets. - Federal government measures included four rounds of measures to tighten mortgage insurance that went beyond reversal of mid-2000s loosening: - reduced the maximum amortization period for high LTV loans to 25 years; - imposed a 5 percent minimum down payment for owner-occupied properties; - introduced a maximum total debt service ratio of 44 percent; - tightened LTV ratios on refinancing loans and on loans to purchase properties not occupied by the owner; - withdrew government insurance backing on lines of credit secured by homes, including non-amortizing HELOCs. - Prudential and oversight measures: - OSFI issued a guideline to strengthen mortgage underwriting standards; - oversight of CMHC was enhanced; - government restricted new guarantees under the National Housing Act Mortgage-Backed Securities program; - CMHC reduced access to its portfolio insurance product. - Econometric evidence suggests that the measures adopted since 2010 were effective; these measures, especially the latest round, have curbed mortgage credit growth and moderated the spike in house prices. - Institutional gaps: - No single body has the mandate for macroprudential oversight nor do any of the oversight committees have membership that allows a comprehensive view of systemic risk across all financial institutions and markets in Canada. - Risks in securities markets, including linkages with other parts of the financial system, are not systematically captured at a national level. - No-one has a mandate to collect and analyze data for the financial system—federally and provincially regulated entities, unregulated entities, and markets—as a whole. - Consequently, a complete set of information is not collected on a systematic and regular basis, and there are gaps in understanding certain segments (e.g. holding company credit intermediation, some pension fund activities, securities markets) and interconnectedness among different areas of the financial universe. - The Bank of Canada performs regular systemic risk analyses as part of the Financial Stability Review but lacks access to a broader range of data and information. ### Systemic Oversight Committees (summary from Table 2) - Committees listed: Financial Institutions Supervisory Committee (FISC); Senior Advisory Committee (SAC); Heads of Agencies Committee (HOA); CSA Systemic Risk Committee (SRC). - Members include OSFI, CDIC, BOC, DOF, FCAC, provincial securities regulators and CSA Chair in various combinations. - Mandates include facilitating exchange of information relating to supervision of FRFIs; sharing information, monitoring emerging risks and discussing policies; coordinating on issues of mutual concern; identifying and analyzing systemic risks in securities markets. - Frequency: Quarterly (or as necessary) for most; SRC meets semiannually with conference calls every two weeks. - Legal form: FISC statutory; others non-statutory. - Note: the CDIC Board meets quarterly and includes DOF, OSFI, BOC and FCAC plus six private sector members; CDIC is a statutory body. - The Joint Forum of Financial Market Regulators (JFFMR) brings together CAPSA (pensions), CCIR (insurance), CSA (securities), with representation from CISRO (insurance) to promote harmonization and coordination. ### Safety Nets, Crisis Preparedness, and Resolution - Federal safety net: - A substantial part of the financial sector is covered by the federal safety net, which is well established and highly credible. - At the federal level, the Minister of Finance (MoF) is legally and operationally the financial stability “gatekeeper.” - The government has broad intervention powers and can supersede decisions of both OSFI and CDIC based on financial stability grounds. - OSFI, CDIC, and BoC have each established leading practices in their areas of responsibility. - Provincial safety nets: - Each of the ten provinces has functionally-independent and heterogeneous safety nets and contingency planning and resolution frameworks; some need substantial improvements. - Provincial deposit insurance practices are highly diverse (some offering unlimited insurance), with evidence suggesting ex-ante funding is relatively low. - Provincial safety nets may benefit from a perception of an implicit federal backstop; problems in a relatively small deposit insurance system could have contagion effects through uncertainty and loss of confidence. - Crisis preparedness: - Several committees engage in oversight, but no single body has an assigned mandate for system-wide crisis preparedness. - Systemic oversight committees play a role in crisis management; only FISC is statutory; meetings are regular and informality permits flexible operation. - No entity currently has a clear mandate or membership to undertake system-wide crisis preparedness, decide whether to trigger crisis actions or powers, or conduct comprehensive simulations to test the capacity of authorities (both federal and provincial) to respond in a coordinated manner to crisis scenarios. - Assigning such a mandate could strengthen response capability and would include development of overarching policy and operational guidance to respond to a system-wide crisis and bring together system wide (both federal and provincial) issues. - Resolution frameworks and BoC liquidity: - Federal legal and institutional arrangements for resolving individual financial institutions are robust. - OSFI’s intervention framework is well articulated, underpinned by strong legal powers, and transparently communicated in a “Guide to Intervention.” - OSFI and CDIC are well advanced in developing recovery and resolution planning for the D-SIBs. - The resolution toolkit is broad, but many instruments require a decision of the Governor in Council following a recommendation from the MoF. - Authorities plan to introduce a bail-in regime for systemically important banks. - The CDIC developed a detailed operational framework for resolution and its deposit insurance function has been recently reinforced by the introduction of a single depositor view system. - BoC has a strong emergency liquidity framework; removing the legal prohibition to take mortgages as collateral would ensure more flexibility in providing liquidity under stressed conditions. ### CDIC Operational Capacity and Recommendations - CDIC’s operational capacity is well developed. - Recommended enhancements: - Bolster operational independence, resolution powers and ex-ante funding. - CDIC should have greater independence in applying various resolution tools and other instruments (i.e., those provided in the Financial Institution Restructuring Provisions title of the CDIC Act), while governmental approval would be maintained in situations involving public funds. - Empower CDIC to require companies in the same group to ensure continuity of essential services in a resolution and to terminate contracts. - Extend existing powers to temporarily stay the exercise of early termination rights to a broader range of resolution tools. - Consider the merits of introducing some form of depositor preference. - To achieve the targeted 100 basis points minimum coverage within a reasonable timeframe, an increase of the premiums paid by financial institutions will be necessary. - Proposed simplification of rules for eligibility for deposit insurance of complex deposit products is welcomed. ### Provincial Crisis Management and Cooperation with Federal Authorities - Provincial arrangements for crisis management and cooperation with federal authorities could be enhanced. - Provincial safety nets should be reinforced to ensure: - well-funded and prepared deposit insurance schemes; - comprehensive resolution frameworks; - clear policies and operational guidance for crisis management. - Longer-term objective: introduce more uniformity across operating standards of provincial safety nets and convergence towards leading practices. - Recommend more integrated communication on financial stability issues at both provincial and federal levels and prioritize active cooperation on systemically important financial institutions. *Source: Excerpt from IMF staff report content unit _cr1429 (PDF chapter/section).* ### Appendix I. Financial Sector Structure ### Appendix I. Financial Sector Structure ### Overview - As of calendar year end-2012 (consolidated balance sheet accounts, market value). - Total financial sector assets: 9,119,921 Millions Can$ representing 100% of sector assets and 501% of GDP. ### Key statistics and sector shares - Total assets (Millions Can$): 9,119,921 - Total assets % of sector: 100% - Total assets % of GDP: 501% ### Sector breakdown (Millions Can$; % Total Assets; % GDP) - Banks: 3,849,384 — 42% of total assets — 212% of GDP - Domestic banks: 3,663,491 - Foreign subsidiaries and branches: 185,893 - Trust and mortgage loan companies 1/: 49,495 — 1% of total assets — 3% of GDP - Credit unions, caisses populaires, central credit unions: 352,326 — 4% — 19% of GDP - Credit unions and caisses populaires: 297,607 - Central credit unions 2/: 54,719 - of which: Federally regulated: 23,116 - Non-depository credit intermediation 3/: 84,872 — 1% — 5% of GDP - Life insurers and segregated funds 4/: 1,009,617 — 11% — 55% of GDP - of which: Federally regulated: 958,763 - Provincially chartered 2/: 50,854 - Mutual funds: 1,133,091 — 12% — 62% of GDP - Property and casualty insurance 5/: 427,411 — 5% — 23% of GDP - of which: Federally regulated (including mortgage insurers) 6/: 415,261 - Provincially chartered 2/: 12,150 - Trusteed pension plans: 1,189,781 — 13% — 65% of GDP - of which: Federally regulated private pension plans 7/: 142,000 - Provincially regulated: 1,047,781 - Financial government business enterprises: 158,545 — 2% — 9% of GDP - of which: Federal: 79,596 - Provincial: 78,949 - Other (excluding monetary authorities): 865,400 — 9% — 48% of GDP - Issuers of asset-backed securities 8/: 122,756 - Other private financial institutions 9/: 742,644 ### Notes (as presented) - Sources: Bank of Canada; OSFI; Statistics Canada; Canadian Council of Insurance Regulators; company reports; and IMF staff calculations. - 1/ Excluding bank trust and mortgage subsidiaries. - 2/ As of end-2011. - 3/ Includes sales finance and consumer loan companies; other non-depository credit intermediaries are included in Other private financial institutions. - 4/ Excluding fraternals, six bank-owned L&H companies, and one L&H company-owned bank. - 5/ Excluding five bank-owned P&C companies. - 6/ Includes CMHC, a Crown corporation of the Government of Canada. - 7/ 2011-12, estimate. - 8/ Might include some conduits that are already being consolidated into bank and other balance sheets, depending on the degree of control over the conduit by the sponsor. - 9/ Includes holding companies, insurance/mortgage/security brokers, investment advisors, and other non-depository credit intermediaries; only loans are reported here. *Source: Appendix I. Financial Sector Structure (as of calendar year end-2012) — IMF staff compilation.* ### 3. Tail shocks ### _cr1429 - 3. Tail shocks ### Scenario analysis - Baseline: - January 2013 WEO baseline, real GDP growth for 2013 is 1.7 percent and 2.3 percent for 2014 - Adverse: - Model-driven scenario generated using the BoC model to simulate a U-shaped recession over 2013-2015, representing the most severe recession in at least the last 35 years, driven by: - a large foreign demand shock and decreasing commodities prices caused by a disorderly default in a peripheral euro area country and a subsequent recession in the euro area and the United States - rising funding costs due to rising uncertainty and adverse confidence - negative wealth effects affecting households and business - Paths under the stress scenario of other relevant macroeconomic and financial variables are generated by the central bank using its own macroeconomic models ### Sensitivity analysis - Credit risk shocks: - increase obligor correlation by 25 percent on a relative basis - Interest rate risk in the banking book: - steepening of the yield curve depending on currency (e.g. 100 bps widening in the short end of the curve; 350 bps widening in the long end of the curve for CAD) - Downturn LGDs: - downturn LGDs were subject to additional shock to follow the dynamics of projected LGDs by banks in the BU test; new downturn LGDs were used for calculation of expected losses and RWAs for credit risk - Point-in-time and through-the-cycle PDs: - Point-in-time PDs were replaced by through-the-cycle PDs updated to reflect point-in-time PDs in 2013-2017 - Market risk shocks on Trading, AFS securities and CVA: - (i) currency moves: 10 percent depreciation of the CAD against the U.S. dollar, 15 percent depreciation of the euro against the U.S. dollar, 10 percent depreciation of the GBP against the U.S. dollar, 20 percent appreciation of the U.S. dollar against the MXN, 15 percent depreciation of the U.S. dollar against the JPY - (ii) stock market decline: Nikkei and S&P500 by 30 percent; TSX, MSCI and STOXX50 by 40 percent - (iii) commodity price decline: energy, base metals, precious metals and grains by 60, 65, 25 and 40 percent respectively - (iv) interest rates (depending on the currency and maturity) and credit spreads (depending on exposure) increase - Asset correlation: - negative asset correlation was replaced by positive asset correlation in the IRB formula (sensitivity analysis) - Additional notes: - Downt​urn LGDs provided by OSFI; PIT PDs and downturn used for both credit losses and stressed RWA calculations - Positive asset correlation used in sensitivity analysis of RWAs for credit risk ### Risks and Buffers (general) - Risks/factors assessed: - Credit risk (households, corporates, sovereign, domestic and foreign exposures) - Market risk including equity, exchange rate and interest rate risk in the trading and banking book - Taxes: - set at the regulatory requirement (some domains) - set at the effective rate in the base-year (other domains) - Behavioral adjustments: - Projected balance sheet growth were supposed to be consistent with the assumptions on credit growth provided by OSFI/BoC - Any capital actions that are designed to offset the impact of the stress scenario on the bank were not allowed - Dividends paid per share were set to be constant throughout the Stress Years and consistent with the dividends paid in the Base Year. If constrained banks (CET1 < 7 or 8percent) should have followed capital conservation rule - Balance sheet items were projected using forecasted loans (asset items) or deposits (liability items) and a share of each balance sheet item to loans or deposits; loans were taken from the stress scenario whereas deposits were projected using nominal GDP - Balance sheet growth and deposits growth were assumed to be equal to credit growth provided by the BoC (generated using BoC models as part of model-driven scenario) - Dividend payout schedule follows the capital conservation rule; banks could distribute maximum dividend amount equal to dividend payout ratio (dividends over net income) in the base-year; dividends were paid out only if bank records profits - Asset disposals and acquisitions over time were not considered; the portfolio composition remained unchanged over time, with maturing exposures replaced with similar ones ### Regulatory and calibration of risk parameters - PDs and Delta PDs: - The End of Base Year PDs used as a starting point are based on banks’ historical experience using annual exposure-weighted default rates (of non-defaulted exposures) - Delta PDs, representing the year-over-year change in the annual point in time PDs were taken from the BoC (applied to point-in-time PDs in 2012 provided by banks in the BU test) - Through-the-cycle PDs were updated to reflect dynamics of point-in-time PDs - LGDs and write-offs: - LGDs calibrated; write-offs calibrated - Downturn LGDs provided by OSFI - RWAs for credit risk: - For IRB exposures, stressed RWAs were calculated using Basel II, IRB formula that translates downturn LGDs, changes in point-in-time PDs, changes in assets correlation and the maturity adjustment parameter into stressed RWAs in economic terms - Banks projected changes in the credit quality of their exposures consistent with macroeconomic and financial factors provided in the Baseline and Stress scenarios; IRB banks were allowed to move exposures into different IRB LGD/PD buckets but were not allowed to recalibrate IRB LGDs or through-the-cycle PDs - Risk-weighted assets were modeled using two approaches: (i) by applying risk weights from 2012 BU stress test in the stress scenario, and (ii) using IRB formulas by asset classes assuming there are no standardized exposures using downturn LGDs, through-the-cycle PDs and exposures reported by banks in the BU test - Market risk RWAs: - The calculation of Market Risk RWA should consider VaR: during a period of negative GDP growth rates, VaR should be set to the Base Year Stressed VaR, and during a period of positive GDP growth rates, VaR should be set to the level of the Base Year VaR. Stressed VaR should remain constant at the base year Stressed VaR level - Market risk in a period with negative GDP growth is added to the base years market risk RWAs - Operational risk: - Operational risk calculation follows TSA which depends on gross income; banks recalculated the charge for operational risk to be consistent with the Baseline and Stress scenarios - CVA and CCR: - Full implementation of the CVA charge—RWAs for CCR and CVA were calculated based on Basel III rules; The Current Exposure Method (CEM) was used for calculating CCR RWA, and the Standardized CVA capital charge with CEM-based EAD was used to calculate CVA capital requirements - Other: - Real RWAs levels calculated were not used in a calculation of capital requirements; percentage changes in calculated RWAs were applied to the base year ### Banking sector: Liquidity risk - Institutional perimeter: - 6 commercial banks (RBC, TD, BNS, CIBC, BMO, NBC) - 93 percent of total banking sector’s assets - Data provided by banks for liquidity tests; consolidated banking group as of October 2012 - Methodology: - MFRAF: funding liquidity risk (and network effects) is modeled as an endogenous outcome of the interaction between market liquidity risk, solvency risk and the structure of banks’ funding under the baseline and the adverse scenario; liquidity (and network effects) are translated into losses that affect capital position of each bank - Tail shock (size): - The shock is endogenous and is represented by a run by short-term creditors conditional on the size of credit losses and liquidity measure which depend on calibrated fire-sales discounts, amount of liquid and illiquid assets and the value of liabilities maturing over the next 6 months; calibrated parameters of the liquidity measure are in large part consistent with emerging international standards under the two scenarios - Risks: - Funding and market liquidity risk (including information contagion risk) due to solvency issues - Buffers: - Liquid assets - Calibration of risk parameters: - Parameters are calibrated based on banks’ monthly balance sheet reports; parameters of the liquidity measure in large part consistent with emerging international standards; liquidity losses are assumed to be equal to 2.25 percent of RWAs - The “run point” is an increasing function of bank’s capital, liquid asset holdings, and the return on short-term debt and a decreasing function of the amount of short-term funding and the opportunity cost of short-term creditors ### Banking sector: Spillover risks - Institutional perimeter: - 6 commercial banks (RBC, TD, BNS, CIBC, BMO, NBC) - 93 percent of total banking sector’s assets - Data provided by banks for network tests (exposures that arise from traditional lending estimated by entropy maximization algorithm, cross-shareholdings and off-balance sheet instruments such as exchange traded and OTC derivatives from OSFI’s Survey) - Consolidated banking group as of April 2013 - Methodology: - MFRAF: includes network externalities caused by counterparties’ default which depend on credit losses and losses caused by market and funding liquidity disruptions - Tail shocks (size): - Defaulting banks are unable to fully honor their interbank liabilities - Risks: - Spillover risks/default ### Life insurance sector: Solvency risks - Institutional perimeter: - 3 largest life insurers: Sunlife Financial, Great West Lifeco, and Manulife Financial - Over 60 percent of premiums written in 2012 - Insurers’ own data; Baseline date: 2012Q4 - Methodology and horizon: - Insurers’ internal models with OSFI guidance - Stress test horizon: 2013-2017 - Tail shocks (sensitivity analysis): - Credit spread shocks: increase in Canadian, U.S., and European issuers’ spreads identical to the calibrations for the bottom-up analysis by banks: up to 3-4 the level of end-2012 credit spreads for 2013, gradually declining in the following years - Interest rate risk: decline in CAD, USD, Bund, and JPY interest rates in 2013, gradual increase from 2014 onwards - Equity index shocks: stock market decline (TSX by 36 percent, S&P 500 by 25 percent, Stoxx 50 by 49 percent, MSCI Asia (ex Japan) by 37 percent, Nikkei 225 by 21 percent) - Currency valuation shocks: 10 percent depreciation of the CAD against the U.S. dollar, 11 percent depreciation of the euro against the U.S. dollar, 13 percent depreciation of the GBP against the U.S. dollar, 20 percent appreciation of the U.S. dollar against the MXN, 9 percent depreciation of the U.S. dollar against the JPY - Policy holder behavior: stressed lapse rates, 20 percent higher than in baseline scenario - Combined effect of all shocks above - Risks/factors assessed: - Credit risk (federal and provincial governments /agencies, corporates, domestic and foreign exposures) - Market risk including equity, exchange rate and interest rate risk - Buffers: - Capital ### Mortgage insurance: Solvency risks - Institutional perimeter: - Largest mortgage insurance financial institution - FI provided data; Baseline date: 2012Q4 - Methodology and horizon: - FI internal models with OSFI guidance - Stress test horizon: 2013-2017 - Tail shocks (sensitivity analysis): - Same as life insurers (except for higher lapses) - Risks: - Credit risk (mortgage loans) - Market risk including equity, exchange rate and interest rate risk - Buffers: - Capital *Source: _cr1429 - 3. Tail shocks (IMF PDF chapter).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1429.pdf_