Canada’s Financial Sector: How to Enhance its Resilience

IMF Blog, March 9, 2015

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Authors: Hamid Faruqee, Andrea Pescatori
Publication date: March 9, 2015
Theme: financial crisis management; assessment of Canada’s financial-sector resilience following the 2008 financial crisis and policy options to strengthen it further.

Canada’s financial system held up remarkably well after the 2008 financial crisis, outperforming Group of Seven peers.
The banking system is dominated by a handful of large players that are well capitalized with safe, conservative, and profitable business models concentrated in mortgage lending—much of it covered by mortgage insurance and backstopped by the federal government.
Household debt:
- Household debt increased to historical highs over the past decade, reaching over 150 percent of disposable income—one of the highest among member countries of the Organization for Economic Cooperation and Development.
- Although household debt levels appear to have stabilized recently, they remain a vulnerability.
House prices:
- House prices have risen more than 60 percent nationwide since 2000.
- Major metro areas leading the run-up include Toronto, Calgary, and Vancouver.
- Vancouver was recently ranked second in terms of the lowest affordability globally after Hong Kong.
External and macro risks:
- Lower oil prices have raised concerns in the IMF’s recent report on Canada’s economy.
- Weaker terms of trade, lower growth, and prospects of higher U.S. interest rates could cool an overvalued housing market and raise the risk of a hard landing.
- Early signs include rising home listings to sales in oil-rich Alberta.

Measures implemented:
- Tighter lending standards on insured mortgages, including lower amortization periods, higher down payments, and house price caps, appear to have slowed mortgage credit growth and improved borrower quality.
Leakage and remaining risks:
- Expansion of uninsured mortgages (loans with loan-to-value ratio below 80 percent) has become the bulk of mortgage originations and helps fuel housing demand.
- House price increases concentrated in single–family homes in fast-growing markets seem tied to uninsured mortgages.
- If financial risks escalate, policymakers may need to tighten rules on uninsured mortgages.

Reform the government’s role in mortgage insurance:
- Gradually reduce taxpayer exposure and limit the federal backstop to increase private sector risk sharing and encourage prudence.
- Changes should be gradual given the system’s current reliance on insured mortgages to allow private sector role to expand as the public sector’s role recedes.
Strengthen policy frameworks and institutional arrangements:
- Mandate macroprudential oversight of the financial system as a whole to a single entity to strengthen accountability and the ability to identify and respond to systemic risks; such a body should have broad participation and powers to collect required data to “connect the dots.”
- Establish a coordination framework to support timely decision-making and to test the capacity of federal and provincial authorities to respond to crisis scenarios; extending institutional arrangements in this way can support both the capacity and willingness to act during financial stress.

Source: Canada’s Financial Sector: How to Enhance its Resilience, Hamid Faruqee and Andrea Pescatori, March 9, 2015.