Bank of Canada Sees Financial Risks Rising on Weaker Growth
(Bloomberg) -- The Bank of Canada said risks to the financial system have increased “slightly” over the past year amid growth worries and expanded risk-taking in global markets, while reiterating its confidence in the country’s ability to handle any shock.
In its annual Financial System Review, Canada’s central bank cited slowing growth, trade uncertainty, falling oil prices and riskier borrowing in the corporate sector as reasons why risks to financial stability have picked up. At the same time, key vulnerabilities in the system that would amplify shocks -- primarily high household indebtedness and pricey housing markets -- have eased, it said.
“Global uncertainty is rising, and risks to financial stability have edged up in the past year,” Governor Stephen Poloz said in a statement accompanying the report, which aims at identifying main vulnerabilities and low-probability risks that could have an impact on financial stability. “Still, confidence in the resilience of Canada’s financial system remains high, and we are seeing improvements in some of the key vulnerabilities we’ve been worried about for many years.”
The concerns expressed in the report parallel some of the main messaging from the Bank of Canada in recent weeks -- that of a weaker economic outlook fueled by growing trade uncertainty, which has prompted a dovish tilt globally by central banks on interest rates. After five increases since 2017, the Bank of Canada has indicated it will likely be on hold indefinitely amid the slowdown.
How this analysis -- and the interaction between risks and vulnerabilities -- plays into the central bank’s rate policy is ambiguous. Easing vulnerabilities could give policy makers more confidence in raising borrowing costs, for example, though higher rates could also inflate risks -- such as a recession, or housing price correction -- that raise the likelihood of a shock to the system. Lower rates meanwhile could end up fueling vulnerabilities, even as they reduce risks of any shock.
For example, the Bank of Canada cited how global financial conditions have eased since the end of last year and remain accommodative because of growth concerns, while at the same time warning about the impact of cheap money on risk-taking in markets.
The Canadian financial system’s two key vulnerabilities -- debt and housing -- remain elevated but the situation has improved, the Bank of Canada said.
Tougher mortgage qualification rules and the central bank’s recent rate hikes have slowed borrowing and improved the quality of new lending, while curbing price growth in the Toronto and Vancouver housing markets, it said. In his statement, Poloz reiterated he remains confident a recent slump in the housing sector will end and the “sector will return to growth” later this year.
“New measures have curbed borrowing, reduced speculative behavior in housing markets and made the financial system more resilient,” the governor said.
The Bank of Canada, however, did identify one new emerging vulnerability: rising corporate debt levels, particularly among businesses with lower creditworthiness. This has made the sector more susceptible to shifts in investor sentiment and a repricing of risk.
While the development is global, the central bank said corporate debt in Canada has also risen to well above historical levels, driven by commodity sectors with a growing reliance on U.S. high-yield bonds and leveraged loans.
Still, stress tests conducted by the Bank of Canada indicate that even if major risks materialize to the system, large Canadian banks would be well positioned to manage them.
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