ADVERTISEMENT

Wilkins Says Canada's Financial System Resilient Despite Threats

Wilkins Says Canada's Financial System Resilient Despite Threats

(Bloomberg) --

Bank of Canada Deputy Governor Carolyn Wilkins cautioned against complacency in the face of financial stability risks at a time of growing global uncertainty.

In a speech titled “Financial Stability in an Uncertain World,” Wilkins highlighted the need to “have the right safeguards in place” in a world of rising uncertainty -- from the trade war between China and the U.S. to Brexit and social unrest in Hong Kong.

“The global context has worsened, increasing risks to the global expansion and chances of financial stress,” she said.

And while Canada's economy is performing well overall and financial vulnerabilities have stabilized on the back of more stringent regulations, the nation's debt levels remain elevated -- a situation unlikely to change if global interest rates remain low, she said. That would make the country's economy more vulnerable to an economic shock.

“This is not the time to let our guard down,” Wilkins said in a speech that represents the Bank of Canada's semi-annual update of financial stability issues in the country. “Robust defenses are especially important when difficulties abroad could affect us at home.”

Worries about Canadian household debt levels -- among the highest in the developed world -- have emerged as the biggest obstacle for the Bank of Canada to match monetary policy easing elsewhere.

The Bank of Canada -- which has the highest policy rate in the industrialized world -- last month said it chose not to cut interest rates at its October decision in part because it was wary of aggravating financial vulnerabilities -- an argument repeated by Wilkins in her speech Tuesday.

“With vulnerabilities high and inflation close to target for more than a year, we said at our most recent interest-rate decision that taking out insurance wasn't worth the cost at that time,” the Bank of Canada's No. 2 official said.

“We also said that in considering the appropriate path for policy, we'd watch how the trade situation and household vulnerabilities evolve as well as fiscal policy developments,” Wilkins said.

She noted that should an “adverse scenario” play out, the Bank of Canada still would have room to manoeuver with the policy rate, along with other tools such as forward guidance.

To be sure, Canada's banking system is “highly resilient” and the economy is doing well, and stress testing shows the nation's financial sector could withstand a severe, system-wide shock.

“The Canadian economy is performing relatively well overall,” she said. “Inflation is close to target, the unemployment rate is near historic lows, and wage growth has picked up.”

At the same time, given high debt levels globally, any potential future downturn could be “deeper than usual and fraught with financial stresses,” said Wilkins, while adding the Bank of Canada doesn't expect to see a recession to happen either globally or at home as the most likely outcome.

“It's still our job to understand what might happen if things were to go terribly wrong,” Wilkins said. “That means looking at different ways that a perfect storm might play out.”

Wilkins laid out a list of potential vulnerabilities globally, on top of high household leverage in countries like Canada. These include declining quality of non-financial corporate debt that could spill over into the exchange-traded fund market. She also cited the growing issuance of collateralized loan
obligations as an area of concern.

Officials need to be cognizant of the risks of an increase in uncertainty creating a “perfect storm” that sparks a sharp reversal in risk appetite.

“What I mean by a perfect storm is a combination of an economic downturn and financial stress,” Wilkins said. “An increase in uncertainty or bad trade news could be the trigger.”

©2019 Bloomberg L.P.