–Canadian Financial System ‘Resilient’ So Far but BOC Monitoring Risks
–High House Prices, Household Debt Are Vulnerabilities for Financial System
–Rising Mortgage Costs Tough on Some Canadians but Higher Rates to Bring Down Inflation
By Max Sato
(MaceNews) – Non-bank financial institutions manage a large share of assets for Canadians but are excluded from the supervision and capital requirements that apply to traditional deposit-taking lenders, posing a threat to the financial system due to their high financial leverage and limited ability to provide cash liquidity, Bank of Canada Senior Deputy Governor Carolyn Rogers said Tuesday.
Non-bank intermediaries are “a very important source for asset management and increasingly a very import source for financing” as they account for about 60% of financial assets in Canada, Rogers said in a fireside chat hosted by the Ottawa chapter of Young Canadians in Finance, after delivering a speech on risks to the stability of the Canadian financial system.
“The absolute size and the size relative to the banking sector is a really important change we’ve seen in recent years,” Rogers said.
“There isn’t much transparency in these institutions,” she said, adding that they are regulated by different agencies for banking, investment, and pension management, and thus it is hard to pull the overall picture together and see where those vulnerabilities are.
Concerned about Leverage, Liquidity
“Our concern is that given the size of these institutions, particularly in relation to the banking sector, which typically intermediates with liquidity events, and that … in the event that would cause what we call a dash for cash, rates for liquidity, it would overwhelm the ability to supply that liquidity,” Rogers warned. “And if you combine a liquidity event with leverage, you can get some pretty extreme financial stability risk. We saw that played out in the UK recently.”
To stave off a liquidity crunch in Canada, different financial regulatory bodies are working more closely together and “trying to get the full picture of where liquidity and leverage is,” she said.
A former banking regulator, Rogers said she does not think there is an inherent risk from the large amount of the financial assets that are sitting in non-bank institutions as risks are well managed in a transparent manner.
As for the banking sector, Canada has been conducting stress tests, which are a good forward-looking indicator for assessing the health of the financial system, she said.
On other financial issues, Rogers said, “For cryptocurrencies to be a threat to monetary policy transmission, they would need to largely replace the existing payment that we have now, so they would need to basically replace cash. So far, I don’t see a lot of that risk happening.”
So far cryptocurrencies are defined as a speculative asset class and they haven’t proven themselves to be a stable store of value or an effective formal payment method, she noted.
Watching Crypto Link to Financial System
But the Bank of Canada is monitoring cryptocurrencies closely so that they would not cause damage to the financial system from the viewpoint of consumer protection and transmission from this type of speculation into the more traditional financial system via so-called stablecoins, Rogers said.
FTX, a crypto exchange, “failed in a way that is very traditional to a financial system,” she said.
“Because crypto assets are not accepted form of payment, ultimately you have to convert them back to fiat currency, and that usually happens through these stablecoins,” she said.
“Stablecoins are pegged to fiat currency,” she said, referring to the government-issued money that is dominant in financial transactions and controlled by the central bank. “In some cases, in order to transition from that world to the traditional world, you can create a link to the traditional financial world. I think regulators are paying close attention to that transmission channel.”
Earlier, in her speech, Rogers said high house prices and elevated household debt have been “vulnerabilities” for Canada’s financial system for a long time, and they built up even more during the pandemic.
“The bottom line is that mortgage costs for some Canadians have already increased, and they will likely increase for others in time, making home ownership more expensive,” she predicted.
Canada’s Financial System Resilient So Far
“So far, Canada’s financial system has proven resilient in the face of significant economic upheaval,” Rogers said.
But at the same time, to ensure the financial system remains strong, Bank of Canada policymakers will continue to monitor the impacts of higher interest rates on Canadians and on financial system stability as well as getting inflation back to target, she said.
“The road back to lower inflation may cause hardships for some Canadians. But we must stay the course – higher interest rates in the short term will bring inflation down in the long term,” she said, repeating the bank’s main message.
Takes Time to Return to Low Inflation
“It will take time to get back to solid growth with low inflation, but we will get there,” Rogers concluded. “By working through this difficult phase, we will get back to price stability with sustained economic growth, which benefits everyone.”
In response to questions, Rogers said, “We are trying to get the economy back in balance. The economy is hot and demand is very high.” She also noted that Canadians are facing “economic uncertainty” after coming out of the uncertainty of not being able to plan or travel during the earlier stages of the Covid pandemic.
The BOC is watching how people’s inflation expectations are developing, she said. “We really need to keep inflation expectations anchored.”
Asked how the aggressive credit tightening by the Federal Reserve is affecting Canada’s economy and policy, Rogers replied that it is leading the U.S. dollar to appreciate against almost all currencies and making Canadian imports from the U.S. more expensive.
“We take account of what’s happening in the U.S., particularly how it will affect inflation here in Canada, but our monetary policy decisions are set for the Canadian economy,” she said.
Earlier this month, Governor Tiff Macklem indicated that the bank’s aggressive tightening mode is coming closer to an end but also stressed its job to restore price stability is not done yet amid elevated inflation.
Economists expect the Bank of Canada to raise its policy interest rate by another 50 basis points to 4.25% as consumer inflation, while easing from a recent peak, remains too high and broad for sustained economic growth.