Does shadow banking pose challenge for Canada?

Pressure in fixed-income space from coronavirus revives focus on risks from non-bank financial institutions

Does shadow banking pose challenge for Canada?

Policy experts have already issued warnings about how shadow banking could threaten Canada’s financial stability, and with the continuing impact of the coronavirus outbreak on markets, those warnings are being revisited.

In a newly released commentary, DBRS Morningstar noted that the shadow banking sector in Canada has exploded, outpacing the global industry’s rate of growth. With an average annual growth of 12% annually, it has reached some US$1.5 trillion in assets as of 2018, compared to US$0.6 trillion in 2010. Over the same period, Canadian banks grew at just a 0.7% annual pace, from US$1.9 trillion to US$3 trillion.

“[B]anks are still the largest FI sector in Canada, but nonbank FIs have become much more important over the last decade,” DBRS Morningstar said. Canada’s total financial assets amounted to US$10.5 trillion as of 2018, according to data from the company and the Financial Stability Board (FSB).

The growth in shadow banking, the commentary noted, has been supported by low interest rates, an expanding economy. The industry has been driven by an increase in fixed-income funds, money market funds, mixed funds, and hedge funds, to which investors seeking higher-yielding assets have contributed significantly.

“This segment poses financial stability risks primarily due to funding mismatches, as well as leverage and credit risks,” the commentary said.

Investment vehicles that fall under the umbrella of shadow banking, it noted, are considered by the FSB as part of the “EF1” group of financial institutions that are susceptible to runs. Canada’s retirement system, which provides tax advantages for individuals who hold their savings in registered accounts such as RRSPs and TFSAs, was cited an important driver of the growth in such funds.

“In Canada, the EF1 segment has grown in tandem with the growth of the wealth of individuals, encouraged in particular by the growth of their retirement accounts,” the commentary said, noting that EF1 assets as of 2018 represented US$1.1 trillion of the country’s US$1.5-trillion shadow banking space.

“All in all, the growth of the shadow banking sector could pose a challenge for Canada because, especially in the current uncertain environment, disruptions from nonbank financial institutions could have a widespread impact on the financial system at large,” DBRS Morningstar said.


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