Is Canada heading for a financial crisis?

A global banking body is seeing signs of weakness in the Canadian economy

Is Canada heading for a financial crisis?
Credit issues, property prices, and potential hikes in interest rates in Canada have led an international banking entity to flag the country for “vulnerabilities.”

In a quarterly report, the Bank of International Settlements (BIS) has placed Canada among jurisdictions that show early warning signs for financial crises and domestic banking risks, according to the Financial Post.

“Canada, as well as a group of Asian countries, saw increases in the credit gap since September 2016,” the BIS said in its fall report. Highlighting Canada’s credit-to-GDP rations – one of the highest among developed nations – the report said the “unusually” high level posed a threat to the banking system.

The most recent report has Canada’s credit-to-GDP level at 17.4% – below China’s 26.3%, but still well above the BIS threshold of 10%. The report notes that in two thirds of banking crises, credit-to-GDP gaps exceeding 10% were observed during the three years prior to the event.

Another point of concern was Canada’s large property price gap, which puts it in league with countries including Germany, Greece, Japan, and Portugal — although the BIS clarifies that high price gaps in the last three countries are driven by price growth returning to “normal” levels after extended declines, so they don’t necessarily signify vulnerabilities.

The BIS report notes that debt-service ratios for most countries can be managed assuming that interest rates don’t change. Canada, however, is one of several countries that face potential risks in case of a 250-basis-point rise in rates.

The global banking body predicts a jump in Canada’s debt-service ratio from 3.6% to 7.9% in such a scenario, which would be the second highest among 22 countries.

The report cautions, however, that the interest-rate sensitivity figures are not taken from a “proper stress test,” and a rise in rates would take time to translate into higher debt-service demands. Consumers might also be partially insulated from higher rates, depending on factors such as share of debt at floating rates, debt maturities, and shifts in borrowing behaviour.

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