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Canada Financial System Stability Assessment Summary

Core Content

This document presents the Financial System Stability Assessment (FSSA) on Canada, prepared by the International Monetary Fund (IMF) staff team as part of the periodic consultation with Canada. The assessment was completed on June 6, 2019, and is based on information available up to that date. It outlines the structure, performance, and vulnerabilities of Canada's financial system, as well as recommendations for enhancing its stability and resilience.

Main Findings

1. Financial System Performance

• The Canadian financial system has shown strong performance, characterized by:
  • Solid profitability in the banking sector.
  • Significant capital buffers across major financial institutions.
  • Resilience of the insurance sector even in a low-interest rate environment.
  • Growth in nonbank financial sectors, particularly pension funds and mutual funds.
  • Stable system-wide liquidity conditions.

2. Macrofinancial Vulnerabilities

• Elevated household debt and housing market imbalances are major concerns.
• The low interest rate environment has contributed to increased risk-taking in nonbank financial sectors.
• Housing finance is broadly resilient, but the non-prime mortgage lending segment shows vulnerabilities.
• Procyclical effects could be amplified due to borrowers' refinancing behavior and lenders' risk-based pricing in a housing downturn.

3. Systemic Risk and Interconnectedness

• Canada's financial system is increasingly interconnected both domestically and internationally.
• Cross-border spillovers and overseas operations pose potential risks.
• The low interest rate environment and foreign-currency funding increase systemic risk exposure.

Key Risks and Vulnerabilities

1. Housing Market Risks

• High house price overvaluation increases downside risk.
• Mortgage insurers may face capital shortfalls in severe adverse scenarios.
• HELOCs with interest-only payments have grown rapidly, increasing exposure.

2. Nonbank Financial Sectors

• Life insurers, pension funds, and mutual funds have increased risk-taking.
• Derivatives usage and foreign-currency exposure are significant.
• Non-prime mortgage lending remains a weak point.

3. Liquidity and Systemic Risks

• Major deposit-taking institutions have sufficient liquidity to withstand large funding outflows.
• Systemic liquidity is stable, but contingency plans for market-wide liquidity support need further development.
• Bail-in mechanisms and depositor preference should be strengthened to improve resolution frameworks.

Financial Stability Architecture

1. Institutional Setting

• Canada has a high-quality financial sector oversight system.
• The Bank of Canada (BOC) and Office of the Superintendent of Financial Institutions (OSFI) play key roles in supervision and regulation.
• The Cooperative Capital Markets Regulatory System (CCMRS) initiative aims to address dispersed oversight in securities markets.

2. Systemic Risk Oversight

• The federal-provincial coordination is generally effective but needs improvement.
• A federal-provincial platform (e.g., the Heads of Agencies Committee (HOA)) is recommended to discuss systemic risk issues and formulate policy responses.
• A single body for systemic risk oversight is the ideal solution, but in the absence of that, the BOC's role should be formalized and strengthened.

3. Crisis Management and Safety Net

• The bank resolution regimes and deposit insurance systems are aligned with international best practices.
• Contingency planning for market-wide liquidity support and securities market interventions should be further developed.
• Emergency Liquidity Assistance (ELA) needs to be operationalized for provincially regulated institutions through indemnity agreements.

Policy Recommendations

1. Strengthening Financial Resilience

• Raise capital requirements for mortgage exposures at both banks and mortgage insurers.
• Increase risk-based differentiation in mortgage pricing.
• Develop a policy framework to manage a housing market downturn.
• Enhance transparency and data collection to improve risk monitoring.

2. Improving Financial Sector Oversight

• Clarify roles and responsibilities of financial market infrastructure (FMI) overseers.
• Strengthen credit risk oversight for real estate-related exposures.
• Complete the CCMRS initiative to improve securities market regulation.
• Address regulatory gaps in OTC derivatives and client duties.
• Enhance inter-agency cooperation, especially between federal and provincial authorities, through Memorandums of Understanding (MoUs).

3. Crisis Preparedness and Safety Net

• Task the Senior Advisory Committee (SAC) with overseeing Canada-wide crisis preparedness.
• Strengthen CDIC's operational independence.
• Expand recovery and resolution planning to all deposit-taking institutions.
• Further develop the valuation framework for bail-in compensation.
• Adopt depositor preference to minimize losses to deposit insurers.
• Operationalize ELA with key provinces.
• Develop contingency plans for market-wide liquidity support, including foreign-currency liquidity provision.

Key Institutions and Authorities

• Bank of Canada (BOC): Central bank, responsible for monetary policy and systemic risk surveillance.
• Office of the Superintendent of Financial Institutions (OSFI): Regulates and supervises financial institutions.
• Canada Deposit Insurance Corporation (CDIC): Provides deposit insurance.
• Autorité des marchés financiers (AMF): Oversees securities markets in Quebec.
• Ontario Securities Commission (OSC): Oversees securities markets in Ontario.
• British Columbia Securities Commission (BCSC): Oversees securities markets in British Columbia.
• Financial Institutions Commission (FICOM): Oversees financial institutions in British Columbia.
• Heads of Agencies Committee (HOA): Proposed platform for federal-provincial coordination on systemic risk issues.

Summary of Key Recommendations

Conclusion

Canada's financial system is robust and resilient, capable of managing severe macrofinancial shocks. However, elevated household debt, housing market imbalances, and increased risk-taking in nonbank sectors pose substantial financial stability risks. While the regulatory and supervisory frameworks are strong, there is a need for enhanced coordination between federal and provincial authorities, improved systemic risk oversight, and stronger contingency planning. The FSAP team recommends a series of policy actions to strengthen the system's resilience and preparedness for future challenges.