On Sunday, The Bank of International Settlements (BIS) published their quarterly review of central banks, noting Canada is among the top three economies in the world most at risk of a banking crisis.
The 196-page report from the Swiss-based organization outlines an assessment of various banking indicators; observing potential signs that can lead to stress at domestic banks. The report looks at four measures based on the set of early warning indicators (EWIs), in which two of those measures (credit-to-GDP gap and total debt-service ratio) hint to troubles for Canada. Both debt measures have exceeded a threshold that points higher probability of a banking crisis. The other two measures (debt service ratio for households and cross-border claims to GDP) triggered amber alerts for Canada. Canada is the only country listed where all four measures are highlighted (see Fig. 1).
The consumer debt levels amongst Canadians is cautiously high; currently sitting in the red zone with a debt-to-GDP ratio of 9.6. Hong Kong, China, and Switzerland are also sitting in the red zone with a debt-to-GDP ratio of 30.7, 16.7, and 16.3 respectively. Canada’s debt-service ratio, which measures Canada’s ability to pay the interest on its debts, sits at 2.9 per cent; nearly double the country average of 1.8 per cent. According to the BIS, “the flashing red signals for Canada and Hong Kong are reinforced by property price developments.” Essentially, steep rising prices in Canada has forced more Canadians to take on debt to afford their homes. As a result, Canadians are more at risk to rising interest rates that could push their monthly payments beyond a manageable level.
During the first few months of 2017, there was an extraordinary demand for houses, as parts of the Canadian housing market reported year-over-year price gains of over 30 per cent. Recently, measures have been put in place to cool down the overheated market including tougher stress testing for borrowers, taxes on foreign buyers, and increased interest rates. According to the latest provincial outlook by the Royal Bank of Canada, the economy is expected to gradually slow due to the newly implemented measures. The Bank of Canada (BoC) recently announced it would keep rates flat despite having raised its rates three times over the last six months. As the country absorbs the recent decline in home sales, and continues to re-negotiate NAFTA, the BoC is expected to take a pause on further interest rate hikes until it sees more clarity in its economic growth forecasts. While the BIS has recognized Canada is in a fragile place, it appears the BoC may be tempering its optimism as well.