Bank of Canada says financial risks have eased, but housing still chief threat

By Gordon Isfeld, Financial Post December 10, 2013 - OTTAWA - The threat to Canada’s financial stability has eased for the first time in two years — but risks are never far away. A resurgent domestic housing market and large consumer debt, aided by still-tantalizingly low interest rates, remain major concerns to government and monetary officials.

And while the financial crisis that has engulfed much of the eurozone — amid equally threatening sovereign debt defaults — appears to have abated, future concerns have not.

“Five years after the start of the global financial crisis, economic growth remains modest, dampened by the repair of balance sheets by households, financial institutions and governments,” the Bank of Canada said Tuesday.

“Nonetheless, there have been positive developments in the global financial system,” the central bank said in its semi-annual Financial Systems Review, which updates its June report.

“First, and most importantly, the euro area has continued to stabilize. A modest economic recovery has begun, and there are clearer indications that structural imbalances are subsiding. As a result, the likelihood of a euro-area financial crisis has diminished,” it said.

“Second, long-term interest rates in most advanced economies have increased, helping to improve the financial position of institutional investors with long-duration liabilities, such as pension funds and life insurers.”

Attempting to strike a balance between risks and reforms, the Bank of Canada has cut its threat rating to “elevated” from “high” in June — acknowledging that financial risks are at their lowest point since the ranking system was introduced in December 2011.

The top reading is “very high,” which has never been reached, and the lowest being “moderate.”

However, the bank warned “lower political resolve, due to reduced market pressures or reform fatigue, could delay much-needed progress on reforms, leaving the euro area vulnerable to a renewed period of financial turmoil.”

For Canada, the biggest threats have been — and remain — an overheated housing market and record-high household debt. Those concerns grew from initial efforts by then-Bank of Canada governor Mark Carney to keep the trendsetting lending rate low to encourage spending as the country exited the 2008-090 downturn.

That rate has remained at 1% since September 2010, with policymakers — now led by governor Stephen Poloz — only recently dropping their long-standing statement that borrowing costs would eventually need to increase, reflecting the reality of a sluggish recovery here that might require a rate-cut jump start.

The borrowing frenzy that followed the lower-for-longer rate stance has boosted Canada’s household debt-to-income ration to a historic high of more than 163%.

“The high level of household debt and imbalances in the housing sector are the most significant domestic vulnerabilities to address,” the central bank said.

“If the upcoming supply of units is not absorbed by demand as units are completed over the next few years, there is a risk of a correction in prices and construction activity.”

While Finance Minister Jim Flaherty has tightened mortgage rules four times in four years, and has said he would consider doing so again if required, “it is also the responsibility of the private sector — including households, builders, developers and lenders — to manage risks wisely, ensuring that debts can continue to be serviced over time as interest rates return to normal,” the bank said.

© 2013 National Post, a division of Postmedia Network Inc. All rights reserved.