December Financial System Review

This significant report from the Bank of Canada is released bi-annually, and covers the most important aspects of the domestic financial markets. The main focus is to discuss the possible risks which may affect the Canadian financial system.

In the last three issues (December 2008, June 2009, and the latest – December 2009) the bank has identified five key sources of risk, and has followed their development. From the current report, it is apparent that the overall risk has declined since June. However, potential threats have not disappeared.

1.Funding and liquidity

The stability of the Canadian financial system is well known, and the global liquidity crisis had only a limited impact on the industry. Banks were able to quickly react and strengthen their liquidity positions, using both commercial market tools and liquidity support from the Bank of Canada. Liquidity crises arise very fast and often unexpectedly, but this risk is currently identified as not being a major issue.

2.Capital adequacy

Capital positions have improved and leverage has been decreasing. Currently, the main concerns are keeping the capital ratios of market participants healthy, and the ongoing global regulatory efforts.

3.Household balance sheets

This indicator is one of the only sources of risk which showed an increase in the latest report—the debt-to-income ratio of Canadian households is at a record high. The upcoming months will continue to be a challenge for many households’ financial situations. The immediate risk remains low, but appears to be continuing in this uptrend for the near future.

4.Global economic Outlook

The global economic recovery remains vulnerable; however, the worst is believed to be behind us. This source of risk has declined since the June report.

5.Global imbalances and currency volatility

The Bank believes this threat has remained unchanged since June’s report. Poorly maintained fiscal positions of many countries combined with the geographical shift of consumer demand away from the U.S. toward Asia may influence global financial markets in the future. The Canadian government’s fiscal position should remain unaffected, but various industries across the country may be negatively impacted by these factors.

The short-term risks are on the decline globally, and central banks are withdrawing some of their discretionary liquidity facilities, including the Bank of Canada. However, some of the midterm risk are increasing around the world. There will inevitably be a new equilibrium of the global financial markets; global capital flows which we have seen during last 20 years may be revised. Industries, businesses, and consumers will have to rethink their standing strategies.  

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