Remarks by Toni Gravelle
Deputy Governor of the Bank of Canada
Autorité des marchés financiers
Montréal, Quebec
November 23, 2020
(via webcast)
Financial stability and the
COVID-19 pandemic
Introduction
Thank you for the invitation to connect with you virtually in these unusual times.
The Bank of Canada has enjoyed a long and productive relationship with the
Autorité des marchés financiers. We have worked together on our respective
oversight of financial market infrastructures and shared our perspectives on
stress testing of systemically important institutions.
And, of course, I have known several of you personally, including Mr. Morisset,
for some time through this work and through my role supporting and participating
in the Heads of Regulatory Agencies (HoA).1
The Bank greatly values your contributions to maintaining a stable and healthy
financial system-not just for Quebeckers but for all Canadians.
the Bank's
My remarks today are part commitment to update Canadians twice a
year about key vulnerabilities and risks to the financial system.2 We continually
ability
assess the financial system's to function well in both good times and bad.
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We do this work precisely for times like these, when the economy and financial
system have been hit by a calamitous shock like the COVID-19 pandemic.
Canada already faced significant financial vulnerabilities before the onset of
COVID-19, most notably the high level of household debt and the imbalances in
some housing markets. Given these, we have long warned that a recession could
create broad stress across the financial system. Yet, despite the devastating
economic impact of the pandemic, this risk has not-as of yet-materialized.
hasn't
The main reason it come to pass is the unprecedented policy response to
the pandemic. Early on, the Bank acted quickly to restore and maintain market
functioning, and the federal government launched a range of support programs to
help millions of households and businesses cover financial gaps.
Another fundamental reason is that our financial institutions were capitalized well
enough coming into the crisis that they could be flexible about debt repayments
without risking their own solvency. This underscores the importance of having a
resilient financial system, such as Canada's, when the economy faces a major
Canada's financial
shock. system has continued to serve Canadians well through
the pandemic-just as it did during the 2008-09 global financial crisis.
Nonetheless, the pandemic remains a source of considerable financial system
risk, despite this resilience. From a system-wide perspective, we still have to
watch for the possibility that the tough times many households and businesses
are facing could lead to credit losses that ripple throughout the financial system.
If losses make it harder for banks to make loans, the recovery in economic
activity and employment will be hampered, amplifying an already challenging
situation. So we need to remain vigilant.
I'd like to
With that in mind, begin with some details about vulnerabilities and
risks arising in the household and business sectors.
After that, I'll talk
about the overall resilience of the Canadian financial system,
including what our latest Financial System Survey tells us about how COVID-19
has affected the perceptions of people who work in the financial industry.
Financial vulnerabilities and risks from COVID-19
The impact of COVID-19 on lives and livelihoods is unlike anything we have seen
Monetary Policy
in our lifetime. And as we outlined most recently in the October
Report (MPR), a full economic recovery will take quite some time.
The longer the pandemic constrains jobs and incomes, the greater the risk of
financial trouble for highly indebted households, and the greater the risk of
defaults that could impair the whole financial system.
Also, many businesses in sectors where physical distancing is difficult-such as
restaurants, bars, hotels and gyms-are struggling to remain solvent as they try
to cover fixed payments with less revenue. This too could become a financial
stability risk as time goes on.
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Household sector risks
In the May 2020 Financial System Review (FSR), we explained that COVID-19
had hit employment incomes hard and that many households faced great
difficulty, especially if they were already carrying a lot of debt.
clear that
Six months after the FSR, it's government income support programs
have been instrumental in getting millions of Canadians through the crisis.
The financial system has also helped households cope, with deferrals on a range
of loans, including mortgages, lines of credit and credit cards. Since the start of
the pandemic, about 14 percent of homeowners with mortgages and 10 percent
of renters have asked for deferrals on some kind of debt repayment.
Still, these measures were always meant to be temporary-by the end of
September, about 60 percent of all payment deferrals had expired. That includes
about 70 percent of deferrals on credit card debt and automobile loans.
We have been tracking this closely to gauge the risk of defaults on loans and
whether they could be sufficiently widespread to threaten financial stability.3
the Bank's latest
Data from Canadian Survey of Consumer Expectations indicate
that about 1 in 3 borrowers who asked for deferrals did so as a precaution or to
repay other debt, not to help manage income losses due to COVID-19 (Chart 1).
This suggests there is reason to be optimistic that they will be able to return to
regular debt repayment as their deferrals expire.
Chart 1: Many borrowers who asked for deferrals did so for reasons that were unrelated
to the COVID-19 pandemic
%
0 10 20 30 40 50
Could not pay due to
pandemic-related decline in
household income
Could not pay due to reasons
unrelated to COVID-19
Requested as a precaution
Decided to repay other
obligations
Other/not applicable
Own with mortgage Rent
Source: Canadian Survey of Consumer Expectations-Third Quarter of 2020
Last observation: 2020Q3
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Indeed, so far, the risk of a wave of consumer defaults seems low. The vast
majority-over 99 percent-of households with expired deferrals on any kind of
debt have resumed repayment (Chart 2).
Chart 2: Almost all households with expired deferrals have resumed repayment
Share of accounts at least 30 days behind on payments
%
5
4
3
2
1
0
Mortgages Installment and auto Home equity lines of Lines of credit (excl. Credit cards
loans credit (HELOCs) HELOCs)
All accounts before COVID-19 Expired deferrals
Last observation: September 2020
Sources: TransUnion and Bank of Canada Calculations
It is too soon to be definitive, though, especially about mortgages. Many
mortgage deferrals ended only in October, so we may not have a full picture of
how many homeowners have fallen behind on those payments until the end of
the year or early 2021.4
Although the risk of widespread defaults appears well managed, we still need to
closely monitor the underlying vulnerabilities. This is particularly important given
that we expect to keep interest rates low for quite some time.
To be clear, low interest rates are necessary to support a broad recovery of
economic activity. By supporting jobs and incomes today, monetary policy has
helped minimize financial risks from the sharp economic slowdown and jump in
unemployment that resulted from the pandemic.5 But there is a trade-off: low
interest rates can increase key financial vulnerabilities, making the financial
system and economy less resilient to future shocks. Targeted macroprudential
policies, such as the mortgage-interest stress test, can be particularly effective at
helping to limit the growth of vulnerabilities. So, it is important for all
policymakers to keep a close eye on how vulnerabilities are evolving.
Let's
turn to what the Bank is seeing in terms of the household debt burden.
The overall ratio of household debt to income fell during the second quarter-at
the height of containment measures-from 175 percent to 158 percent. This is
mainly because government transfers boosted income for many households. In
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fact, total household debt was relatively unchanged, although there were
significant differences between consumer and mortgage debt.
Outstanding consumer debt has declined since the pandemic began, driven by a
drop in credit card balances of roughly 15 percent because many households
have paid down debt or increased savings. This is probably because people in
sectors where more workers can do their jobs from home are more likely to have
remained employed-a reminder of the uneven effects of this crisis. It is also
because people are spending less on non-essentials, which has meant less
overall credit use, particularly during the spring and early summer (Chart 3).
Chart 3: Consumer credit fell in the spring and has stayed below pre-pandemic levels
Index: March = 100 Index
105
100
95
90
85
80
75
Mar Apr May Jun Jul Aug Sep
Personal loans Credit cards Lines of credit Total
Source: Bank of Canada
Last observation: September 2020
However, the bulk of total household debt is mortgage debt, and it has continued
to grow at a solid pace-supported by the strength in the housing market that we
saw over the summer and into fall.
Since imbalances in some housing markets have been another key source of
financial vulnerability in Canada, we're naturally paying close attention to how
this evolves.
While low interest rates have supported housing, the strong bounce back in
many markets also reflects pent-up demand that built up over the containment
period as well as a shift in preferences toward homes with more space. Since
real estate activity picked up again in late spring, households that haven't seen
much or any loss of income have been in a position to act. To this point, we do
not see signs that home prices are rising due to speculation, like we saw in the
greater Toronto and Vancouver areas a few years ago. Moreover, recent price
growth has been strongest in cities where mortgages are more moderate relative
to income, such as Montréal, Ottawa and Halifax. The next few months will give
us a better sense of where the housing market is fundamentally. But we still need
to watch for possible downward pressure in certain pockets, even if the overall
picture seems well-balanced.
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More specifically, the shift in preferences as people spend more time at home
and want more space has obvious implications for condominium markets in
major cities like Toronto. Another factor limiting demand for condos during the
pandemic has been lower immigration and fewer foreign students coming to
Canada.
On the supply side, a softer rental market could lead some real estate investors
to list their units. Active listings for condo rentals in Toronto were 210 percent
higher in October than a year earlier (Chart 4), and the median rent was
13 percent lower. And plenty of construction was underway in Toronto before the
pandemic, so thousands of units will hit the market in 2021.
Chart 4: Active condo listings in the greater Toronto area have risen while rents have fallen
Year-over-year percent change
%
%
300 15
10
200
5
100 0
-5
0
-10
-100 -15
2015 2016 2017 2018 2019 2020
Active listings (left scale) Median condo rent (right scale)
Sources: Realosophy Realty Inc. Brokerage and Bank of Canada calculations Last observation: October 2020
Business sector risks
Let's
turn to businesses. Back in May, we said that the businesses facing the
most stress were those that came into the crisis with high debt levels and few
liquid assets. Businesses faced a situation much like that of households: the
longer the economic recovery, the greater the risk that cash flow issues could
become solvency issues.
Six months later, the pandemic continues to create a challenging environment,
especially in sectors that involve in-person contact or confined spaces.
In the second quarter of the year, total revenue in the non-financial business
sector fell 14 percent. We saw even larger declines in industries such as
transportation, arts and entertainment, and accommodation and food services
(Chart 5).
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Chart 5: Operating revenue fell sharply in many sectors during the second quarter of 2020
Utilities
Professional, scientific and technical services
Real estate
Pipelines
Telecommunications
Educational and health care
Agriculture, forestry, fishing and hunting
Repair, maintenance and personal services
Construction
Rental and leasing
Warehousing
Administrative support
Mining and quarrying
Wholesale
Information services
Retail trade
Total non-financial industries
Manufacturing
Transportation
Arts, entertainment, accommodation and food services
Oil and gas extraction and support services
-50 -40 -30 -20 -10 0 10 %
Sources: Statistics Canada and Bank of Canada calculations
Last observation: 2020Q2
Even after much of the economy reopened in the third quarter, many businesses
in these and related sectors continued to report lower revenue compared with
pre-pandemic levels. For example, in August, revenue was down at least
40 percent from a year earlier for almost half of all arts and entertainment and
recreation businesses. The drops have been sharpest for smaller companies,
which may find it relatively tougher to access funds.
As well, firms in the oil and gas sector have had to deal with the drop in oil prices
that occurred after global travel ground to a halt. Revenue for the sector as a
whole plunged 45 percent in the second quarter, even as energy companies
were still adjusting to the 2014-15 collapse in oil prices.
Government measures such as wage and rent subsidies have helped businesses
in many sectors manage their cash flow needs. The recent extension of these
subsidies into 2021 will continue to help businesses-and their employees-hurt
by the pandemic. The Canadian Emergency Business Account has also played
an important role, allowing almost 800,000 small and medium businesses to
obtain subsidized loans to help them manage their expenses.
Taken together, these measures mean fewer businesses facing severe shortfalls
due to COVID-19 are using traditional forms of financing such as loans, bonds
and equity to survive the crisis. Aside from a "dash for cash" in March-as large
firms drew on their lines of credit-business financing has been relatively
subdued over the pandemic. And business insolvency filings remain below
prepandemic levels (Chart 6).
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Chart 6: Business insolvencies have remained below pre-pandemic levels
400
350
2018-19 average
300
250
200
150
2018 2019 2020
Source: Office of the Superintendent of Bankruptcy
Last observation: September 2020
But the pandemic is far from over. As we said in the October MPR, even if
aren't imposed
widespread lockdowns again, we expect successive waves of the
virus will require ongoing localized and targeted restrictions.
Bank staff have been working to assess how well businesses could manage what
is likely to be a long and bumpy recovery. We expect that an increasing number
of businesses will need financing in the coming quarters to get by. Staff will be
conducting simulations using firm-level data to quantify this, and we plan to
publish those results in the next couple of months.
Market functioning
The likelihood that more businesses will need financing highlights how important
it is for the financial system to function properly.
Think back to early in the pandemic. As uncertainty rippled through global
markets, investors were dumping debt securities in favour of cash or halting their
trading altogether. To alleviate these market stresses, the Bank launched a
series of asset purchase programs and liquidity facilities in March, April and May.
These programs sought to restore market functioning to make sure that our
monetary policy actions could pass through to the economy and that
businesses-and households-could still get credit if they needed it.
Today, markets are functioning well enough that several of these programs have
been discontinued.
When the Bank provides markets with extraordinary liquidity support, we try to
we're trying to solve
make sure that we address the problems without creating
incentives for financial system participants to take on undue risks in normal
times. In other words, we aim to avoid moral hazard. Just as it is important to
so they don't become
gradually wean a patient off painkillers as their injuries heal
addicted, we gradually phase out our various facilities once painful market stress
has dissipated. This should not be surprising to market participants.
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But make no mistake: if market-wide stresses reappear and we need to do more
to ensure that the financial system can continue to support Canadian households
and businesses, we will.
Gauging resilience in the financial system
Ultimately, the more resilient the financial system is, the more it will be there to
help Canadians deal with the pandemic, just as it helped Canadians during the
global financial crisis.
When COVID-19 hit Canada, the Bank needed to quickly figure out whether the
financial system could withstand its impact. So, for our FSR we conducted a
on Canada's six biggest
stress test banks, which make up close to 90 percent of
bank assets in the financial system. The stress test was based on the most
pessimistic scenario from our April MPR, which highlighted the wide range of
plausible outcomes for how the pandemic could affect the economy.6 The
exercise found that the banks had adequate capital buffers to withstand such a
negative economic scenario-a clear sign of a robust, resilient financial system.
Since then, the economy has performed better than the scenario that we used in
the stress test, which further reduces concern about financial stability. That being
said, we are now in the slower-growth recuperation phase of the recovery, and
total employment is still around 640,000 jobs lower than before the pandemic.
There is, unfortunately, scope for more hardship-and for financial vulnerabilities
to grow.
In addition to our own monitoring and stress testing, another important piece of
the Bank's
assessment of financial stability is our Financial System Survey.7
Given the extreme uncertainty that COVID-19 injected into our outlook, surveys
such as this provide us with uniquely valuable information.
The autumn 2020 survey, released on Friday, tells us that financial industry
ability
professionals are broadly confident in the financial system's to withstand a
were at least "fairly
severe shock. Nearly all respondents-98 percent-said they
confident" the system can withstand such a shock.
Yet, the survey respondents also think that risks to the system have grown
considerably. The share of respondents who said risks have increased materially
in the short term, less than a year, rose by 40 percentage points from the autumn
2019 survey
(Chart 7).
Chart 7: Financial System Survey participants have grown more concerned about the
short-term risk of a shock that impairs the financial system
Percentage of respondents Index points
100 1.2
75 0.6
50 0
25 -0.6
0 -1.2
Spring 2018 Autumn 2018 Spring 2019 Autumn 2019 Autumn 2020
Decreased materially (left scale) Decreased slightly (left scale)
Remained unchanged (left scale) Increased slightly (left scale)
Increased materially (left scale) Risk index (right scale)
Note: Short-term is defined as "less than a year". The risk index is constructed with the following weights: increased materially:
2 points; increased slightly: 1 point; remained unchanged: 0 points; decreased slightly: -1 point; decreased materially: -2 points.
Source: Bank of Canada Autumn 2020 Financial System Survey
Many respondents cited the aggressive public sector response to the crisis as
the main reason for their confidence that the system would be resilient in the face
of another shock. This included support from the Bank, the federal government
and financial regulators.
At the same time, those who said risks have grown said the pandemic has left
the economy and financial system in a more precarious position. They also
wondered about the capacity for further interventions by public institutions.
Respondents were asked to rank risks that could have the most negative impact
on the overall financial system and on individual financial firms. The two they
cited most often were rising defaults in the household or corporate sector,
reflecting the negative effects of the pandemic on the economy, and a major
cyber attack or incident.
Although the liquidity issues that followed the onset of COVID-19 have passed,
ensuring markets can function smoothly remains a top priority for the Bank. We
asked respondents how hard it was to make transactions in a variety of markets
at the onset of the pandemic. They identified markets for Canadian corporate
bonds and securitized products as the most affected. More than 40 percent of
those who are active in the corporate bond market said they had had "major
difficulties" conducting transactions. Both markets are working well now, but the
feedback will help us prepare for any future episodes of stress-just as lessons
we learned a decade ago helped us earlier this year.
I should note that when staff conducted the survey in September, they got the
highest response rate ever. This strengthens the messages reported in the
survey, which are extremely helpful for our risk monitoring, and for informing our
policy actions. I would encourage our financial system contacts to participate in
future surveys.
Another piece of our monitoring is the information that we gather through the
Heads of Regulatory Agencies, or HoA, the group I mentioned early in my
speech. The Bank chairs the HoA, as well as one of its sub-committees, the
Systemic Risk Surveillance Committee (SRSC). These venues make it much
easier for federal and provincial partners to compare notes on vulnerabilities
stemming from COVID-19. They also provide a forum to discuss other key
that I didn't get to
financial stability issues today, such as climate change, cyber
resilience and crypto assets. The impact of climate change and the transition to a
low-carbon economy is a risk to the financial system that is clearly accelerating.
Governor Macklem spoke about this increasingly important topic just last week.8
I conclude, I'd like to thank everyone at the
Before Autorité for your work in
making the SRSC a success. In particular, thank you for sharing your expertise in
the areas of insurance, securities, derivatives and non-bank deposit institutions.
Conclusion
Now it's time for me to conclude.
Our financial system has acted as an important shock absorber to help fill the
financial gaps that so many households and businesses are grappling with due to
the COVID-19 pandemic. We will continue to monitor risks as they evolve to help
ensure that the financial system is always there for Canadians.
In the months ahead, leading up to our 2021 FSR, Bank staff will continue to
research the data on deferrals to see whether debt repayment is proving difficult
for households. We will also deepen our analysis of the pressures that
businesses face. And we will take a close look at other topics related to
COVID-19. These include the underlying causes of the strains in market liquidity
that occurred when the pandemic struck and how physical distancing and shifting
to remote work will affect the long-term viability of commercial real estate.
We must monitor the buildup of financial system vulnerabilities and remain
vigilant as the economy recovers from this crisis. But at the same time, we must
not lose sight of ongoing issues that are also very important to financial stability,
such as climate and cyber risks.9
Canadians should be confident that the Bank and its partners are doing their part
to keep the financial system resilient.
Thank you very much. I'd be happy to take a few questions.