Tiff Macklem: Release of the Financial System Review
Opening statement by Mr Tiff Macklem, Governor of the Bank of Canada and Ms
Carolyn Rogers, Senior Deputy Governor of the Bank of Canada, at the press
conference following the release of the Financial System Review, Ottawa, Ontario, 18
May 2023.
* * *
Good morning. I'm pleased to be here with Senior Deputy Governor Carolyn Rogers to
discuss the Bank of Canada's Financial System Review (FSR).
In addition to its price stability mandate, the Bank plays a critical role in preserving and
promoting the stability of the Canadian financial system. Financial system stability and
price stability go hand in hand. Price stability-confidence in the value of money-is the
bedrock of a stable, well-functioning financial system. And financial stability is a
precondition for price stability.
The FSR is our annual assessment of risks that could test the resilience of Canada's
financial system and affect its important role of serving the economy.
It is different from the Monetary Policy Report (MPR), which provides our outlook-our
forecast-for the Canadian economy. The FSR is not a forecast. It does not provide what
we view as the most likely outcome for the financial sector. Rather, it examines the
vulnerabilities and risks that could test the stability of Canada's financial system and
affect its ability to act as a shock absorber. And as Carolyn will explain shortly, this
year's FSR takes a slightly different approach from previous versions, with the aim of
outlining areas of concern more clearly and concisely.
Over the past year, global financial conditions tightened in response to monetary policy
actions aimed at reducing inflation. The forceful response by central banks, including
here in Canada, is proving successful at bringing inflation down. At the same time, we
have seen periods of volatility and pockets of stress, particularly in the US banking
sector. Just as households, businesses and governments are adjusting to higher global
interest rates, so must the financial sector. As this adjustment unfolds, participants in
the financial system, regulators and central banks must all be vigilant.
The recent banking stresses in the United States and Switzerland are a reminder that
risks can materialize and spread quickly. They highlight that the business models of
some financial institutions rely too much on an environment of low interest rates and
low market volatility.
Fortunately, authorities in those countries took swift actions to limit the spillover effects
of these stresses to the broader financial system. Equally important, banks around the
world are more resilient today than they were before the
2008-09 global financial crisis, thanks to significant improvements in financial buffers
and risk management practices. Here in Canada, regulators have taken important steps
to ensure that Canada's financial system and Canadian banks remain robust.
Nevertheless, if global financial stress were to re-emerge and prove more persistent,
Canada could see more significant spillover effects-especially if stresses triggered a
severe global recession and interacted with existing vulnerabilities.
Let me now turn to Carolyn to discuss all of this in more detail.
Thank you, Governor.
As the Governor noted, the FSR is not a forecast. It's a deliberate look at what could go
wrong and the resulting implications for financial stability. And this year we've
reorganized the FSR to make our communication about these potential risks clearer.
We've moved away from discussing financial system vulnerabilities and risks
separately. Instead, we've combined them and organized them under key sectors or
areas of focus. This approach reduces repetition and allows for a more concise analysis
of the kind of risk that could arise if future shocks were to occur. You can expect further
changes and refinements in next year's FSR.
Let me take you through three areas we're monitoring closely.
The first is Canadian bank funding. Banks channel money from savers and investors to
borrowers. As interest rates go up, banks need to pay savers and investors more, so
the funding they use to make loans becomes more expensive. This is an intended
outcome of monetary policy tightening.
The increase in bank funding costs is coming at a time when sources of low-cost
deposits are declining. And Canadian banks generally have more demand for loans
than can be funded solely by Canadian deposits and investments, so they rely on
attracting additional funding from global wholesale markets. These markets can be
significantly affected by global events, such as the recent banking stress.
We are closely monitoring the combined impact of these factors on bank funding. The
recent turbulence in global markets stemming from bank failures had little direct impact
on Canadian banks. But if global stresses were to return and persist, bank funding
costs could rise beyond the higher levels induced by tighter monetary policy. In
addition, in a severe stress situation, funding could also become harder to secure. In
response, banks would likely constrain credit to households and businesses, potentially
exacerbating an economic downturn.
The second area we are monitoring closely is the interaction between global stresses
and liquidity in fixed-income markets, both globally and in Canada. In an environment of
greater pressure on bank funding, major banks may have less capacity to supply
liquidity to market participants in periods of stress, which is when they need it most.
This market liquidity is crucial to financial stability, given the growing importance of
asset managers and other non-bank financial intermediaries that rely on it. The extreme
market stresses at the outset of the COVID-19 pandemic showed that the financial
system is vulnerable to sudden spikes in demand for market liquidity.
The third area the Bank is watching closely is the ability of Canadian households to
service their debt at higher interest rates. Higher debt-servicing costs are stretching
budgets and reducing borrowers' financial flexibility. About one-third of households
have seen their mortgage payments increase since February 2022, just before the Bank
started raising its policy interest rate. More households will see their payments go up in
the next few years as they renew their mortgages. Lenders and regulators are taking
steps to provide borrowers with options for managing higher payments, such as
extending amortizations. However, as borrowers make use of these options, they may
have less capacity to absorb future shocks.
Canadians have a long history of paying their debts even under stressed conditions.
And, so far, households are proving resilient despite the sharp increase in interest
rates. However, in a severe and prolonged recession, mortgage defaults could rise,
leading to credit losses for lenders. That, in turn, could lead to a further pullback in
credit, worsening the downturn.
This Review also outlines emerging risks that we are monitoring, including cyber
incidents and climate-related financial risks. It also provides an update on
developments in cryptoasset markets.
I'll conclude by underlining a few things about resilience.
The vulnerabilities described in the FSR may not threaten overall financial stability on
their own. But shocks tend to have more impact when vulnerabilities have built up. So
our main message is that-as the adjustment to higher interest rates continues-financial
institutions need to adapt, and central banks and regulators need to be extra vigilant.
I also want to assure Canadians that the steps taken to bolster our financial system are
proving their worth. Canadian banks are held to the highest global regulatory standards
and subject to rigorous supervision.
At the Bank of Canada, we will continue to monitor the financial system closely for signs
of stress. And we have the tools needed to provide emergency liquidity if severe
stresses develop. In fact, we recently reviewed our pandemic-related liquidity
interventions to help us better target our responses in the future.
We stand ready to act, if needed, to safeguard the stability of the Canadian financial
system.
The Governor and I will now be happy to take your questions.