Carolyn Rogers: Financial stability in times of uncertainty
Remarks by Ms Carolyn Rogers, Senior Deputy Governor of the Bank of Canada, to
Young Canadians in Finance, Ottawa, Ontario, 22 November 2022.
* * *
Introduction
Good afternoon and thank you to Young Canadians in Finance for inviting me to be
here today. It's great to see so many people here in the room and a warm welcome to
those of you connecting virtually, from other chapters across Canada.
No matter where you're joining us from, I'm sure you've all been hearing a lot about the
Bank of Canada in recent months. Central banks around the world have been making
headlines by rapidly increasing interest rates to get inflation under control.
High inflation is something we haven't seen in Canada in more than three decades,
which means many in this room are experiencing it-and the stress that comes with it-for
the first time. It's undoubtedly frustrating to face the uncertainty of inflation and the
impact of higher interest rates at a point in time when you are just getting financially
established-building your career, buying a house, starting a family.
And as members of this organization, many of you may also be dealing with the broader
impacts of tightening fiscal and monetary policy on financial markets as part of your day
job. So, I am particularly glad to have the chance to meet with you today to talk about
the Bank's update on financial system stability.
What I plan to do is give you a very high-level overview of why and how we monitor
financial system stability at the Bank of Canada. I'll then touch on some of the global
trends we're seeing that are affecting financial stability around the world and here at
home. And finally, I will take a bit of a deeper dive into an area of financial stability that
is currently on the minds of many Canadians-housing.
I'm aiming to keep my opening remarks short-about 10 minutes-to leave plenty of time
for your questions.
The importance of a strong financial system
Most central banks, including the Bank of Canada, have as part of their mandate the
responsibility to monitor the soundness and stability of their country's financial system.
Financial system stability, like price stability, is crucial to the health of our economy.
Low, stable and predictable inflation contributes to sustained economic growth and
prosperity. And a strong financial system-with solid institutions, robust payment systems
and efficient markets-helps preserve savings, channel investment and facilitate
payments. A weak financial system, on the other hand, can amplify or spread shocks
throughout the system. And just as periods of uncertainty can test price stability, they
can also test financial stability.
The Bank's approach to monitoring financial stability takes a broad view. Canada's
financial system is made up of a complex network of institutions, including banks and
credit unions, pension funds and other asset managers. And many of our largest
institutions operate globally.1
We monitor the financial system for risks and vulnerabilities. Vulnerabilities are
weaknesses that often build over time and can make the system more susceptible to
stress. They exist in almost any system. And, on their own, they may not lead to
financial stress or instability. For that to occur you generally need a trigger-an event, or
shock-whose impact can be amplified by the presence of vulnerabilities.
It's the combination of these two things that can lead to periods of financial instability or,
in extreme cases, a financial crisis.
We use the information we gather in our monitoring to conduct research, inform policy
decisions and communicate with Canadians. We publish a report each spring and give
an update each fall-both of which talk about global and domestic conditions and the
state of the Canadian financial system through the lens of the risks and vulnerabilities I
just spoke of.
And I am pleased to announce that today we launched an interactive dashboard of
2
financial vulnerability indicators on our website. We're sharing information on what we
monitor to help people better understand the vulnerabilities we all face.
The uncertain world we live in
So, let's turn to an update on global financial conditions and the environment we're in
today.
It's an understatement to say that the past few years have seen major global economic
changes and financial system developments.
First, we are emerging from two years of a global pandemic and the resulting health
and economic impacts. Less than a year has passed since Canada's economy fully
reopened, and parts of the world-China, most notably-are still enduring lockdowns. This
has had a dramatic and enduring effect on both supply and demand. As a result,
inflation has risen in most countries around the world.
In response, central banks have shifted rapidly to tighten monetary policy to bring
inflation down. As interest rates rise, financial conditions are tightening, liquidity is
scarcer, and risk assets are repricing.
Second, geopolitical tensions have increased, primarily because of Russia's invasion of
Ukraine. This has created a lot of volatility and uncertainty in global commodity markets,
especially energy.
And third, we have a legacy of debt coming out of the COVID-19 crisis. Governments
around the world took extraordinary measures to support people and businesses
through economic shutdowns. Businesses-particularly in hard-to-distance sectors-have
endured a difficult few years, and some took on additional debt to get through them.
And while some individuals and households were able to accumulate extra savings over
the pandemic, others took on additional debt.
These three forces-inflation, volatility in commodity and financial markets, and
increased levels of debt-are not unique to Canada. Most countries around the world are
facing these same challenges right now. But the impact on each country will depend, at
least in part, on the resilience of that country's financial system-which in turn depends
on those pre-existing vulnerabilities I just described.
And given how interconnected the global financial system has become, and the fact that
Canada is a medium-sized, open economy, the impact here at home will also depend
on how other countries weather the storm.
Housing and financial stability
Let's now take a closer look at two vulnerabilities we're watching closely- household
debt and housing-and their relationship to financial stability. Housing is certainly top of
mind for many Canadians these days.
If you were to dig up the Bank of Canada's reports on financial system stability that I
just mentioned, you would find analyses dating as far back as 2006 on escalating
housing prices and increasing household debt. In other words, these two vulnerabilities
have existed in Canada's financial system for a long time.
The buildup of these vulnerabilities continued after the global financial crisis in 2008
and 2009. Canada's financial system sailed through that shock relatively smoothly, and
our economy recovered more quickly than most. A decade of low interest rates, a
growing population and constrained housing supply all combined to feed a steady
march upward in house prices.
Higher house prices meant Canadians were taking on more debt to buy homes. And as
prices continued to rise quickly, some Canadians saw housing as an investment
opportunity as well as a source of shelter and took on additional debt to invest in
housing.
Well before the arrival of COVID-19 Canadians were worried about the cost of housing
becoming detached from incomes-particularly for first-time homebuyers. And they were
worried about investors contributing to rapid increases in house prices, particularly in
large urban markets.
Then the pandemic hit and our housing market shifted up another gear, and not just in
places like Toronto and Vancouver. We were all spending more time at home, and
people in cities wanted more space, which put pressure on housing demand in smaller
3
cities and towns. Low interest rates that supported the economy through the pandemic
also helped fuel high house prices by reducing carrying costs. Over the course of less
than two years house prices went up by more than 50% in most markets. And housing
activity-the number of houses being bought and sold-was about 30% higher than
prepandemic levels.
This spring, as we emerged from pandemic restrictions and monetary policy began to
tighten rapidly in response to high inflation, the housing market started to react. This
was to be expected. The level of price increases and sales activity were both
unsustainably high. And because most people borrow to buy a house, housing is one
area of the economy that is the fastest to react to tighter monetary policy.
This tightening cycle, though, has been particularly steep. We have moved interest
rates up quickly because history tells us that front-loading rate increases gives us the
best chance to cool the economy quickly and keep inflation expectations anchored. This
avoids the prospect of larger increases down the road.
Higher interest rates are starting to work to slow the economy and tame inflation. We
have a long way to go to get inflation back to target, but there are some early signs that
monetary policy is working. Unfortunately, this adjustment is not without some pain. We
recognize that.
What this means for Canadians
One group of Canadians who will be finding this adjustment painful are those who
recently purchased a home, potentially stretching their budget to do so, and who chose
a variable-rate mortgage.
This is not a large share of households, but it is larger than it would have been based
on historical trends. This is because more Canadians opted for a variable-rate
mortgage over the last year than have in the past, at a time when housing prices were
high.4
Borrowers with a variable-rate mortgage will already have seen a significant increase in
their monthly payments if their payments are also variable. Borrowers with a
variablerate mortgage and fixed payments may face higher payments if they hit their "trigger
rate"-the rate at which their monthly mortgage payment is covering onlythe interest and
not paying down the principal. The Bank has done some work to estimate the share of
households that have reached their trigger rates, which is available on our website.5
Homeowners with fixed-rate mortgages may also be looking at higher payments when
they renew, depending on when they took out their mortgage and whether they have
room to extend their amortization period.
The bottom line is that mortgage costs for some Canadians have already increased,
and they will likely increase for others in time, making home ownership more expensive.
In addition, house prices are also coming down-albeit modestly so far-relative to their
recent increase. We need lower house prices to restore balance to Canada's housing
market and make home ownership more affordable for more Canadians. But lower
house prices may add stress for those people who purchased recently. They will have
reduced equity, and this may limit their options to refinance.
So back to our framework to monitor financial stability. Canada's economy has
longstanding vulnerabilities in the form of escalating house prices and elevated levels of
household debt that were further exacerbated during the pandemic. And the risk of a
trigger that may affect financial stability has increased, as a result of high inflation and
the response of increasing interest rates.
But there are good reasons to believe that the system as a whole will be able to
weather this period of stress and remain resilient.
Since the 2008-09 global financial crisis, countries around the world have put in place a
series of reforms-including higher capital and liquidity levels at banks-to shore up
financial system resilience and protect against future shocks. Here at home, these
measures also included a borrower-level mortgage stress test to ensure Canadians
could continue to afford their homes when interest rates rose. And, importantly, we are
not expecting a severe economic downturn with the kind of large job losses typical of
past recessions.
This is not to minimize the very real hardship that some are feeling. Higher mortgage
payments are difficult to handle for many people-and all the more so when other costs
are also going up.
Looking ahead
In this environment, the Bank of Canada is making two important contributions.
First, we will continue to monitor the impacts of higher interest rates on Canadians and
on financial system stability.
Second, we will get inflation back to target. We know higher interest rates are difficult
for many Canadians-particularly young Canadians-many of whom are recent
homebuyers and are therefore carrying higher debt loads.
We don't want this transition to be more difficult than it has to be. But higher interest
rates in the short term will bring inflation down in the long term. Canadians are looking
for ways to protect themselves from rising prices, and we are working to protect them
from entrenched inflation.
It will take time to get back to solid growth with low inflation, but we will get there. By
working through this difficult phase, we will get back to price stability with sustained
economic growth, which benefits everyone.
Thank you for your attention, and I look forward to your questions.
I would like to thank Stephen Murchison and Louis Morel for their help in preparing this
speech.
1
Financial Stability Board, " 2021 List of Global Systemically Important Banks (G-SIBs) "
(November 23, 2021).[]
2
Bank of Canada, "Tracking the financial vulnerabilities of households and the housing
market."[]
See L. Morel, "Analyzing the house price boom in the suburbs of Canada's major
cities during the pandemic," Bank of Canada Staff Analytical Note No. 2022-7 (June
2022).[]
4
Regulatory filings of Canadian banks show that, since the onset of the pandemic,
about 670,000 mortgages for home purchases were originated with a variable rate.
Both the volume of new mortgages and the share of new mortgages with a variable rate
have risen. Variable-rate mortgages have represented around 50% of new lending
since mid-2021, up from an average of 20% in the five years before the pandemic. For
more information, see "Funds advanced and outstanding balances for new and existing
lending by chartered banks " on the Bank of Canada's website.[]
5
See S. Murchison and M. teNyenhuis, "Variable-rate mortgages with fixed payments:
Examining trigger rates," Bank of Canada Staff Analytical Note No. 2022-19 (November
2022).[]