david dodge : improving financial system efficiency a€ “ the need for action remarks by mr david dodge, governor of the bank of canada, to the economic club of toronto, toronto, ontario, 11 december 2006. * * * two years ago, i gave a speech here in toronto in which i dealt with the theme of efficiency as it relates to the economy in general and to the financial system in particular. today, i want to return to the theme of financial system efficiency. in doing so, i will draw on material from our latest financial system review ( fsr ), published last week. 1 this publication, for those of you not familiar with it, is one way that the bank contributes to the soundness of the financial system. the fsr reports on developments and trends in financial systems here and abroad, summarizes recent research by bank staff on financial sector policies, and promotes discussion of how to strengthen our financial system. in short, the goal of the fsr is to improve financial system efficiency and stability. when i spoke two years ago, i stressed that all of us need to keep in mind the goal of efficiency, and that canadian financial institutions and markets need to be as efficient as possible. since that time, the global financial services sector has continued to undergo sweeping changes. the integration of global financial markets is continuing. exchanges and financial institutions are consolidating, and new financial instruments are constantly being developed. all of this is changing the way that global markets operate, with important implications for the competitiveness and efficiency of canadian markets and institutions. today, i want to talk about how canada has been responding to these developments. in doing so, i hope to underline just how important efficiency is for everybody who is concerned about canada's long - term economic health. but before i begin, i should start by saying why financial system efficiency is so important. when a financial system is operating at peak efficiency, investors receive the highest risk - adjusted returns on their investments, and borrowers minimize the costs of raising capital. with an efficient financial system, economic resources are allocated to the most productive investments. another key reason to promote efficiency in the financial system is the importance of the financial sector to the industrial base. the financial services sector represents more than 6 per cent of canada's gdp. however, the long - term health of this sector may be at risk unless we all act to increase its efficiency and competitiveness. i'll return to this topic in a few minutes

of the story. the bank recently established the canadian fixed - income forum to enable a continuing dialogue, and we ’ ve modified our operations to help alleviate some of these issues. the governing council believes it ’ s important to continue studying the matter, not just as it pertains to government bonds, but also to other asset classes. given the new regulatory architecture, we may not know just how resilient market liquidity is until there ’ s a true stress event. let me now turn to vulnerabilities being created by persistently very low interest rates in canada. the post - crisis situation has quite naturally fuelled the accumulation of household debt, as well as heightened activity in the housing sector. we can observe other elements of risky financial behaviour, but these two vulnerabilities have been our main focus for some time and have continued to grow in importance since our last fsr. in terms of household debt, income growth hasn ’ t kept pace with increases in borrowing, since mortgage growth continues to rise. more borrowing was expected, given the reductions in our policy interest rate earlier this year. it ’ s important to remember that while rate reductions have increased vulnerabilities at the margin, they ’ ve also mitigated the risk to the bis central bankers ’ speeches financial system by helping offset the decline in incomes and employment tied to the drop in commodity prices. our analysis shows that there has been an increase in the number of highly indebted households in canada, by which i mean those whose debts are more than 350 per cent of their annual gross income. not only are there more of these highly indebted households, they also carry a growing share of household debt. these people are more likely to live in british columbia, alberta or ontario, where house price gains have been the largest. the governing council ’ s reading of the situation is that these vulnerabilities are quite highly concentrated – about 720, 000 households fall into this vulnerable category. in terms of the housing market, we continue to see regional markets evolving along different tracks, as we ’ ve indicated before. activity in the energy - producing regions of alberta, saskatchewan, and newfoundland and labrador has declined noticeably, which was expected following the decline in oil prices. the housing markets of toronto and vancouver have seen renewed momentum, driven by stronger employment growth and migration, both interprovincial and international. the governing council ’ s base - case scenario continues to be a constructive one : housing activity should stabilize in