IMF Publishes Reports Assessing Financial System Stability in Canada

The FSSA report reveals that the financial system would be able to manage severe macro-financial shocks, but mortgage insurers would probably need additional capital. Even in a severe adverse scenario, major deposit-taking institutions would be able to rebuild their capital positions to meet the regulatory requirements. However, large life insurers appear somewhat exposed to financial market stress and lower interest rates. While the overall capital buffers of banks are adequate, lender risk-weights for mortgage exposures should be higher. Mortgage insurers’ capital requirements should also be tightened. In addition to properly accounting for through-the-cycle credit risk, these measures can help improve mortgage risk-pricing and limit procyclical effects of falling house prices.

The key vulnerabilities stem from banks’ external foreign-currency funding; extensive use of derivatives; rising risk-taking by life insurers, pension funds, and other non-banks; non-prime mortgage lending; and potential spillovers from overseas operations and cross-border exposures. Furthermore, continued efforts to address data gaps are essential to support more effective risk monitoring and analysis. Financial sector oversight is high quality, but there are important areas for improvement. Cooperation between federal and provincial authorities should be further improved, supported by additional memorandums of understanding (MoUs). The roles and responsibilities of the authorities that oversee financial market infrastructures should be further clarified. Given the macro-financial vulnerabilities, the regulatory and supervisory frameworks of deposit-taking institutions regarding credit risk related to real estate exposures should be strengthened, as per the assessment. The bank resolution regimes and deposit insurance systems for federal and Québec jurisdictions are generally aligned with international best practices.

Another recommendation is that the recovery and resolution planning, which is advanced for major deposit-taking institutions, should be expanded. Given the likelihood of compensation to bail-in-able debt holders, the valuation framework should be further developed to increase certainty about bail-in outcomes. The framework of the Bank of Canada for managing liquidity during stress is well-defined. Modernization of the financial stability architecture would help enhance systemic risk oversight and crisis preparedness. A single body in charge of systemic risk oversight would be the first-best solution. Second-best solutions include formalizing and strengthening the leading role of the Bank of Canada in systemic risk surveillance and creating a federal-provincial platform to discuss systemic risk issues and to formulate policy responses. 

The staff report highlighted that the macro-prudential measures have mitigated housing-related risks to financial stability. The IMF Directors welcomed the assessment that the overall financial system is healthy and resilient. They also noted that the informal framework for systemic risk surveillance and crisis management has served Canada well. While acknowledging that there is no one-size-fits-all solution, the Directors encouraged continued efforts to modernize the arrangement and strengthen micro-prudential oversight and safety nets along the lines of the Financial Sector Assessment Program (FSAP) recommendations.

Related Links

• FSSA Report
• Staff Report
• Selected Issues Report

Keywords: Americas, Canada, Banking, Insurance, Securities, Pensions, FSSA, FSAP, Article IV, Systemic Risk, Macro-Prudential Policy, FMI, Bank of Canada, IMF