Banking Sector
18. The banking sector’s performance is strong, with solid profitability and sizeable capital
buffers (Figure 8, Table 6). Banks have steadily improved their capitalization, benefiting from their
robust revenue-generating capacity based on universal banking even in the low interest rate
environment. Credit-related impairments have been remarkably low. Large banks have established
their footprints overseas, particularly in the United States, and thus become exposed to
macrofinancial conditions in those markets. Going forward, the sector’s ability to continue growing
domestically while maintaining high profit margins and low capital charges from mortgage lending
could be more difficult given market saturation. Banks’ funding appears diversified, largely
comprising retail and wholesale deposits. However, banks have increasingly relied on foreigncurrency funding (slightly more than half of total funding) mainly to fund their international
operations and to a smaller extent their domestic activities. Derivatives-related liabilities are sizeable
and have contributed to volatile liquidity profiles.
0
1
2
3
4
5
6
7
8
0
10
20
30
40
50
60
70
Increase in the adverse scenario (2020) Latest (2016)
Household Debt-at-Risk
(In percent of total debt)
Debt-at-risk, not
covered by assets (in
percent; right scale)
Debt-at-risk
(in percent; left scale)
0
2
4
6
8
10
Current
situation
(2018)
Adverse
scenario
Current
situation
(2018)
Income
shock
Funding
cost shock
Adverse
scenario
(combined
shocks)
Others
Energy
Materials
(inc. mining)
Utilities
Corporate Debt-at-Risk
(In percent of total debt; based on firms with publicly available financial statements)
Increase due to shock(s)
Sources: Statistics Canada, Survey of Financial Security; and IMF staff estimates.
Note: Financially weak households are defined as households whose debt-servicing
obligation is larger than 40 percent of disposable income. Debt of these financially
weak households is considered at risk. The sensitivity analysis assumes a decline in
income by 15 percent, an increase in interest rates up to 230 basis points (depending
on the renewal profile of borrowers), and a decline in house prices by 40 percent.
Sources: CapitalIQ; and IMF staff estimates.
Note: Financially weak firms are defined as firms whose earnings before interest, tax,
depreciation and amortization (EBITDA) is less than interest expense (including
capitalized interest). Debt of these financially weak firms is considered at risk. The
sensitivity analysis assumes income shock (i.e., 25 percent decline in EBITDA) and
funding cost shock (i.e., 5 percentage points increase).
CANADA
INTERNATIONAL MONETARY FUND 17
19. Smaller deposit-taking institutions show some vulnerabilities. Some banks rely on less
stable brokered deposits. Credit unions’ loan books are concentrated in residential mortgages, and
hence could be hard hit following a significant decline in house prices.
20. D-SIFIs appear resilient to severe macrofinancial shocks (Figure 9).2 Based on the stress
tests that covered six domestic systemically important banks (D-SIBs) and Québec’s D-SIFI, the solid
revenue-generating capacity would contribute to an upward trajectory of capital ratios in the
baseline. In the adverse scenario, the aggregate common equity tier-1 (CET1) capital ratio would
decline by 4.8 percentage points to 7.4 percent in 2020 before recovering to 9.6 percent in 2021.
During the stress testing horizon, most entities would tap into capital conservation buffers, therefore
subject to dividend restrictions. By 2021, all entities would meet the regulatory minimums (including
D-SIFI capital surcharges). Larger credit-related impairments, lower net interest income and noninterest income, and increased risk-weighted assets would contribute to a larger capital depletion in
the adverse scenario than in the baseline. Staff stress test results are largely aligned with BOC
results.
21. The capital dynamics would be largely driven by credit risk. In the adverse scenario,
cumulative credit-related impairments would reduce aggregate capital ratios by 4.4 percentage
points. Underlying credit quality would also deteriorate significantly, raising risk-weighted assets and
thus reducing aggregate capital ratios by 0.8 percentage points.
22
. However, additional losses could materialize due to Canada-specific features that were
not fully captured in the abovementioned results. The sizeable undrawn exposures in the
banking book, including HELOCs, could be drawn at time of stress, resulting in additional creditrelated impairments of Can$18.5 billion (0.9 percent of risk-weighted assets) according to sensitivity
analysis. Similarly, if lenders adopt a more dynamic risk-based pricing of mortgage spreads by
charging larger spreads for financially weaker borrowers, additional credit-related impairments
would amount to around Can$14.5 billion.
2 See Appendix III for the methodological details for all stress tests (banks, insurers and investment funds).
7.9 7.4
9.6
12.2
13.4
14.3
15.2
6
8
10
12
14
16
2018 2019 2020 2021
Adverse scenario
Baseline scenario
Common Equity Tier-1 Capital, 2018-21
(In percent of risk-weighted assets)
Source: IMF staff estimates.
4
6
8
10
12
14
16
-12
-9
-6
-3
0
3
6
9
12
2018 2019 2020 2021 2019 2020 2021
Others
Dividend payout
Taxes
Market risk
Credit risk
Operating expense
Non-interest income
Net interest income
CET1 (right scale)
Contribution to Common Equity Tier-1 (CET1) Capital,
2018-21
(In percent of risk-weighted assets)
Source: IMF staff estimates.
Baseline scenario Adverse scenario
CANADA
18 INTERNATIONAL MONETARY FUND
23. D-SIFIs appears to hold sufficient liquidity buffers to withstand sizeable funding
outflows. The cash-flow analysis identifies small liquidity shortfalls for some entities under severe
scenarios,3 with aggregate shortfalls amounting up to Can$91 billion. The exercise suggests that a
large funding outflow would be needed to generate a liquidity shortfall. The Liquidity Coverage
Ratio (LCR) tests confirm similar findings. D-SIFIs would be able to manage large outflows from
either retail or wholesale funding segments separately, including by significant currencies. However,
certain vulnerabilities exist. Counterparty risk could be material given the sizeable repo books and
derivatives exposures (e.g., currency swaps and total return swaps); the latter, potentially associated
with complex bank-specific risk profiles, was not assessed due to data limitation.
Insurance Sector
24. The insurance sector’s performance has been strong even in a low interest rate
environment (Figure 10, Table 6).4 Return on equity remains stable for the life and mortgage
insurance sectors but has declined for the property-and-casualty insurance sector in recent years.
Overall, insurers in all sectors maintain strong solvency positions, holding some capital buffers in
excess of the supervisory targets. Following the expansion of their business abroad, the three large
life insurers have increasingly relied on earnings from their overseas operations (more than half of
their net premiums).
25. Large life insurers are somewhat exposed to financial market stress and lower interest
rates. The stress tests covered the five largest life insurers and assessed the sensitivity of their
solvency to macrofinancial conditions in 2019Q3 (most severe financial market stress) and 2021Q4
(lowest interest rates) in the adverse scenario. In 2019Q3, the aggregate core capital ratio would
decline by 34 percentage points to 61 percent, largely driven by the impact of widening credit
spreads and falling equity prices. Essentially, life insurers hold a sizeable amount of low-rated and
unrated bonds. Some entities would see their capital ratios below the regulatory minimums. In
2021Q4, the aggregate core capital ratio would fall marginally by 5 percentage points. However, life
3 The horizon of stress events would be 3 months. Under the most severe scenario, funding outflows would amount
to Can$1.1 trillion (nearly 20 percent of total assets).
4 The discussion only covers federally regulated insurers.
-1,500
-1,000
-500
0
500
1,000
1,500
Reverse repos
Securities held
Cash
Committed facilities
Repos
Maturing debt issued
Wholesale outflows
Retail outflows
Net CBL
Counterbalancing Capacity and Funding Outflows, 2018Q3
(In billions of Canadian dollar)
Mild Severe Severity of scenario
Source: IMF staff estimates.
60
70
80
90
100
110
120
130
140
Scenario-3 (combined)
Scenario-2 (wholesale funding outflows)
Scenario-1 (retail funding outflows)
Starting point (2018Q3)
Liquidity Coverage Ratio (LCR), 2018Q3
(In percent)
Source: IMF staff estimates.
Total LCR LCR - U.S. dollar LCR - Canadian dollar
CANADA
INTERNATIONAL MONETARY FUND 19
insurers’ solvency would be hit harder in a more sustained low interest environment. For example, a
downward parallel shift in the risk-free yield curve by one percentage point would reduce the core
capital ratio by 40 percentage points.
26. Mortgage insurers are vulnerable to severe macroeconomic downturns with significant
house price declines. Based on the stress tests that covered all three mortgage insurers, cumulative
insurance claims would amount to Can$25 billion, consistent with credit losses of banks’ insured
mortgage portfolios, in the adverse scenario. Mortgage insurers would need additional capital of
Can$15 billion to meet the supervisory solvency target, half of which is for one insurer.
27
. Required capital for insured mortgages may not sufficiently reflect potential
deterioration of credit quality during severe downturns. The seven D-SIFIs currently have capital
buffers for insured mortgage exposures equivalent to 0.17 percent of outstanding insured
mortgages. Accounting for mortgage insurers’ required capital for insurance risk, system-wide
capital buffers would amount to 1.96 percent. In adverse scenario, these buffers should go up to
4.32 percent. This would imply additional capital need of Can$28 billion to cover expected and
unexpected losses for insured mortgage exposures
