Overview
9. Elevated household indebtedness and housing market imbalances continue to pose
financial stability concerns. During the decades-long credit upcycle, low interest rates and low
capital charges for mortgage lending, together with policies promoting housing affordability, have
fueled borrowing to finance home purchases in the face of rapidly rising house prices. Risk
mispricing has contributed to debt accumulation among financially weak households, with problems
more exacerbated in regions experiencing larger housing market imbalances. During severe
downturns, Canada-specific housing finance characteristics may amplify procyclical effects of falling
house prices, and the impact on growth could be protracted due to household balance sheet
adjustments.
10. Market data suggests that systemic stress of financial institutions is low. Based on the
market-based analysis of 19 large financial institutions as of December 2018,
the probability that
several financial institutions experience distress
simultaneously was near historical lows. The
systemic stress measure, which captures the
number of institutions potentially becoming
distressed and the system-wide expected loss, has
been broadly stable over the past few years.
Nevertheless, potential contagion effects appear to
have risen over the past decade, reflecting
interconnectedness among financial institutions
and/or growing common exposures to the housing
market.
11. The financial system would be able to
manage severe macrofinancial shocks, but
additional required capital for mortgage
exposures would help improve its resilience.
While major deposit-taking institutions would
remain resilient, mortgage insurers would be
vulnerable. Furthermore, larger capital buffers to
account for potential sharp deterioration of credit quality of mortgage exposure during severe
downturns, along with measures to improve mortgage risk-pricing, can help moderate procyclical
effects driven by housing market corrections. The non-prime mortgage lending segment, albeit
small, shows some vulnerabilities. Existing government support, which underpins the overall
Sources: Bloomberg; Moody's Analytics; and IMF staff estimates.
1/ The analysis is based on the “Surveillance of Systemic Risk and
Interconnectedness” approach. See Segoviano and Goodhart (IMF WP/09/4) and
Technical Note on Systemic Risk and Interconnectedness Analysis, 2016 United
Kingdom FSAP (IMF Country Report No. 16/164). The sample includes 10 depoittaking institutions, 7 insurers, and 2 other nonbank entities.
2/ Cascade effects capture the probability that at least another institution become
distressed given than a particular institution became distressed.
3/ The systemic stress measure comprises (i) number of institutions to become
distressed given than at least one became distressed; and (ii) expected loss related to
the 1st-percentile tail risk. Both indicators are combined based on their percentile
ranking.
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
0
10
20
30
40
50
60
70
80
90
100
2005M3 2007M12 2010M9 2013M6 2016M3 2018M12
Cascade effects of systemic banks and insurers (probability; right scale) 2/
Joint probability of default
Systemic stress measure 3/
Market Perception of Systemic Stress, 2005-181
Index between 0 and 100, representing from low to high systemic stress
CANADA
INTERNATIONAL MONETARY FUND 13
robustness of housing finance, should be guided by a policy framework that achieves proper riskpricing and promotes financial stability.
12. Vulnerabilities are emerging due to rising risk-taking by nonbanks and increased
interconnectedness, warranting enhanced monitoring. In response to the low interest rate
environment, institutional and retail investors are taking greater risks to achieve higher returns,
contributing to compressed risk premiums. The rapid unwinding of these investment positions could
amplify market volatility. Furthermore, Canada’s financial system continues to evolve rapidly, with
complexity and interconnectedness potentially masking vulnerabilities and amplifying spillovers.
Key Macrofinancial Risks and Vulnerabilities
13. Macrofinancial vulnerabilities have declined recently but are still substantial. Given
relatively limited fiscal and external vulnerabilities (Figure 3), financial stability risks remain
heightened mainly due to:1
High household indebtedness (Figure 4). Household debt reached 96 percent of GDP at end2018. Canadian households are among the most indebted in advanced economies. Their debtservicing obligations, already relatively large, could increase as interest rates rise. Households as
a whole have large buffers, with net wealth of 489 percent of GDP. However, the share of debt
belonging to households with excessive indebtedness or weak debt-servicing capacity exist has
increased significantly over the past decade.
Persistent housing market imbalances (Figure 5). Overvalued house prices (relative to
fundamentals such as income or rent) continue to underpin the imbalances. House price-at-risk
analysis suggests that house price overvaluation and tight financial conditions have contributed
to downside risk to house prices. Based on current macrofinancial conditions, a large housing
market correction in the medium term is possible. With a 5 percent probability, average real
house price could fall by at least 12 percent year-on-year over the next three years, with
potential larger price declines in major cities such as Toronto and Vancouver.
Growing corporate debt (Figure 6).
Corporate debt has risen rapidly to 111 percent of GDP at
end-2018, largely driven by debt issuance (including in foreign currency) and non-mortgage
borrowing. Overall profitability has recovered from the economic slowdown, but firms in the oil
and gas and mining sectors continue enduring weak earnings. The rapid increase in debt of
firms in the real estate sector raises a concern, especially given their weak income growth. The
share of debt belonging to financially weak firms (with publicly available financial statements) is
small.
14. Growth-at-risk analysis points to substantial downside risk to growth due to
significant macrofinancial vulnerabilities. Growth-at-risk analysis provides a distribution of real
GDP growth forecasts conditional on financial conditions and macrofinancial vulnerabilities, the
1 See Appendix II for the methodologal details of macrofinancial vulnerabilities analysis.
CANADA
14 INTERNATIONAL MONETARY FUND
latter capturing corporate and household sector vulnerabilities, housing market imbalances, and
credit-to-GDP gap. As of 2018Q3, the analysis suggests a 5 percent probability that real GDP growth
would be -1.7 percent or less over the next year, and -1.6 percent (annualized) over the next three
years. Downside risk to growth has declined over the past year due some reductions in housing
market imbalances and credit-to-GDP gap