Good morning everyone. Welcome to the Bank of Canada and this morning's press conference about today's financial stability report. The Governor and Senior Deputy Governor will deliver their opening statement and after that we will be happy to take your questions for about a half an hour.
Thank you Paul and good morning. Senior Deputy Governor Carolyn Rogers and I are very pleased to be here to discuss the Bank of Canada's financial stability report with you this morning. Each year, the bank assesses the stability of Canada's financial system and highlights risks that could threaten that stability. While some risks have diminished, the current trade environment has pushed risks higher overall. But let us look back for a minute before we look ahead. The country's financial system has faced unprecedented shocks in recent years, and it has proven resilient. Households, businesses, banks, and other financial institutions weathered the upheaval of the pandemic and the sharp rise in inflation and interest rates that followed. It was a difficult period for many Canadians and pockets of stress remain, but proactive steps taken by households and businesses together with substantially lower interest rates put the system on a more resilient footing heading into 2025. Now the Canadian economy and financial system face a new threat. US trade policy has taken a dramatic protectionist shift. Tariffs and uncertainty have sharply reduced prospects for global economic growth and financial markets have been rocked by chaotic policy announcements and reversals. A long-lasting trade war poses the greatest threat to the Canadian economy. It also increases risks to financial stability. There are two key concerns. In the near term, the unpredictability of US trade policy could cause further market volatility and strains on liquidity. In an extreme case, market volatility could turn into market dysfunction. In the medium-term, a prolonged global trade war would have severe economic consequences. It would reduce growth and increase unemployment. This could in turn have important ramifications for the financial system. With debt still at high levels, some households and businesses may be unable to keep up with payments. If loan losses occur on a large enough scale, banks could cut back on lending in response. This would exacerbate the economic downturn and put more pressure on businesses and households.
What we are evaluating in this report are the indications of stress in the overall financial system. There are many uncertainties. We still don't know what tariffs will remain, whether they'll be reduced or escalated, and how long all of this will last. That makes it particularly difficult to anticipate the risks to the financial system. In our April monetary policy report, we presented two illustrative scenarios to show how a trade war could affect the economy. In the FSR, we focused on the more severe of those scenarios to explore how the trade war could affect different parts of the financial system. To be clear, our analysis is not a projection. It's an assessment of vulnerabilities, pockets of existing or potential stress that could spread across the financial system. So, let me now turn to the Senior Deputy Governor to outline these vulnerabilities and how they affect the four key sectors of our financial system. Households, businesses, banks, and institutions known as non-bank financial intermediaries. This is a broad category including finance companies, pension funds, insurance companies, and fund managers. Carolyn.
Thank you Governor. I'll start with households. Total debt relative to disposable income is lower than it was a year ago, but still high by historical standards. Despite lower interest rates, signs of financial stress have risen over the past 12 months, particularly in households without a mortgage. For example, the share of these households that are behind on credit card or auto loan payments has continued to go up. Among households with a mortgage, about 60% are facing renewal this year or next. Most of those renewing will see their payments rise because they took out their mortgage during the pandemic when rates were at historic lows. But the average increase in payment will be smaller than we expected a year ago. Still, if a large shock causes job losses, it'll be harder for some households to keep up with their debt payments. A prolonged trade war may be that shock. It would cause demand for Canadian exports to fall. It would disrupt supply chains, threatening jobs and incomes. Workers in trade dependent industries could find it particularly difficult to continue managing their debt. A prolonged trade war would also matter for businesses. Most Canadian businesses have managed to adjust to past interest rate increases and the small surge in small business insolvencies last year proved to be temporary. But businesses in trade related sectors, especially those with high debt, low profitability or cash reserves, could also fall behind on debt payments. A strength in our financial system is that Canadian banks are well positioned to absorb higher credit losses. Banks have increased their capital buffers in recent years and more recently they've also increased their provisions for credit losses and these both bolster their resilience. Liquidity levels remain high and access to funding for banks is also good. But if credit losses occur on a large enough scale, banks could cut back on lending in response. Struggling households and businesses would then have less access to credit to get through tough times. This cycle could exacerbate the economic downturn. In the non-bank financial sector, the growing presence of hedge funds in the market for government of Canada bonds raises some concerns. Government bond markets are the foundation of the financial system and they need to function smoothly for all other markets to work well. The increased activity by hedge funds has helped absorb increased issuance of government debt, keeping yields lower and liquidity higher. But hedge funds have also taken on increasingly large amounts of leverage to fund their purchase of government bonds and this makes them more likely to pull back from these crucial markets in periods of stress introducing added volatility. The recent gyrations in the US Treasury market clearly illustrated this risk. If the trade war causes a larger spike in volatility than we've seen so far, leveraged hedge funds might rush to sell their holdings that could strain liquidity across core markets, increasing stress throughout the financial system. Moreover, the growing connection between banks and non-bank financial institutions could make it easier for stress to spread. Against that backdrop of increased market volatility and given their importance in the government bond markets, hedge funds need to make sure that they're prepared to respond to sudden liquidity needs without disrupting broader market functioning.
The Canadian system is resilient despite high indebtedness and the economic turbulence of the pandemic. Households, businesses, and banks weathered a rapid increase in interest rates. That was a big test, and the system proved to be a source of stability. But we must all remain vigilant. Vulnerabilities remain and there is another test on the horizon. By identifying vulnerabilities, we can help the financial system prepare for future stress. We're watching developments closely and remain in regular contact with financial system participants and with other authorities in Canada and globally. A stable, resilient financial system that absorbs shocks rather than amplifying them benefits every Canadian. And with that, the Governor and I would be pleased to take your questions.
Okay, thank you both. We will go to questions now starting with the reporters here in the room in Ottawa and after which we'll go to those who have joined remotely. Today we're going to do one question and if desired one quick follow-up per outlet please. If I forget to do so please state your name and affiliation. So let's start here in Ottawa. I'm going to call on Eric Herzberg from Bloomberg News, please.
Good morning. Firstly, how much responsibility does the Bank of Canada ascribe to itself when it comes to the rise in household balance sheet vulnerabilities in the last decades?
Look, I think you know the purpose of the report is to highlight where the vulnerabilities are. And why do we do that? Well, we do that to help the financial system prepare for worst case outcomes. So I mean coming to households, household indebtedness has risen now going back a large number of years. I'd have to actually go back to put a number on it but it's been, I mean we've been expressing concern about rising household indebtedness for many years now. And that's happened against the background of low interest rates. It's happened against the background of high interest rates. So I think it's a broader issue than monetary policy. What we saw last year actually is the combination of strong income growth and also lower interest rates. You actually saw households' debt relative to income start to move down. I think the ratio went from the high 170s to the low 170s. So it was moving in the right direction and when you combine that with lower interest rates, our assessment is that for most households that is making servicing their debt more manageable. You know, the big message in this report is we now face a new threat. The trade war poses new risks. So even if things were moving in the right direction, it's a really good time to get prepared for possible turbulence ahead.
And just to follow up, on the new threat, how do you view the US president's threats and pressure on Powell and the Fed from a financial stability perspective? Is this a risk?
Well look, the independence of the central bank is, it's sacrosanct. I mean it is a key element of central banks around the world. There's a reason you have independent central banks and the record of independent central banks with clear mandates, in our case an inflation target, has served Canadians very well and similarly in other countries. So, I don't think you want to threaten the independence of the central bank.
Okay, we're going to go to Greg Quinn from Market News now, please.
Good morning. Not sure who wants to answer this one. The report had a discussion around hedge funds and their increasing activities in Canada's government debt markets. I just wondered about the supply of government debt. You know, we've had large deficits through the pandemic. I mean, isn't that policy a reason why hedge funds may be coming into Canada? Maybe, in other words, haven't we kind of invited some of these concerns?
Well, this is actually a pretty global phenomenon. In fact when I was in Washington a couple of weeks ago around the IMF meetings, it was an opportunity to compare notes with other countries and you're seeing this actually globally. More generally, non-bank financial institutions have been growing more rapidly than the banking sector for a good decade now. And part of that is the growth of hedge funds. And there are some benefits. Hedge funds are a new investor class for government bonds and in Canada as you mentioned, like everywhere else, government debt levels have been higher. Hedge funds are, they're new, they're buying bonds. They're adding liquidity to the market. So the issue really is that hedge funds tend to buy government bonds using a lot of leverage. And when you're a leveraged investor, if you see a rapid change in market conditions, you may need to exit your positions. You may need to pull back. And so, while the entry of hedge funds is bringing some benefits, it's also posing some new risks. And we highlighted this actually in the last FSR. We're highlighting it again today. And really the message to the hedge fund community is, we're in a more turbulent period. Make sure you manage your liquidity, make sure you're risk managing your positions so that you can handle higher turbulence.
Deputy Rogers, you became famous in the political class for a break the glass moment on Canadian productivity. You know, we now have an existential threat to our economy from the US. Yet I still see premiers talking about bilateral free trade deals, whether they can even move wine from British Columbia to Alberta. Doesn't seem like based on that, I could say it doesn't seem like we're really meeting the risk. Is the glass broken? Would it not be better if provinces could trade on the same terms internally as we're asking the United States to trade with us?
And I think the conversation has started. We need that conversation to turn into policy decisions. That takes time though. Interprovincial trade was only one of the things we talked about when we talked about productivity. So it's good to see some movement on that. We're also hearing calls for more business investment, more training, better use of AI, all of those things. So I think the conversation has shifted. We do need to see that to continue. We need the momentum to continue to see some policy changes, but I'm optimistic.
All right. Next up, I'm going to go to Jordan Gowling from the Financial Post, please.
Good morning. Governor, you highlighted in your opening remarks that Canada's financial system has weathered unprecedented shocks in recent years. You talked about the pandemic, the inflation crisis. Are you confident it can weather this tariff shock in the same way as it did with previous shocks?
Well, we both might want to take this question. I'll just say a couple words coming into it. You know, the banks' capital cushions are higher. They've got pretty high levels of what we call CET1 capital which is sort of the best loss-bearing capital. They've also increased their provisions. Now provisions are for the credit losses that you can predict might happen. Then for the things you really can't anticipate, you've got capital. And both of those things are at very solid, good levels. So yes, we are confident that the banking sector is well positioned to withstand a severe shock and you see that for example the stress test that we report that the IMF did with us as part of the FSAP, the financial sector assessment program the IMF runs every four years with their members. You can see, I mean it's a very severe scenario, it has a big impact on banks, capital levels come down but the capital levels are able to absorb the shock. The risk though that we are concerned about in a very extreme situation, banks might, in a very extreme situation where they are facing large credit losses banks may be in the situation where they need to pull back on lending to protect their capital. And if that happens, the banking sector moves from being a shock absorber to a shock amplifier and that's what you don't want to happen. That makes a bad situation worse. But I think we are confident that banks are coming into this in a good place and the message here is this is a time for vigilance.
The only thing I'd add to that is that you always have to be careful not to fall into the trap of preparing for the last crisis. The thing about a crisis, what makes it a crisis is you didn't expect whatever happened to happen, right? So this is one of the things we do in the FSR is we think of what could possibly go wrong. We devise these stress tests. They're not forecasts. They're actually designed to be very sort of tail risk scenarios. And we basically run a model to see what do we think the banks would do in that situation and how would they fare. So the ones that we present in the FSR this year are pretty extreme scenarios so that's the thing that gives us confidence that the banks are well positioned to be that shock absorber but you have to stay vigilant and the banks themselves run these tests too. So these are our stress tests, they run their own stress tests. So this is how they're thinking too, what could go wrong and are we prepared for that?
The report paints a pretty bleak picture for mortgage arrears in a worst case global trade war scenario making them comparable to the '08 financial crisis. How long do tariffs have to remain in place for this scenario to turn into a reality?
Well, again, it's important to remind you that this isn't a forecast. So really as I said what we've done here is we've taken one illustrative scenario out of the MPR and then we've also taken the scenario out of the FSAP stress test and modeled our, used them as channels through which the financial sector would sort of travel and looked at what could happen. But it isn't a forecast. We can't tell you if X months happen then we get to X position in arrears. It's not that detailed scenario. It's a pretty extreme scenario. I mean scenario two, the IMF's, it's longer than their extreme scenarios. They imply a pretty dramatic escalation of the trade war and something that lasts for a long time. I mean to put it in simple terms when you're doing the FSR you put your gloomy hat on. You really, you get gloomy, you think about okay what could go wrong and then you ask how well prepared are we, how do we get better prepared. And you can look at table 1, Jordan, and you'll sort of see the scenario mapped against previous episodes of stress and sort of how extreme things would need to be.
All right let's go to Prom from Thompson Reuters please.
Good morning Governor. In the light of the meeting between Prime Minister Carney and President Trump, what do you think are the chances of the trade war not being protracted and prolonged?
