Canada’s financial system remains highly vulnerable to a further deepening of the European debt crisis and to a correction in the housing market, which is showing some overvaluation, the Bank of Canada said on Thursday.
In its semi-annual Financial System Review, the bank said that while Canada’s financial system is still robust, the overall risks to it are high, at the second-highest of the four risk levels the bank has delineated. That level is the same as in December, but the bank noted that in the interval conditions in Europe had improved early this year but then deteriorated again.
The central bank put the risk from euro sovereign debt at the highest level due to widespread doubt about the capacity and resolve of European policymakers to address unsustainable fiscal situations and balance-of-payment problems, and undercapitalized euro-area banks.
“If these issues are not dealt with in an orderly way, the contagion effects on global financial conditions could be significant,” the bank said, calling on the Europeans to deepen their union.
Bank of Canada Governor Mark Carney, who also heads the G20’s financial regulatory task force, has been pushing for a euro zone banking union. This week he applauded European authorities’ move to lend Spain up to 100 billion euros ($125 billion) to rescue its banks as an important step towards such a union.
Domestically, the bank said risk from high household debt levels and a potential correction in the housing market were elevated and had not diminished since December.
“The continued high level of activity and stretched valuations in some segments of the housing market are of increasing concern,” it said.
While households are not adding to their debt as fast as before, income growth is still not keeping up with debt accumulation. So the bank expects the household debt-to-income ratio to rise from the fourth quarter’s 150.6 percent, a level that is already higher than in the United States and Britain.
Low interest rates since the 2008-09 recession have contributed to a heated housing market and the high household debt. Policymakers are particularly worried about a condominium boom in Toronto, while some reports suggest property prices are gradually cooling in other parts of the country.
The bank said measures of housing affordability are broadly unchanged from December and suggest some overvaluation.
The review made pointed remarks at China, urging it and other countries to address current account imbalances.
“Among other things, this will require a more decisive move toward market-determined exchange rates by economies with current account surpluses, notably China,” it said.