The World Economic Forum consistently ranks Canada’s banks among the world’s safest. Competent regulators have overseen stress tests, tightened lending standards and delinquency rates are low. Demographics are good and the country’s diversified economy is backed by a treasure of oil, wood, gold and other natural resources.

So the experts say.

Canada Banks Stress Tests
Photo by Unsplash (Pixabay)

Institutional investors, relying on the work of Jeremy Rudin, Canada’s chief bank regulator, agree. In fact, Canadian financials accounted for 35.5% of the market capitalization of the benchmark exchange (NBF February).

However this façade hides major uncertainties. Key concerns stand out, which if unaddressed, could spark solvency and liquidity issues in one or more of Canada’s Big Six banks.

The fragilities can be seen in an IMF report, which calculated that Canada’s financial sector accounted for a stunning 500% of GDP in 2012. Today, the assets of the Big Six banks alone are more than double the size of the country’s economy.

Each (RBC, CIBC, Scotiabank, BMO, TD and National Bank) have been designated “systemically important,” which in turn, due to sheer size and interconnectedness, suggests that they are almost certainly “too big to fail.” That means the collapse of any one Big Bank would threaten to trigger systemic implosion.

More ominously, if Canada’s financial system, arguably the world’s best, is riddled with pores, what does that say about the US, the UK, and Japan? Let alone Italy and Spain?

Yet signs of fragility are everywhere. Consider:

Complacency following “secret” $114 billion bailout

A quick review of key metrics suggests Canada’s banking sector, which, on the surface, having largely escaped the 2008 financial crisis, has thus learned little from it.

As David Macdonald demonstrated in a paper for the Canadian Center for Policy Alternatives, Canada’s Big Banks benefited from nearly $114 billion in cash, liquidity, and other bailout help from both local and US sources following the financial crisis.

“Three of Canada’s banks – CIBC, BMO, and Scotiabank – were at some point under water,” Macdonald writes. “With government support exceeding the value of the company.”

Sadly, details were largely kept secret, Macdonald says, hidden in footnotes and legalese, where even the term “bailout” was shunned. Reforms that could have strengthened the system were thus avoided and the Canadian public remains largely unaware of the dangers.

(A Canadian Bankers Association spokesperson denied that any Canadian bank was bailed out or was in danger of failing, but conceded that the Canada Mortgage Housing Corporation (“Canada’s Fannie Mae”) bought up $69 billion worth of assets and that the Bank of Canada advanced additional liquidity funding).

“Canada’s Fannie Mae” piles on risk amidst residential real estate bubble

In March, the Economist magazine calculated that Canadian residential housing is 112% overvalued relative to rents and 46% overvalued relative to incomes. Even Canadian bank economists, enablers of previous excesses, now describe average Toronto prices, which surged 23% last year to CAD $727,000, as a bubble.

Canadian banks have lent into much of the excesses and “Canada’s Fannie Mae” (the CMHC) has guaranteed more than $500 billion in mortgages; almost as much as the US GSEs did relative to GDP prior to the 2008 crisis.

Canadian banks have never seen a major real estate implosion

Because Canadian real estate prices never collapsed during the 2008 financial crisis to the degree they did in the US and the UK (let alone Japan), regulators, investors and analysts are totally unprepared for any such eventuality.

As noted above, there are no indications that any Canadian regulatory body such as OSFI or any financial institution has had a Japan style scenario gamed out by independent risk experts. This even though some Canadian demographic trends, particularly with regards to workforce aging and retirements for the coming decade are roughly similar to what Japan’s were, at the peak of its bubble.

Canadians are in record debt

Worse, Canadians are in debt up to their eyeballs. According to Statistics Canada the ratio of household credit market debt (this excludes government, financial and business debts) reached a record 166.9% of disposable income in the third quarter of 2016. That was up from 166.4% in the second quarter.

Inflated asset prices currently keep those debts under the rug. However asset price levels are temporary; debts linger.

Wolves are in charge of the hen house

Another dangerous sign stems from the fact that all key stakeholders that facilitated the 2008 bubbles and ensuing crisis escaped unnoticed. That means the wolves remain in charge of the hen house.

For example, as Macdonald notes in his paper, Gordon Nixon, CEO of RBC, Canada’s largest bank during the crisis, took in CAD $9.6 million in compensation in 2008, and $12.1 million in 2009.

Canadian bank CEOs and directors now figure that they’ll be bailed out and collect their bonuses, no matter what risks they take.

Bank CEOs aren’t alone in escaping blame for running the system into the ground in 2008. Most Canadians wouldn’t recognize David Dodge either. However, as governor of the Bank of Canada, he fostered the easy-money policies which facilitated the debt and asset bubbles that led to the ensuing troubles.

SFI: financial sector “group think” stress tests

Another key threat to Canada’s financial system relates to the “group think” that pervades top officials, which leads them to err simultaneously.

This is evident in the stress tests that various regulators (the IMF, OSFI, the BOC) have conducted or overseen on the big banks, which remain riddled with holes.

Shorn of business cycle theorists, the stress tests only considered scenarios based on Canada’s history dating back to the 1980s. This despite the fact that eight years of unconventional monetary policy suggests that there are high risks that Western economics are in the midst of a 1930s-style liquidity trap.

As if that were not enough, the stress tests only considered Canadian economic performance. But the first question a doctor will ask is what ailments there are in your family history. Canada’s family (the G-7) includes Japan. An obvious stress test scenario would have looked at Japanese metrics during the past two decades.

Worse, regulators allowed the banks themselves to conduct the key bottom-up stress testing, rather than outsourcing the job to independent consultants. That’s like asking a drunk to check the inventory list in the wine closet to make sure everything is still there. Finally, the stress tests appear to have omitted any probability of freezing up of key counterparties, as occurred with AIG during the 2008 crisis. What would happen if there was a 1% default in the notional value of the $1 quadrillion global derivatives market? (a $10 trillion loss) We don’t know.


The fact that bureaucrats who looked away during the buildup to the 2008 financial crisis weren’t reprimanded will have major implications going forward. That’s because Jeremy Rudin, head of OSFI, the organization most closely charged with overseeing Big Bank stability, was one of those bureaucrats.

Rudin’s story is instructive because it mirrors that of almost all key Canadian financial sector regulatory officials.

Rudin (according to his official biography) spent the pre-2008 crisis years in increasing positions of responsibility in Canada’s finance ministry, which culminated in an assistant deputy minister posting. As insiders know, ADM is a crucial position, which gave Rudin, if he did his job well, better access to information and

1, 2  - View Full Page