IMF Releases Assessment of Canada's Financial Sector

Yesterday, the International Monetary Fund (IMF) released its Financial Sector Assessment Program Report (Report) on Canada (which the IMF is required to prepare every five years). The Report noted that Canada’s financial system successfully navigated the global financial crisis, and that stress tests suggest that major financial institutions would continue to be resilient to credit, liquidity and contagion risks arising from a severe stress scenario. The Report also noted that elevated housing prices and high household debt remain areas of concern (despite the substantial level of government-guaranteed mortgage insurance), though targeted prudential and macro-prudential measures were proving to be effective. The Report concluded that the regulatory and supervisory framework is strong and is complemented by a credible federal system of safety nets, although there is no single body with an explicit mandate to take a comprehensive view of systemic risk or to undertake crisis preparedness. Finally, the Report noted that improving cooperation between federal and provincial authorities would further reinforce system-wide oversight arrangements.

The Report made the following key recommendations for implementation in Canada. Given Canadian authorities’ clear desire to obtain "full marks" in an assessment of this nature, it is expected that Canada will implement many, if not all, of these recommendations—although certain of the recommendations which require provincial cooperation and coordination may prove particularly challenging to implement. In this bulletin, we provide a description of each of the recommendations organized according to the implementation periods proposed by the IMF, followed by comment on the potential implementation of each recommendation based on the more detailed commentary in the Report.

IMF’s Key Recommendations and Comment on Potential Implementation

Within 12 Months

  • Recommendation: Expand financial sector data collection and dissemination with a view to enhancing coverage, regularity, and availability of time-series to facilitate analysis.

    No authority currently has the mandate to collect and analyze data for the financial system as a whole, and consequently there are gaps in both understanding certain segments of the market (e.g., holding company credit intermediation, some pension fund activities, securities markets) and the interconnectedness among different areas of the financial universe.
  • Recommendation: Augment OSFI’s top-down stress-testing framework for banks with risk sensitive concepts of key credit risk input parameters and econometric, model-based approaches using longer time series.

    Implementation of these recommendations would include addressing data gaps by collecting longer time series of granular data on a greater range of items, using econometric, model-based approaches for forecasting income statement and balance sheet items, and incorporating economic concepts in the determination of credit risk input parameters.
  • Recommendation: Include major regulated entities at federal and provincial levels in a regular, common stress-testing exercise, which would involve a degree of collaboration between relevant federal and provincial authorities.

    This would include subjecting all major federal and provincial entities to common stress-test frameworks (described in the previous recommendation) and establishing a liquidity stress-testing framework that incorporates Basel III metrics.
  • Recommendation: Address shortcomings in risk identification and enforcement in securities regulation.

    This would include stronger coordination, additional capacity in specialized areas, more robust quantitative analysis and more on-site inspections. In addition, more coordination with the federal government would be necessary in areas of identification of systemic risk and criminal enforcement. The Report notes that the recent agreement in principle to establish a cooperative capital markets regulator could bring efficiency gains in this area.
  • Recommendation: Enhance supervisory cooperation among federal and provincial supervisors and subject all systemically significant financial institutions to intensive supervision.

    This would include better two-way communication and protocols to share supervisory information between OSFI and the regulators of the securities subsidiaries of the large banks and, with respect to insurance, to establish a clear and consistent regulatory framework for group wide supervision of market conduct requirements at the group level. The Report also proposes that OSFI should have full prudential oversight over the operations of CMHC.
  • Recommendation: Provide a clear mandate to an entity (i) to monitor systemic risk to facilitate macro-prudential oversight, and (ii) to carry out system-wide crisis preparedness.

    No single body has the mandate for macro-prudential oversight, nor do any of the oversight committees (e.g., Financial Institutions Supervisory Committee) have the membership that would allow for a comprehensive view of systemic risk across all financial institution markets in Canada. The Report believes that the Canadian system would be strengthened by assigning this responsibility to a specific entity to develop an overarching policy and operational guidance to respond to system-wide crises and to conduct comprehensive simulations to test the capacity of authorities to respond in a coordinated manner to crisis scenarios.

Within 1-3 Years

  • Recommendation: Equip OSFI with powers to make its own enforceable rules by administrative means, supplementing the use of guidelines and government regulations; amend legislation on statutory decisions to give OSFI sole decision-making authority on prudential criteria.

    This may include making OSFI guidelines legally enforceable and to require that, if OSFI rejects a transaction on prudential grounds, that the decision cannot be overridden by the Minister except in extraordinary circumstances and with full public disclosure.
  • Recommendation: Replace certain informal and ad hoc reporting requirements by FRFIs with more formal requirements.

    This may include more statutory-based reporting obligations, such as for large exposure and related party transactions.
  • Recommendation: Adopt a transparent and consistent regulatory regime for group-wide insurance supervision; give OSFI the authority to take supervisory measures at the level of the holding company.

    This would include the formulation of a clear and consistent regulatory regime for group-wide supervision that includes material non-regulated entities as well as prudential and market conduct requirements at the group level.
  • Recommendation: Increase the ex-ante funding of CDIC and enhance its data collection and analysis of depositor profiles.

    This could include an increase in the premiums paid by deposit-taking institutions, more autonomy for CDIC in the exercise of its resolution powers and greater powers for CDIC to ensure continuation of essential services for companies in the same group in a resolution. The Report also recommends that authorities consider the merits of some form of depositor preference and supports the simplification of the rules for eligibility for deposit insurance of complex deposit products.

Over 3 Years

  • Recommendation: Reduce the government’s exposure to mortgage insurance gradually.

    This could include a gradual increase in the market share of private mortgage insurers and/or to change the mortgage insurance product to involve more risk sharing as has occurred in other jurisdictions such as Hong Kong. In addition, the Report recommends that, over the longer term, the need for extensive government-backed mortgage insurance should be re-examined and notes that the Australian mortgage market was similar to Canada’s in the mid 1990’s, but it was privatized in 1998.

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