- The market of frothy real estate in Canada has prompted the Bank of International Settlements to note various warning signs of an anticipated financial crisis.
- Although it is difficult to say when or even if that crisis could happen, the high credit-to-GDP gaps, debt service rates and property gaps tend to be red flags.
Canadian real estate prices have helped push Canada into a warning for a financial crisis. The Bank of International Settlements (BIS) published their quarterly overview of central banks. The assessment is an exhaustive assessment of bank indicators, looking for signs that could lead to stress at domestic banks. Canada is now flashing a warning signal for all four categories, which would normally lead to a financial crisis.
The Bank of International Settle-what?
The BIS is known as the bank for central banks. The organization based in Switzerland carries out research and advice for the 60 central banks that finance and own them. The aim is to ensure that monetary policy is "more predictable" and "more transparent". It is a club where central bankers can meet without the curious eyes of their local authorities. You know, so they can get advice from each other, that may not be so useful for ordinary people.
The BIS is one of the few organizations that marked the US for a banking crisis. Although we knew what would happen in the mid-2000s, the Great Recession would still strike in 2008. Knowing something does not mean that you can do something about it. Although some of the world's largest fund managers appreciate the warnings.
Credit-to-GDP gaps, debt service rates & property gaps
The most useful thing that the BIS produces are the Early Warning Indicators (EWI). The EWI are a series of binary indicators that are looking for rapid changes that can put the banking system under pressure. Binary indicator means that they either warn or not, there is no estimate of how severe the crisis will be. The Credit-to-GDP gap, debt service ratio and the real estate gaps are the big EWIs you want to know.
These are extensive calculations, but they are fairly simple concepts. The credit-to-GDP gap is the rate at which the credit changes, in contrast to GDP (we have actually touched a similar comment on Friday ). The debt service ratio (DSR) is the level of the debt service, which is the payments required to maintain credit in good standing. The gap in the real estate price is how fast house prices are rising. I know, your broker says that fast moving real estate prices are a good thing. The BIS thinks that this leads to bank instability.
Canada flashes three warning signs
The report of 196 pages in the BIS reports that "Canada, China and Hong Kong SAR stand out." They can not tell us when a financial crisis is going to happen. However, they indicate red or orange warning indicators. Either a warning is indicative of a financial crisis, two thirds of the time. Canada is the only country that displays warning indicators for all four categories.
The BIS is paying special attention to credit-to-GDP warnings, combined with a gap in house prices. Canada has the third highest credit-to-GDP gap, from countries that also have a gap in house prices. Only Hong Kong SAR and Switzerland are higher. Again, a higher number does not mean that the correction will be more severe. It means that the probability that the problem resolves itself is smaller.
Canadian property debt has been the primary engine of three of the four EWIs. This warning follows the US Federal Reserve, which refers to Canadian property buyers as "exuberant", UBS ranks Toronto as the largest bubble in the world and IMF expresses concern to senate . It is probably nothing.