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Winnipeg Free Press - PRINT EDITION

Bank charts shock scenarios

-- European crisis to hit U.S. first -- Job losses, mortgage defaults in Canada

By: Gordon Isfeld

Posted: 06/15/2012 1:00 AM | Comments: 0

OTTAWA -- Canadian households be warned: Your finances could soon be hit with a big shock.

Any spillover from an unbridled European financial crisis could carry over to this side of the ocean, first rocking the U.S. banking sector and then Canada's. In that scenario, already debt-burdened households could begin defaulting on their mortgages, banks would start tightening their lending, jobs would be lost and the hot housing market would go into the deep-freeze, as fewer people are able to buy.

That could be the effect of shock scenarios the Bank of Canada highlighted Thursday in its biannual financial system review, in which the word "shock" is used liberally.

Given all the uncertainty that engulfs the eurozone's faltering finances, that may not even be the worst-case scenario. "Conditions in the international financial system are fragile," the central bank said in the review.

"If the sovereign debt crisis in Europe continues to intensify, it would further weaken global economic growth and prompt a general retrenchment from risk. In turn, the weaker global outlook would fuel sovereign fiscal strains and impair the credit quality of bank-loan portfolios."

Many of the risks highlighted in Thursday's document have been examined previously, but this time the analysis appears more urgent in tone.

The bank's shock analysis is also timely, coming ahead of Sunday's national election in Greece that has been characterized as a take-it-or-leave-it vote on the European Union-International Monetary Fund rescue plan. Also Sunday, Prime Minister Stephen Harper will travel to Mexico for a critical Group of 20 summit, accompanied by Finance Minister Jim Flaherty and Bank of Canada governor Mark Carney, who is also chairman of the global Financial Stability Board.

Growing concerns about Europe "reflect widespread doubts about the capacity and resolve of policy-makers to address unsustainable fiscal situations, the capital adequacy of some euro-area banks and the underlying balance-of-payments problems within the euro area," the bank says.

It warned that "if these issues are not dealt with in an orderly way, the contagion effects on global financial conditions could be significant."

While Canadian banks have limited exposure to the European countries most affected by the crisis -- such as Greece, Spain and Italy -- should the contagion spread further, the impact on this country's financial system "could be significant," the bank said.

"The indirect impacts could become especially important if entities in the United States were significantly affected by the crisis."

Specifically for Canada, the high indebtedness of households and bloated house prices "require continued vigilance."

"These conditions make households especially vulnerable to adverse shock," the bank said, adding household debt levels continue to be "the most important domestic risk to financial stability in Canada."

The bank noted households have been piling on debt at a slower rate recently, with the ratio of debt to income basically unchanged from a peak of 150.6 per cent in the last quarter of 2011 -- but that's still higher than households in the U.S. and the U.K. Growth in borrowing -- both for mortgage and non-mortgage purposes -- has slowed from an annualized six per cent between May and October 2011 to four per cent from November 2011 to April 2012.

The Bank of Canada went even further in its analysis, saying households could be hit by two interrelated shocks -- a big drop in house prices and a "sharp deterioration in labour-market conditions."

-- Postmedia News

Republished from the Winnipeg Free Press print edition June 15, 2012 B3

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