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The global financial crisis and its impact on Canada

Philippe Bergevin
International Affairs, Trade and Finance Division

December 2008

What happened in the United States?

The current global financial crisis was triggered by difficulties in the US housing market. A large number of mortgages – so-called sub-prime mortgages – were granted to Americans with poor credit histories who were seeking to take advantage of historically low interest rates and relatively lax credit standards. With falling home prices and rising interest rates on their mortgages, a significant proportion of these sub-prime borrowers are now unable or unwilling to re-pay their mortgages.

Most sub-prime mortgages were bundled and sold to investors globally through a process known as securitization, which transforms mortgages and other assets into tradable financial instruments such as collateralized debt obligations (CDOs). Investors in CDOs and similar financial instruments suffered relatively heavy losses as US borrowers defaulted on their mortgages. Moreover, the complexity of these instruments, and uncertainty surrounding their value, have contributed to a “market freeze” for such products, further exacerbating the losses suffered by investors.

Because of the losses related to US sub-prime mortgages, a number of financial institutions in the United States and elsewhere either went bankrupt or received government support. Banks have become wary of lending to each other due to fear that other institutions will be unable to repay their loans, thereby raising the cost of inter-bank loans. The higher cost of raising cash, coupled with the need to make their balance sheets look better, has resulted in banks lending less and at higher interest. This “credit crunch” is now leading to decreased consumption and investments, giving rise to fears of a worldwide recession.

How is Canada being affected?

So far, Canada’s financial system has been relatively less affected by the global financial crisis than those of other industrialized countries such as the United States and Great Britain. The World Economic Forum has recently ranked Canada’s banking system as the soundest in the world. Canadian banks are profitable, well-capitalized and well-positioned to withstand economic shocks. As well, with the six largest domestic banks holding more than 90% of banking industry assets, the banking industry is relatively stable. Furthermore, the regulatory framework for Canada’s financial sector is both more responsive and more prudent, in some respects, than that of the United States.

Relative to their American counterparts, Canadian banks were less active in the sub-prime lending and securitization activities that are at the centre of the current financial crisis. In 2006, sub-prime loans accounted for less than 5% of new mortgages in Canada, compared to 22% in the United States. Furthermore, whereas more than 50% of all mortgage debts outstanding in the United States were sold to investors through securitization, more than 75% of Canadian mortgages were held by financial institutions on their balance sheet in a more traditional fashion (as of 31 December 2007).

While the Canadian financial system seems to be doing relatively better than those of other countries, Canada’s economy is nonetheless feeling the global economic slowdown. The economic difficulties experienced by our largest trading partner – the United States – are resulting in weaker Canadian exports and further problems for the manufacturing sector. Moreover, the strong Canadian energy and natural resources sector is likely to suffer as the world economic slowdown brings about lower demand and weaker prices for commodities. Although Canada has been relatively insulated from the worst of the financial crisis to date, the impact of the economic slowdown in the United States and elsewhere has affected, and will continue to affect, our nation.

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