Canadian housing prices are higher than levels consistent with current fundamentals in some provinces. The empirical estimates suggest that a 10 percent decline in housing prices would lead to a 1¼ percent decline in private consumption. The high level of household leverage and housing prices could prove to be a source of vulnerability. The rebound in debt and housing prices after the crisis largely reflects the resilience of the financial system and the stronger economic recovery in Canada, as well as historically low interest rates.

Abstract

Canadian housing prices are higher than levels consistent with current fundamentals in some provinces. The empirical estimates suggest that a 10 percent decline in housing prices would lead to a 1¼ percent decline in private consumption. The high level of household leverage and housing prices could prove to be a source of vulnerability. The rebound in debt and housing prices after the crisis largely reflects the resilience of the financial system and the stronger economic recovery in Canada, as well as historically low interest rates.

IV. Bilateral Financial Linkages in an International Perspective1

A. Introduction

1. This note provides a snapshot of Canada’s international financial integration at the end of 2010. It characterizes the size and composition of Canada’s external assets and liabilities and their evolution over time, and compares Canada with other advanced economies. It then examines these claims and liabilities by the residence of the counterpart, to provide a broad assessment of the sensitivity of Canada’s external balance sheet to shocks originating in different countries and regions.

B. Canada’s External Position

2. Canada’s external assets and liabilities at market value totaled C$1.76 trillion (108 percent of GDP) and C$1.94 trillion (120 percent of GDP) respectively as of end-2010. As in other advanced economies, these ratios have increased significantly over the past two decades (text Chart). Canada’s net international investment position (NIIP), which turned progressively less negative between the early 1990s and 2006, reflecting in particular a string of current account surpluses during 1999-2008, has deteriorated somewhat since the crisis, with net liabilities of around 12 percent of GDP at end-2010 (and a similar level in Q2 2011). Canadian external assets have grown steadily as a share of total Canadian financial assets from around 8 percent in 1990 to over 12 percent during the 1990s, and have remained broadly in that range since then, with fluctuations partly reflecting exchange rate movements.2 Canadian external liabilities have instead declined from a peak of 16 percent of total financial liabilities to around 13½ percent in 2010, in line with the reduction in Canada’s net external liabilities.

uA04fig01

External Assets and Liabilities, 1990-2010

(Percent of GDP, market value)

Citation: IMF Staff Country Reports 2011, 365; 10.5089/9781463929237.002.A004

Sources: IMF International Financial Statistics and Fund staff calculations.
uA04fig02

External Assets and Liabilities, 1990-2010

(Percent of total financial assets and liabilities)

Citation: IMF Staff Country Reports 2011, 365; 10.5089/9781463929237.002.A004

Sources: IMF International Financial Statistics and Fund staff calculations.

3. Canada’s external assets and liabilities are comparable in size to those of other non-EU advanced economies (Table 1). Specifically, Canada’s external portfolio in relation to GDP is broadly comparable in size to Australia, Japan, and the United States. Advanced economies with financial centers (such as the Netherlands, Switzerland, and the United Kingdom) have instead ratios of external assets and liabilities of 500 percent and above; also, other European countries (such as France and Germany) have much larger ratios.

Table 1.

International Financial Integration and Net External Position, 2010

(Percent of GDP)

article image
Sources: IMF International Financial Statistics and Fund staff calculations.

International activity of Canadian banks

4. The lower level of external assets and liabilities relative to several other advanced economies reflects in part smaller cross-border positions by Canadian banks (Figure 1). Balance of payments statistics record external assets and liabilities on the basis of the residence principle, with external bank claims being defined as claims by a banking entity resident in the country (including the affiliate of a foreign bank) on a nonresident (including a banking affiliate domiciled in a different jurisdiction). On this “locational” basis, Canada’s external bank assets and liabilities are around 25 percent of GDP, a level similar to the United States but much lower than in most European advanced economies, where those ratios at times exceed 100 percent of GDP. A number of small international financial centers, such as the Cayman Islands, Luxembourg, and the Bahamas, also report high bank claims and liabilities, reflecting the activity of affiliates of banks from other countries.

Figure 1.
Figure 1.

Cross-Border Bank Assets and Liabilities by Residence of the Reporting Entity, June 2011

(Billions of U. S. dollars)

Citation: IMF Staff Country Reports 2011, 365; 10.5089/9781463929237.002.A004

Sources: Bank for International Settlements and Fund staff calculations.

5. Locational banking statistics based on the nationality of the reporting bank show higher international activity of Canadian banks (Figure 2). These statistics capture cross-border claims and liabilities based on the nationality of the reporting bank, regardless of the location of the office booking the claims. They show much larger claims and liabilities for countries whose banks book significant international activity through affiliates domiciled in other countries (such as France, Germany, and Switzerland). For Canada as well, claims vis-à-vis foreign offices booked through affiliates outside Canada are substantial.

Figure 2.
Figure 2.

International Bank Assets and Liabilities by Nationality of the Reporting Bank, June 2011

(Locational basis, billions of U.S. dollars)

Citation: IMF Staff Country Reports 2011, 365; 10.5089/9781463929237.002.A004

Sources: Bank for International Settlements and Fund staff calculations.

6. The consolidated foreign assets of Canadian banks are also much larger than the locational cross-border claims (Figure 3). This measure of foreign assets consolidates claims of banks vis-à-vis their foreign offices and includes lending activity by these offices in the country in which they are located (for example, claims by a Canadian bank affiliate in the United States on U.S. residents). For Canada, “local” claims of Canadian bank affiliates (denominated in the currency of the country where the affiliate is located) account for the lion share of these claims, as discussed further below.

Figure 3.
Figure 3.

Foreign Claims of Selected Banking Systems, by Nationality of the Reporting Bank, Ultimate Risk and Immediate Borrower Basis, June 2011

(Billions of U. S. dollars)

Citation: IMF Staff Country Reports 2011, 365; 10.5089/9781463929237.002.A004

Sources: Bank for International Settlements and Fund staff calculations.

The composition of Canadian external assets and liabilities

7. Canada’s overseas assets reflect primarily equity-related claims, while portfolio debt instruments and foreign direct investment are the most important liability categories (Figure 4). On the external asset side, foreign direct investment and portfolio equity are almost double the size of debt-related claims (portfolio debt securities and other investment assets). On the liabilities side, portfolio debt—which has risen significantly since the start of the global financial crisis—and FDI are the most important components. The current level of foreign holdings of Canadian debt securities (40 percent of GDP as of end-2010) is, however, not unprecedented: during the 1990s, a period when Canada had significant net external liabilities, nonresidents’ holdings of Canadian debt securities were around 50 percent of GDP.

Figure 4.
Figure 4.

Canada: Composition of External Assets and Liabilities

(percent of GDP, 2007 and 2010)

Citation: IMF Staff Country Reports 2011, 365; 10.5089/9781463929237.002.A004

Source: Statistics Canada.

8. Overall, the structure of the Canadian external position (“long equity, short debt”) resembles the one of the United States. Specifically, Canada has a positive net FDI and net portfolio equity position, more than offset by a large negative position in portfolio debt instruments. Hence Canada’s IIP tends to improve in periods of strong global stock market performance and worsen during global stock market downturns. In terms of currency composition, Canada is ‘long” in foreign currency and “short” in domestic currency, as most other advanced economies, reflecting the fact that most external assets are foreign-currency-denominated while a sizable fraction of external liabilities are denominated in Canadian dollars. As a result, Canada’s net IIP tends to improve when the Canadian dollar depreciates and viceversa.

Canadian external position by sector

9. Canadian pension funds and mutual funds are the biggest holders of foreign portfolio assets, which account for over 20 percent of their total portfolio as of Q2 2011 (Table 2), while direct holdings of foreign portfolio instruments by banks and households are modest. The largest component of outward foreign direct investment is in finance and insurance, followed by mining and manufacturing. Finally, banks’ holdings are the largest component of other investment assets.

Table 2.

Share of Foreign Portfolio Investment in Total Financial Assets

(Q2 2011, billions of Canadian dollars)

article image
Sources: Statistics Canada: National Balance Sheet Accounts.

10. On the liability side, according to Canadian-source data nonresidents held about 17 percent of Canadian shares and 28 percent of outstanding bonds.3 Around 60 percent of Canadian bonds held by nonresidents are issued by the federal government, provincial governments, and public enterprises, with the remainder issued by private corporations. Foreign direct investment in Canada is concentrated in manufacturing and mining, followed by finance and insurance, and other investment liabilities reflect primarily cross-border borrowing by banks.

C. Bilateral Claims and Liabilities

11. This section presents a decomposition of Canada’s external position by financial trading partner (see Milesi-Ferretti, Strobbe, and Tamirisa, 2010 for a global view of bilateral financial linkages at the eve of the financial crisis). The decomposition can provide a rough measure of the sensitivity of Canada’s external balance sheets to shocks originating in different countries. A general caveat is, however, the absence of data on positions in derivatives, which makes it impossible to assess the extent to which cross-border positions are hedged. In light of the comprehensiveness of Canadian bilateral international investment statistics, the bilateral decomposition relies primarily on Canadian-source data. For example, Canada reports a bilateral international investment position vis-à-vis the United States by type of instrument. For other partner countries, the estimation of bilateral positions relies on Canadian data for Canadian FDI assets abroad, FDI in Canada, Canada’s portfolio investment assets, and Canada’s bank claims and liabilities. These data are complemented with partner-country data for Canada’s portfolio investment liabilities (from the IMF’s Coordinated Portfolio Investment Survey—CPIS), other investment assets and liabilities of Canadian nonbanks vis-à-vis foreign banks (from the Bank for International Settlements—BIS) and bilateral positions by instrument vis-à-vis Canada reported by the euro area. Additional details are provided in the Appendix.

12. Around half of Canadian external assets are vis-à-vis the United States, a share considerably lower than the share of exports (Figure 5). The largest portion of claims on the United States is in the form of portfolio equity, with FDI claims also significant (mostly in banking and insurance). Conversely, Canadian residents have lower holdings of U.S. debt securities, reflecting a more general orientation of their portfolio holdings towards equity instruments. Among remaining countries, three groups account each for around C$200bn or 10 percent of total Canadian claims: the euro area, and other advanced economies in Europe (such as the Sweden, Switzerland, and especially the United Kingdom), and the Caribbean and other small financial centers. The composition of claims on the euro area and advanced European countries is broadly similar to the composition of claims in the United States, while claims on Caribbean and small financial centers reflect mostly FDI. Claims on Asia and Pacific economies are around C$150bn (over half of which in portfolio equity claims), while claims vis-à-vis Central and Latin American countries are around C$70bn (with FDI accounting for over half of the total).

Figure 5.
Figure 5.

Canada External Assets and Liabilities, Bilateral Basis, 2010

(Billions of Canadian dollars)

Citation: IMF Staff Country Reports 2011, 365; 10.5089/9781463929237.002.A004

Sources: Fund staff estimates (see Appendix).

13. Over 60 percent of claims on Canada are held by U.S. residents (Figure 5). Claims from the euro area and other advanced European countries represent a significant portion of the remainder. For these countries, the majority of the claims are in the form of securities, with holdings of Canadian debt larger than holdings of Canadian equities, with sizable claims in the form of FDI as well. Asian and Pacific economies that report the geographical distribution of their portfolio claims hold about C$160bn in Canadian assets, most in the form of securities.4

14. Canada has net liabilities vis-à-vis the United States and advanced European economies (including the euro area), partly offset by net claims vis-à-vis the Caribbean and small financial centers as well as Central and Latin America (Figure 6). The negative net position vis-à-vis the United States reflects primarily the large holdings of Canadian equities and bonds by U.S. residents.

Figure 6.
Figure 6.

Canada Net External Position, Bilateral Basis, 2010

(Billions of Canadian dollars)

Citation: IMF Staff Country Reports 2011, 365; 10.5089/9781463929237.002.A004

Sources: Fund staff estimates (see Appendix).

D. Cross-Border Activity of Canadian Banks: A Consolidated Perspective

15. As noted earlier, statistics on external claims and liabilities based on the residence principle (balance of payments) understate the extent of cross-border activity of Canadian banks. For example, the “local” claims and liabilities of the affiliate of a Canadian bank in, say, the United States are not reflected in Canada’s IIP because the affiliate is considered a resident of the United States.5 Table 3 uses consolidated banking statistics by nationality to provide information on the geographical allocation of foreign claims by Canadian banks. These claims are divided into international claims (comprising cross-border claims and local claims in foreign currency) and local claims (claims in the country of residence of the affiliate or branch denominated in that country’s currency). The counterpart is reported both in terms of immediate borrower and in terms of ultimate risk (taking into account any risk transfer between the immediate borrower and a guarantor).

Table 3.

Consolidated Claims of Canadian Banks by Nationality, 2007Q2 and 2011Q1

(Billions of U. S. dollars)

article image
Sources: Bank for International Settlements and Fund staff calculations.

16. Affiliates of Canadian banks have sizable “local” claims in the United States, which have expanded significantly relative to the pre-crisis period. These claims—booked in the United States and denominated in U.S. dollars—have increased by some C$200bn between 2007Q2 and 2011Q1, reflecting acquisitions of U.S. banks by Canadian financial institutions, and represent about half of total foreign claims by Canadian banks. Cross-border claims on the United States are instead considerably smaller. Claims on the euro area and other advanced European countries are mostly of a cross-border nature (indeed, cross-border claims on advanced European economies exceed those on the United States). The increase in cross-border claims on European economies explains almost the entirety of the expansion in Canadian banks’ cross-border claims on a consolidated basis since the pre-crisis period. However, the overall size of those claims remains modest if compared with total assets of Canadian banks (over C$3.1 trillion at end-March 2011). With regard to other regions, Canadian banks’ local presence in other regions is particularly high in Central and Latin America (for example in Mexico, Chile, and Peru). In contrast, consolidated claims on offshore and small financial centers are smaller than locational statistics suggest, with the latter likely reflecting positions of Canadian banks vis-à-vis affiliates in such centers on-lent to other countries.

E. Conclusions

17. Canada’s extent of international financial integration has increased sharply over the past two decades, as in other advanced economies. External assets and liabilities are broadly in line with those in other non-European advanced economies, but remain much lower than in most European advanced economies, also reflecting smaller cross-border activity by Canadian banks on a residence basis. In the years since the crisis the expansion in the United States has been important for Canadian banks.

18. Canada has strong financial linkages to the United States. On a balance of payments basis, Canadian claims on the United States reflect portfolio holdings, primarily of equity instruments, mostly held by Canadian pension funds and mutual funds, as well as bank claims, both in the form of FDI and other cross-border claims. On a consolidated basis, claims of Canadian banks on U.S. residents are larger, reflecting a significant local presence of Canadian banks in the U.S. market. Overall, claims on U.S. residents account for under 20 percent of total claims by Canadian banks. Conversely, there is substantial U.S. investment in Canada, reflecting primarily large holdings of Canadian debt and equity securities. Indeed, U.S. source data indicates that Canada is the second largest destination for U.S. portfolio investment abroad, after the United Kingdom.

19. Canadian assets in advanced European countries reflect primarily equity-related claims (portfolio and FDI). On a consolidated basis, Canadian bank claims in advanced Europe were around C$200bn as of March 2011, reflecting a combination of claims on banks, nonbank private sector, and to a lesser extent government bonds (Table 4). These claims are primarily vis-à-vis United Kingdom borrowers, and to a lesser extent vis-à-vis France, Germany, and the Netherlands, with more modest exposures to Greece, Ireland, Italy, Portugal, and Spain.

Table 4.

Foreign Claims of Canadian Banks by Sector of Borrower

(Ultimate risk basis, 2011 Q1, billions of Canadian dollars)

article image
Sources: Bank of Canada and Statistics Canada.

20. In the current unsettled external environment, the main risks for the external portfolio of Canada would come from the global ramifications of financial distress in the euro area, as well as its U.S. exposure. Given the large trade and financial linkages, Canada is naturally exposed to U.S. shocks. While direct exposures of Canadian banks to the more vulnerable countries in the euro area are modest, indirect spillovers could be significant, operating through a decline in equity prices and higher funding costs for banks. Direct losses on the external portfolio for non-leveraged investors (for example, households and pension funds) would occur primarily through declining foreign equity values (for example, a 20 percent decline in the value of foreign equity holdings would imply a loss on Canadian equity claims overseas of some C$100bn, some 5½ percent of Canadian GDP). However, severe global financial market turbulence would likely imply more significant declines in Canadian wealth through domestic equity valuations and potentially house prices, as discussed in the Staff Report—particularly should turmoil propagate to U.S. financial markets.

References

  • Lane, Philip R. and Gian Maria Milesi-Ferretti, 2011, “Cross-Border Investment in Small Financial Centers,International Finance 14 No. 2, pp.30130.

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  • Milesi-Ferretti, Gian Maria, Francesco Strobbe and Natalia Tamirisa, 2010, “Bilateral Cross-Border Holdings and Global Imbalances: A View on the Eve of the Financial Crisis,IMF Working Paper 10/257.

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Appendix Data Sources and Estimation Methods for Bilateral Claims and Liabilities

Foreign direct investment abroad. Bilateral data as provided in CANSIM Table 376-0051 (all countries).

Portfolio investment abroad, equity instruments. IMF, Coordinated Portfolio Investment Survey 2010 (Table 1.1 for Canada).

Portfolio investment abroad, debt instruments. IMF, Coordinated Portfolio Investment Survey 2010 (Table 1.2 for Canada).

Other investment assets. United States: bilateral international investment position vis-à-vis the United States (CANSIM). Euro Area: bilateral international investment position vis-à-vis Canada reported by the European Central Bank. For remaining countries:

  • Banks, bilateral BIS data on claims in the form of loans and deposits net of estimated FDI abroad by Canadian banks.

  • Nonbanks: BIS data on bank liabilities vis-à-vis Canadian nonbanks reported by Canadian partner countries.

Foreign exchange reserves: United States: bilateral international investment position vis-à-vis the United States (CANSIM). Euro Area: share of reserves held in euros as reported in European Central Bank, 2011, “The International Role of the Euro.”

Foreign direct investment in Canada. Bilateral data as provided in CANSIM Table 376-0051 (all countries).

Portfolio investment in Canada, equity instruments. United States: bilateral international investment position vis-à-vis the United States (CANSIM). Other countries: 2010 holdings as reported by these countries in the IMF’s Coordinated Portfolio Investment Survey (Table 5.1 for Canada).

Portfolio investment in Canada, debt instruments: United States: bilateral international investment position vis-à-vis the United States (CANSIM). Other countries: 2010 holdings as reported by these countries in the IMF’s Coordinated Portfolio Investment Survey (Table 5.2 for Canada).

Other investment liabilities. For the United States, bilateral international investment position vis-à-vis the United States (CANSIM). For the euro area, bilateral international investment position vis-à-vis Canada reported by the European Central Bank. For remaining countries:

  • Banks, bilateral BIS data on liabilities of Canadian banks (locational basis) in the form of loans and deposits.

  • Nonbanks: BIS data on bank assets vis-à-vis Canadian nonbanks reported by Canadian partner countries.

A. Data Issues

In bilateral international investment statistics, discrepancies between data reported by different countries in the same country pair can be substantial (see Milesi-Ferretti et al., 2011, for a discussion). For Canada, reported total portfolio liabilities are lower than the portfolio claims on Canada reported by countries participating to the Coordinated Portfolio Investment Survey (the difference was some C$90 billion at end-2010), even though several countries with large investment in portfolio instruments through foreign exchange reserves, sovereign wealth funds, and investment fund activity (such as China, Saudi Arabia, the United Arab Emirates, and the Cayman Islands) do not participate in the survey or do so only partially. The reason for the discrepancy lies in portfolio equity liabilities, which are considerably lower than the portfolio equity claims on Canada reported by CPIS countries. For 2010 Canada reported portfolio equity liabilities of C$358 billion, of which C$318 billion vis-à-vis the United States. However, partner countries participating in the CPIS reported C$544 billion in portfolio equity claims on Canada, of which over C$400 billion reported by the United States.6 Conversely, Canada reports larger holdings of Canadian bonds by U.S. residents than the U.S. does.

B. Country Groups

Euro Area: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, Spain.

Advanced Europe: Denmark, Iceland, Sweden, Switzerland, United Kingdom.

Other European Countries: remaining European countries (also excluding those classified under “small financial centers” below).

Small Financial Centers: Bahamas, Barbados, Bermuda, British Virgin Islands, Cayman Islands; U.K. Channel Islands; Gibraltar; Liechtenstein; Macao S.A.R. of China; Mauritius; and others (see Lane and Milesi-Ferretti, 2011).

Central and Latin America: Argentina, Belize, Bolivia, Brazil, Chile, Colombia, Costa Rica, Ecuador, El Salvador, French Guiana, Guatemala, Guyana, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Suriname, Uruguay, Venezuela.

Other Asia: Asian and Pacific countries excluding Japan, Australia, New Zealand, and small financial centers.

1

Prepared by Gian Maria Milesi-Ferretti.

2

Most Canadian external assets are denominated in foreign currency and hence increase (decrease) in value relative to domestic assets when the exchange rate depreciates (appreciates).

3

Data reported by partner countries suggests larger foreign holdings of Canadian equities (a share closer to 25 percent). See the discussion in the Appendix.

4

Total holdings of Canadian instruments from that region may well be higher, given that some large holders of foreign securities, such as China and Taiwan province of China, do not participate in the CPIS.

5

The exception is the portion of the accumulated reinvested earnings of the U.S. affiliate channeled back to the parent. Claims and liabilities of the Canadian bank “parent” on the affiliate are classified as foreign direct investment by Canada in the United States. As of end-2010, Canadian chartered banks had FDI claims overseas totaling C$150 billion.

6

The gap with the United States is even larger in 2010, with the Treasury survey of U.S. portfolio assets reporting over $400bn in equity claims on Canada, while Canada reports $318bn in liabilities vis-à-vis the United States.

Canada: Selected Issues Paper
Author: International Monetary Fund
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    External Assets and Liabilities, 1990-2010

    (Percent of GDP, market value)

  • View in gallery

    External Assets and Liabilities, 1990-2010

    (Percent of total financial assets and liabilities)

  • View in gallery

    Cross-Border Bank Assets and Liabilities by Residence of the Reporting Entity, June 2011

    (Billions of U. S. dollars)

  • View in gallery

    International Bank Assets and Liabilities by Nationality of the Reporting Bank, June 2011

    (Locational basis, billions of U.S. dollars)

  • View in gallery

    Foreign Claims of Selected Banking Systems, by Nationality of the Reporting Bank, Ultimate Risk and Immediate Borrower Basis, June 2011

    (Billions of U. S. dollars)

  • View in gallery

    Canada: Composition of External Assets and Liabilities

    (percent of GDP, 2007 and 2010)

  • View in gallery

    Canada External Assets and Liabilities, Bilateral Basis, 2010

    (Billions of Canadian dollars)

  • View in gallery

    Canada Net External Position, Bilateral Basis, 2010

    (Billions of Canadian dollars)