Canada. Stability of Financial System has ensured Credit Flow

In recent months, Canada has been affected by the fallout from the severe decline in international trade and commodity prices. However, its avoidance of excessive reliance on debt has stood both its financial institutions and overall economy in good stead.

In the United States, the growing reliance on low cost debt after 2001 led to changes in investment and savings patterns that ultimately proved unsound for both their financial and economic systems. By contrast, Canada avoided many of these changes in behaviour.

The most visible feature of the global credit crisis in the autumn of 2008 was the drying-up of critical debt markets in the United States, notably for inter-bank lending and commercial paper. The commercial paper market in the United States shrank by 10% (or $15 billion) in the fourth quarter of 2008. Household credit also contracted in the fourth quarter, partly due to an outright drop in lending by US-based commercial banks.

In Canada, the stability of the financial system ensured that credit continued to flow for most borrowers, although often at much higher prices. Despite the global credit crunch, total household borrowing grew by 12.1% between the third quarter of 2007 and the fourth quarter of 2008. Meanwhile, household borrowing in the United States stopped growing.

The setting

Events in financial markets in the past two years occurred against the backdrop of changes in financial behaviour over the previous decade or more. In Canada, the patterns of sectoral net lending or borrowing changed, notably as firms and governments ran large financial surpluses while households borrowed more.

Some of these trends reflected a shift in household behaviour to more investment in housing and financial assets (often debt-financed). Households and investors also increased foreign investments through their holdings of mutual funds and pension assets.

According to Statistics Canada's National Balance Sheet Accounts, household balance sheets changed markedly in the past decade. The debt of the personal sector increased from 68% of gross domestic product in 2000 to over 84% late in 2008.

Much of this rising debt was driven by spending on housing in response to low mortgage rates, reduced down payments and longer mortgage terms, and increased funds available to borrowers through securitization. In Canada, securitized mortgages rose from 5.0% of all mortgages in 1997 to 20.0% in early 2007 and 28.6% late in 2008.

While households in Canada increased their borrowing, governments and corporations were lowering their debt. Government debt liabilities relative to gross domestic product fell from a peak of 94.6% in the mid-1990s to 52.4% by mid-2008, led by the federal government.

Sectoral lending and borrowing differed in Canada and the United States

The trends in sectoral lending and borrowing in the United States were much different than in Canada. In the United States, non-residents were the only consistent source of net lending from 2003 to 2007. Governments in the United States were net borrowers throughout this period, while they were net lenders in Canada.

American firms alternated between small amounts of net lending and borrowing, while Canadian firms posted record high surpluses until late in 2008. And American households borrowed much more than in Canada. The lower reliance on debt of all sectors in Canada proved important when credit conditions tightened in some markets after August 2007.

The national saving rate highlights the differences in the overall financial behaviour in both countries after 2000. In Canada, the national saving rate rose to over 12% of national income, as increased saving by corporations and governments offset a slight decline for personal saving.

In the United States, the national saving rate hovered between 1% and 2% starting in 2002, before turning negative in 2008: low personal saving rates (below 1% in recent years) were not offset by more saving by governments or firms. This left borrowing abroad as the main source of funds in the United States, consistent with record current account deficits.

Decline in household spending

One of the puzzles of the steep economic slide late in 2008 is why household spending fell more sharply in Canada than in the United States. In particular, auto sales in Canada fell 18.8% between September and December, while existing home sales tumbled 30.0%. This compared with declines of 17.5% and 13.0%, respectively, in the United States late in 2008.

The faster decline in Canada was surprising in view of the sharper losses of jobs and wealth and the more severe disruption of credit markets in the United States.

Early in 2009, automobile and home sales recovered faster in Canada than in the United States. Unit auto sales in March rose 8.8% from December in Canada, while existing home sales in April were 32% above their January low. In the United States, both auto and home sales in April were only 2% above their lows.

This suggests that shaky consumer confidence played a large role in the drop in household spending in Canada late in 2008, along with difficulties accessing credit. Both were being repaired quickly in the spring of 2009.

Source:Statistics Canada, June 11, 2009

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