The head of the Bank of Canada is warning that the Canadian financial system, while relatively robust, is not immune to the kind of banking instability that has sunk financial institutions in the U.S. and Europe.
Governor Tiff Macklem said Thursday that the current era of rising interest rates is forcing banks to adjust to new credit conditions, and Canada must be ready for possible fallout if instability spreads.
“The financial system, like the rest of the economy, has to adjust to higher interest rates and we do need to be ready for the possibility that there could be some issues,” he said.
“We do need to be vigilant.”
Macklem made the comments at the International Monetary Fund’s spring meetings in Washington, D.C., on Thursday, a day after the Bank of Canada held its benchmark interest rate for the second consecutive decision.
Uncertainty in the global banking sector over the past weeks has made some central banks more cautious about their rate decisions, some economists have theorized, for fear that too much monetary policy tightening will steepen a looming economic downturn.
Macklem said Thursday that while the banking turmoil was factored into revised economic outlooks released alongside the rate decision, to date, the “spillover” to Canada from recent bank problems in the U.S. and Europe has been “muted.”
He also credited authorities in the U.S. and Switzerland for responding “quickly and forcefully” to limit possible contagion from the folding of regional banks south of the border and near-collapse of Credit Suisse in Europe.
But if tighter credit conditions tied to higher interest rates further erode banking confidence, or a separate shock to the financial system arises, Macklem reiterated that the Bank of Canada stands ready to support Canadian lenders.
“If there is a serious event, if the markets were to freeze up, we are prepared to provide liquidity against good collateral. That is a core function of the central bank,” he said in response to questions about the risk of banking turmoil spreading to Canada.
Macklem also said that, since the 2008 global financial crisis, Canada’s banking system has seen “considerable strengthening” with higher on-hand capital requirements and limits on how leveraged banks can be.
“That has certainly made the system more resilient,” he said. “But we certainly don’t want to be complacent.”
In the Bank of Canada’s monetary policy report released Wednesday, the central bank revised up its economic forecast for 2023 while paring down its outlook for 2024.
Even amid a hot economic start to the year, Macklem did not rule out the possibility of a recession hitting Canada in 2023 when speaking to reporters on Wednesday.