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Report On Business CIBC economist disputes report warning of risks to Canada’s banking system

The large CIBC sign outside the bank's office building at the southeast corner of King St. West and Bay St. in Toronto’s financial district.

Fred Lum/The Globe and Mail

A leading Canadian bank economist is pouring cold water on a recent report that sounded alarms about mounting credit risks to Canada's banking system.

Early last week the Bank for International Settlements (BIS), a prominent international finance group owned by 60 central banks, issued a report raising early warnings about the risks of a financial crisis for more than 25 countries. Canada stood out as the lone country on the list tagged with red or amber alerts for all four key metrics the research tracks.

Yet Avery Shenfeld, chief economist at CIBC World Markets Inc., says "there's plenty of reason to be skeptical about the report's methodology."

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In a sharply worded counterpoint, Mr. Shenfeld questions the BIS track record at predicting such events, and notes there are important differences in regulatory structures, buffers and financial data between Canada and other countries.

"Canadians are attracted to negative reports from abroad about their country like bees to honey," he wrote in a research note released Monday. "So it's interesting that financial markets, for once, essentially yawned" about the BIS report.

A BIS spokesperson declined to comment.

The authors of the BIS research stressed that its indicators are not definitive and should be handled with care. Even when thresholds are breached, there's no certainty a banking crisis will follow. But the BIS claims these measures have proven to be useful early signals of past crashes, including in the United States in 2007 and Greece in 2010.

Canada's credit-to-GDP gap and its total debt-service ratio were both coded red by the BIS, which means they exceeded a high-risk threshold.

On two further measures – the debt-service ratio for households and cross-border claims to GDP – Canada cleared a less stringent marker and received amber alerts.

Mr. Shenfeld takes particular issue with two of those indicators.

The first is Canada's credit-to-GDP gap, which measures by how much the difference between a country's current ratio of non-financial credit to gross domestic product exceeds the long-term trend. But with interest rates that are "miles below their longer term levels," Mr. Shenfeld points out that it's also important to look at who's been getting all that credit.

"Mortgage arrears rates in Canada continue to dive," he said, and recent regulatory changes have tightened the flow of credit from large financial institutions to risky borrowers.

Moreover, where cross-border claims to GDP are concerned, the BIS scored Canada poorly because international borrowing – by Canadian banks and other entities – has risen as Canadian companies issuing bonds find eager buyers in the U.S. and Europe. But Mr. Shenfeld says those firms have often used proceeds for foreign direct investment, earning strong returns, and to buy back foreign-owned companies in Canada.

"The result is that Canada's deficit in investment income flows has been rapidly improving, not getting worse, in recent years," he said. "It's hard to view that as a sign of financial doom ahead."

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