Financial System Survey Highlights

The Bank of Canada conducted its second semi-annual Financial System Survey (FSS) between September 24 and October 12, 2018. The FSS collects expert opinions from individuals working at a senior level in a risk management capacity within the financial system. These experts provide their views on the risks to, and resilience of, the Canadian financial system, as well as emerging trends in financial products and practices. The survey results are a useful benchmark to compare Bank views and analytical work with outside opinions and help Bank staff identify new topics for research and analysis. The highlights of the autumn 2018 FSS, which 41 participants completed, follow. Also included are some comparisons to the previous survey, conducted between March 26 and April 9, 2018.

For more information on the survey and previous results, see the June 2018 Financial System Review.

Key Findings

  • Overall perceived risk has increased somewhat over the past six months, but confidence in the resilience of Canada’s financial system remains high. Survey participants continue to cite the potential for a cyber attack as the most important risk to the Canadian financial system. Relative to the spring survey, respondents perceived increased risk related to a deterioration in the global economic outlook and a reduction in market liquidity.
  • This survey included a special question on rising long-term interest rates. About a quarter of survey participants indicated that a 150- to 200-basis-point rise in Canadian 5-year interest rates over 12 months could trigger adverse events in Canada, such as a house price correction or a large increase in household defaults. However, respondents see a rise in long-term interest rates of this magnitude to be very unlikely over the next year.
  • Machine learning and artificial intelligence and big data continue to be the innovations expected to have the largest impact on the activities of financial firms. Work to develop rules that allow clients to share their banking data with other financial institutions (open banking) was cited as an important emerging development.

Overall perceived risk and confidence

On balance, respondents perceived a slight increase in the medium-term (1- to 3-year) probability of a high-impact event with the potential to severely impair the financial system. Just under half of respondents (44 per cent) stated that the probability of such an event has increased slightly in the past six months (Chart 1), while the other half stated it was unchanged. These results are very similar to those in the spring FSS.

Chart 1: Just under half of respondents see a slight increase in the probability of an adverse high-impact event over the past six months

Still, 95 per cent of respondents are at least fairly confident that the financial system would be resilient if such a shock were to materialize (Chart 2). These results are also roughly unchanged from the spring FSS.

Chart 2: Around 95 per cent of respondents are at least fairly confident that the financial system would be resilient in the event of a large adverse shock

The most important risks

The survey asked participants to list the three risks that, if realized, would have the greatest negative impact on the functioning of the Canadian financial system. It also asked them to list the three risks that would have the greatest impact on their organization’s activities. The risks to an organization’s activities are important when assessing system-wide risks because disruptions or difficulties at an organization can spread rapidly to others in Canada’s closely interconnected financial system. Chart 3 shows the most cited risks to both the financial system and the activities of the respondents’ organizations. They are presented in three broad categories: operational risks, macroeconomic risks and market functioning risks.

Overall, the three most cited risks to the financial system are the following:

  1. A cyber attack, as noted in the spring survey
  2. A deterioration in the global economic outlook, with a notable increase in the proportion of respondents highlighting this risk relative to the spring survey
  3. Geopolitical risk

Disruption in international trade or trade disputes were cited by fewer respondents than in the spring. This could reflect the completion of negotiations of the United States-Mexico-Canada Agreement, which was announced on September 30, during the first week of the autumn survey.

For the main risks to an organization’s own activities, a cyber attack was also the most cited, echoing the spring results. The number of respondents who cited the risk of a reduction in market liquidity increased notably from the spring survey, making it the second most cited risk.

Chart 3: Cyber attacks and a deterioration in the global economic outlook were identified as the most important risks to the Canadian financial system

Note: As part of the question, participants are asked to write down their top three risks. The responses are grouped into the types of risks listed in the chart, which are then divided into the three broad categories.

Risks from rising long-term interest rates

The autumn 2018 FSS included a special question to assess the probability—and the financial system implications—of a rapid rise in Canadian 5-year interest rates. Around a quarter of respondents indicated that a 150- to 200-basis-point rise in the 5-year Government of Canada bond yield over the coming 12 months, should it occur, would be enough to trigger a house price correction or a large increase in household default rates (Chart 4). And more than half of respondents believe that if these risk events materialized, they would be somewhat likely, likely or very likely to severely impair the Canadian financial system (Chart 5). In contrast, while more than a quarter of respondents believe a smaller increase in rates (50 to 150 basis points) could trigger a Canadian equity market sell-off, they indicated that such a scenario would be less likely to impair the financial system.

Chart 4: About a quarter of respondents believe a 150- to 200-basis-point rise in the 5-year GoC bond yield over the next 12 months is enough to trigger a house price correction in Canada or a large increase in household defaults

Note: GoC stands for Government of Canada; bps stands for basis points.

Chart 5: A majority of respondents believe a house price correction or a large increase in household defaults would be somewhat likely, likely or very likely to impair the financial system

Nonetheless, respondents view an increase in 5-year rates between 150 and 200 basis points as very unlikely. Indeed, they estimate a roughly 5 per cent chance that 5-year rates will rise more than 150 basis points over the next 12 months (Chart 6).

Chart 6: Respondents estimate a 5 per cent chance that the 5-year GoC bond yield will rise more than 150 basis points over the next 12 months

Note: For reference, the 5-year GoC yield was roughly 215 basis points during the survey period.

Key financial innovations

The survey asked participants which financial innovations they believed would have the largest impact, positive or negative, on their organizations’ activities over the next three years. Innovations generally fell into two categories: those that would change how financial firms conduct their business activities and those that would change the structure of the markets in which they participate (e.g., changes to the composition of their competitors or counterparties).

From an operational perspective, participants identified machine learning and artificial intelligence, big data and blockchain as the financial innovations that will have the largest impact, as in the spring survey. From a market structure perspective, two innovations were identified as key: systematic trading strategies and open banking, which allows clients to share their banking data with other financial institutions (Chart 7). Open banking appears to be an important emerging development, since in the spring survey, only one participant mentioned it.

Chart 7: Machine learning/artificial intelligence and big data are still expected to be the most important financial innovations over the next three years

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