Thank you, Mr. Chairman.
Good morning everyone. Thank you for inviting me here to discuss the Bank of Canada's perspective on the stability of the Canadian financial system.
As we have consistently emphasized, stabilization of the global financial system is a precondition for economic recovery, both globally and in Canada. To that end, policy-makers around the globe have acted aggressively and creatively by initiating a series of unprecedented actions aimed at stabilizing the global financial system. Central banks throughout the world, including the Bank of Canada, have provided unprecedented liquidity to keep the financial system functioning.
Because the crisis we are facing is global in nature and began outside our borders, most solutions must be found at the international level. We are taking part in discussions with our international colleagues on ways to strengthen financial stability globally. I would note that there has been a great deal of interest worldwide in the resilience of Canada's financial institutions in the face of the global economic crisis. Unlike their counterparts in other major economies, Canadian banks have not been materially affected by the financial crisis. They have managed to raise capital during this troubled period to support continued lending and to make up for some of the decline in the demand for securitized products as well as the exit of non-bank lenders which had relied on securitization for financing their activities. In contrast, banks in most other major economies have suffered significant losses and have required significant capital injections from their governments.
Thus, Canada has maintained much healthier credit conditions since the onset of this global recession than have been seen in other major countries. Still, the Canadian financial sector has felt the effects of the global turmoil which has increased funding needs while at the same time raising the costs and the uncertainty of term funding. In response, the Bank of Canada has made significant efforts to support liquidity in financial markets.
Now, our actions aimed at stabilizing the Canadian financial system since the global crisis began 18 months ago have been unprecedented and significant. The Bank of Canada has moved aggressively by expanding the provision of term purchase and resale agreements to a total of $41 billion, at its peak in December, and $35 billion currently.
The term purchase and resale agreements, or PRAs, as we call them, provide liquidity to key market participants for terms of up to three months against a wide range of securities. The bank has widened the range of assets that it will accept in these operations, and it has extended the range of counterparties with whom it will transact. I should point out that these PRAs are as an auction, so there is kind of a market price to the yields on these term loans.
We've also introduced a new term-loan facility for those financial institutions that participate directly in the large value transfer system and the payment system, taking their non-mortgage loan portfolio as collateral. And that, in a sense, frees up other collateral for them.
Last week the bank announced a new term PRA facility for private sector instruments that extends on the private sector term PRA facility that we had set up last autumn for the money market instruments. The new facility is open to a broader range of participants against a broader range of eligible securities, which would include corporate bonds, and it is available for a longer term and at a lower minimum bid rate than is the facility that it replaces. The liquidity from this new facility should provide indirect support to credit growth in Canada by improving the secondary market liquidity and increasing the demand for corporate securities.
I would like to point out that these facilities have been financed not by expanding the supply of central bank money to the financial system, but rather through the sale of treasury bills, either from the bank's own portfolio or from new issues, the proceeds of which, in turn, are held on deposit at the Bank of Canada. I would note that, on a consolidated basis, the Government of Canada earns net income from these operations. That net income is represented by the spread between the yield on our own term PRAs that we offer and the yield that we could have gotten on treasury bills or that the government is paying on treasury bills. Furthermore, there is little risk to the taxpayer in these operations because we require participants to pledge collateral with a value greater than the amount of money that they borrow from us.
These liquidity operations have resulted in a significant reduction in the spreads at the short end of the market--for example the CDOR, the Canadian deposit offering rate, which is the Canadian equivalent of the LIBOR, the London interbank offering rate, which is the offered rate on bankers' acceptances, essentially. So the CDOR minus OIS, or overnight indexed swap, spreads—the OIS is the expectation of what a future Bank of Canada rate would be—have narrowed substantially since last fall, when conditions were extremely negative. The improvements are especially notable at shorter-term maturities, such as one month, and are largely attributable to the liquidity facilities that have been put in place. But there have also been improvements at the three-month spread, which peaked at about 125 basis points in Canada. This is now close to a more normal level, which is about 25 basis points. That's kind of the new normal. We don't expect to go back to the pre-August 2007 spreads that were abnormally narrow.
While the Bank of Canada's liquidity operations have focused on the short-term financing, I would like to note that the Government of Canada has introduced measures aimed at supporting the long-term financing for businesses and consumers, and I would like to highlight two among the numerous measures.
One measure is the insured mortgage purchase program, which allows financial institutions to fund new financing by selling pools of insured residential mortgages to Canada Mortgage and Housing Corporation. Another is the Canadian secured credit facility, under which the Business Development Bank of Canada will buy term asset-backed securities, which are securities that are backed by loans and leases on vehicles and equipment. It will essentially target this segment of the market, for which financing is unavailable now.
All these measures together are certainly helping to meet the rising demand from businesses and individuals who have been finding it very difficult in this environment to raise adequate funds. We have all heard reports of ongoing tightening in both the availability and pricing of credit. We've heard anecdotes. Our own surveys of businesses and surveys of senior lending officers confirm that. Nevertheless, when you look at the data, our latest figures show continued strong growth in total household credit--9.6% in January--compared with the same period one year earlier. In part, we've seen limited deceleration in the growth of total business credit, although this was more pronounced in January. There is volatility in these numbers from month to month. Total business credit, overall, stood at 4.2% in January compared with the same period one year earlier. What we've seen is accelerating growth in bank lending that has helped offset, or at least partially offset, a contraction in market financing. We will continue to closely monitor credit growth and credit conditions in Canada. We just got the January numbers last week. We are monitoring that very closely.
In conclusion, as we are all well aware, the Canadian economy is feeling the effects of the global turmoil and recession. The authorities, of course, have put a lot of fiscal and monetary stimulus in place in Canada and globally to support the recovery. However, as I noted at the outset, stabilization of the global financial system remains a precondition of the global and Canadian economic recoveries.
Investor and public confidence has been badly shaken. It will recover with the timely implementation of the ambitious plans in some major countries to address their toxic assets and to recapitalize financial institutions. However, if these national and multilateral measures are not timely, bold, and well executed, Canada's economic recovery will be both attenuated and delayed.
I would now be pleased to answer your questions, Mr. Chairman.
Good morning, Mr. Duguay.
Unfortunately, it seems that the economic situation continues to deteriorate. When the Governor of the Bank of Canada appeared recently before this committee, I told him that he was optimistic. He answered that he was not optimistic, but realistic.
To be fair to the governor, his fairly optimistic forecast, he made very clear, was predicated on the situation in the United States improving and on everything working. It seems that there is little confidence in the United States, at this moment, that the crisis of the banking system will be fixed expeditiously.
You probably don't want to come out with a number, but compared with the earlier view that we would snap back and have 3.8% growth in 2010, how would you characterize your current position? How has it evolved since that time?
Thank you, Mr. McCallum.
As we pointed out in our latest interest rate announcement when we lowered rates by another 50 basis points, the data has been weaker than expected. We knew that in the first half of this year there would be a string of bad news--we mentioned that. As you point out, the recovery that we projected starting in the second half of this year is very much predicated on confidence rebounding as the financial situation improves and is resolved. That's a precondition to recovery and the recovery of confidence that comes with it.
We said in our report that the first half of this year would be weaker than expected and the contraction of output would be stronger. Potential delays in stabilizing the global financial system, together with larger than anticipated confidence and wealth effect on domestic demand in Canada, could mean that the output gap will not begin to close until early in 2010.
In our monetary policy report update we had growth above potential output, as you may remember, starting in the fourth quarter of this year. I think we're delaying that. We're saying it won't happen until the beginning of 2010.
We don't have a complete projection at this point. We will have a complete projection. We will be coming out with the monetary policy report in mid-April.
Thank you, Mr. Duguay. You're a brave man to come all by yourself to appear in front of this distinguished committee, which, I might add, actually has female representatives on both sides of the table today, which is a great thing in this old boys' club, where it's refreshing to have some women here with us.
Anyway, thank you for your comments and your reflections today. One comment of yours that I picked up on was that a precondition for recovery is improvement in the world's economic stability. If I can follow up on that, we had finance department officials here who talked about the role Canada is playing in this G-20 leaders' action plan. I know that the Governor of the Bank of Canada, and I'm not sure who else, takes part in these G-20 conferences.
Can you share with us, as much as you can, what role the Bank of Canada plays with other central banks in the G-20, and are you part of this leaders' action plan as well?
The G-20 has what is called the ministers and governors, who meet before the leaders. And of course the ministers and governors, having discussed the situation, will be informing their leaders individually and probably making a recommendation. And the leaders will be deciding in early April on a course of action.
What we are doing, in a sense, is preparing the ground. Below the governors and the ministers, of course, there are meetings of the deputies. One of our deputy governors, John Murray, and Tiff Macklem, from the Department of Finance, who was here yesterday, are G-20 deputies.
As Tiff told you yesterday, there is a diversity of opinion. There are a wide range of solutions that have been contemplated. There are two issues. In the short term, what more do we do, given that the situation has deteriorated. I think the plans to resolve the financial crisis are just about the right plans, and the question here is the execution and the timeliness, so it is imperative to go forward on that.
The second part is that once you win the war, you have to think about the reconstruction and how you prevent something like that from happening again, talking about the regulation of the financial system. That's where, in a sense, there are a variety of views. But I think there is a coming together that some things are important, such as macro provincial regulation and having capital regulations where capital is built up during the upside of the cycle so there is a buffer that can be used to absorb shocks when they happen.
We also want to avoid pro-cyclicality. There is a sense in financial systems that things tend to get amplified by the reactions of people. So we're asking if there is anything that can be done from a regulatory point of view to limit this amplification, which is a part of nature. When things are good, you're optimistic; you understate risk. When things turn bad, all of a sudden the irrational exuberance gives rise to panic. So just as the risk is understated in one case, when you get a string of bad news, risk gets overstated. So how do you try to set a financial system that would be robust to that?
And the third point that's important is, in a sense, the alignment of incentives. Regulation always sets incentives to bypass it, so ensuring that there is a system-wide approach so that the incentives are aligned.... For example, in the ABCP there was a misalignment of incentives because of the original distribution model: the people who were making the loans did not keep any. They were just making loans, sending them, and had no incentive to do a verification of the credit quality of the loan. So alignment of incentive is important, and of course transparency and clear disclosure.
In the context of the ABCP crisis, one of the big problems, as we discussed earlier with Monsieur Laforest, is that disclosure was not adequate.
I will take the last comment made by our colleague, Mr. Menzies, as my starting point. Indeed, many of Canada's actions in regulating our banking system can be envied.
Yesterday, I had the opportunity to meet with John Rodriguez, who is the mayor of Sudbury, Ontario. In the past, Mr. Rodriguez waged the epic battle led by the New Democratic Party at a time when Canadian banks were doing everything possible to free their restraints and were complaining that they did not have the right to do the same as our American neighbours south of the border. At the time, certain people were blaming us for not seeing the big picture and not understanding that if we just let the banks do what they wanted, they could work wonders, just like the Americans. It feels great to acknowledge the historic role played by people like Mr. Rodriguez, whose actions are the reason why we now have a system which is the envy of many.
We have had one round of questions and addressed various subjects. My time is relatively limited, and therefore restricted to focusing on one topic, a topic that was alluded to, but not really explored. Given the context, it is rather important. Mr. Menzies talked about one of the « preconditions » at the international level. You yourself used the term « precondition », whereas I would prefer to use the term « prerequisite condition » or « condition precedent ». You talked about confidence being a precondition to successful recovery of our economy. I must admit that we are rather spoiled to have a man of Mr. Mark Carney's calibre at the helm during a time of crisis. He has our total confidence. He gave what Mr. McCallum called a rather optimistic outlook. Yet, I myself have always read into Mr. Carney's optimism an attempt to instill confidence in better times ahead.
You also talked about—and I made note of this—the requirement for transparency and what you referred to as clear disclosure. Of course, this applies in the context of asset-backed commercial paper. Do you not believe that this clear disclosure must be a condition fulfilled in the public interest as the government introduces measures to stimulate the economy? Is this approach to guarantee accountability in the clearest, most transparent, most straightforward way possible, not part and parcel of all legitimate efforts to revive the economy?
I spoke about transparency and ABCP, but clearly transparency goes far beyond asset-backed commercial paper. As you know, when it comes to monetary policy, the Bank of Canada is committed to being transparent and accountable for its actions. This applies to both monetary policy and all our other initiatives. When one is trying to maintain confidence, transparency and frank, honest and open communications are of the utmost importance.
As for our forecast, which intended to maintain confidence, the governor said that it was neither optimistic nor pessimistic, but rather, it was realistic. Of course, the forecast depends on many factors. It bears witness to a great deal of uncertainty. Recent data has been weaker than what was forecast in the update of the monetary policy report. We indicated that there were some risks relating to the 3.8% rate. Nevertheless, we are of the opinion that this forecast is realistic. To give people confidence, we must explain what is behind this forecast, that is to say, a monetary and financial stimulus. We are reminding people that it takes time for these stimuli to be felt. There will be a series of negative numbers, but it is important to look to the future and consider the fact that there are many stimuli within the system.
Furthermore, with regard to confidence, I must specify that the Bank of Canada has a framework for formulating monetary policy. Our target is an inflation rate of 2%, and we will do everything in our power to reach this target. We have the ammunition to do so. We are not short of ammunition.
The losses at the Caisse de dépôt are, of course, from ABCP, but are basically losses on the stock market. The stock markets have declined. Just as there was some exuberance earlier, fears are currently being reflected in the markets. The point is that over time, some recovery in the stock market will be expected. So it's not clear that those losses per se are necessarily putting pensions at risk, because the pensions have a long horizon to recover some of the losses.
Now, what the Bank of Canada doesn't do is to provide capital. If there is any need for capital, it would have to come from government. As I said, in Canada we don't see the need for capital; but the Bank of Canada would not, in any case, be providing capital. The Bank of Canada is providing financing, it's providing liquidity, providing loans, in a sense.
If you were to look at our new facility, for example, which we just announced last week, we will be taking a number of securities—corporate bonds, for example, or commercial paper, and some bank-sponsored ABCP—and we will be providing liquidity against those, basically to meet the liquidity needs of institutions, which could be pension funds—
Thank you, Mr. Chairman.
Good morning, Mr. Duguay. I'm pleased to see you today.
In Quebec, these infamous asset-backed commercial papers have had a tremendous impact on our large financial institutions and, to a large extent, have resulted in their losses. Earlier, my colleague referred to the Caisse de dépôt et placement. Quebeckers put their savings in this caisse in order to watch their money grow. Many other financial institutions have been affected as well, including the Mouvement Desjardins and the Banque Nationale. This is a very serious topic. We have yet to receive a full explanation regarding the shakeout of these assets. And yet, the rating agencies gave these securities a very high grade. That is one aspect.
My question will therefore be about the rating agencies. I thought that these agencies came under the jurisdiction of the government. Recently, I asked a Department of Finance deputy minister a question on this issue. I was told that these agencies are not subject to government regulation. You said that you rated these commercial papers very negatively. However, I didn't see this anywhere.
You are deeply concerned by the current financial crisis and therefore I would ask you whether there is any need to reform the rating agencies. To whom do they report? Right now, I do not know. It is not the government. I do not know whether the Bank of Canada plays a role in this matter. In addition, these agencies receive funding from the securities issuers. So there is a type of conflict of interest. The problem is very serious.
Are you going to be suggesting that we change the financial regulation of these agencies?
Thank you very much, Mr. Carrier.
Indeed, the bank already published an article on rating agencies in the Financial System Review, in December 2007 or June 2008. A small number of rating agencies operate internationally. They provide an opinion, and, for us, it is important that this opinion be clear. The rating agency simply provides an opinion based on an analysis. As far as the asset-backed commercial paper crisis is concerned, investors gave far too much weight to the rating agencies and, to some extent, did not do their homework. Investors have a responsibility to understand what they're buying and to ask questions about transparency. With respect to a situation of conflict of interest, the rating agencies need to maintain their reputation with investors, because although they are paid by the securities issuers, they will not get paid for nothing if they do not do what is deemed to be useful work, because the investors will no longer consider the opinion given by such rating agencies. I think that the rating agencies have a good incentive. Indeed, they have responded to the criticism levelled by investors, they have changed the way they do things.
Is there need for regulation? The Financial Stability Forum has made recommendations along that line for the international scene. There are some clearly different opinions, but a consensus does appear to be forming. I do not think that we will necessarily be looking to a regulation of rating agencies, but there certainly is talk about an international securities commission organization, which will establish a code of conduct for the rating agencies.
Well, in part 2% is the result of history. We started from very high inflation, and when we adopted the inflation target, inflation in Canada had been 4% and rising and we felt that it was too high. That's not price stability, and the 2% inflation target was jointly agreed to by the government and the Bank of Canada.
In difficult times, when the purpose is to get inflation down first, then of course in the early 1990s, following the recession, the recovery was slow. So in the end, when it came time to renew, although at first we had said that we'd get inflation down to 2% and then define price stability later on and decide whether we keep it or go lower, systematically we've renewed the target at 2% on our last renewal. And the Bank of Canada has done a lot of work on what would be the desirable rate of inflation. There are a number of arguments saying that it should be lower. There are not many arguments that would justify raising it. We've summarized some of that research in the past, but the last time we agreed with the government on maintaining the 2% figure we did point out that we would be very thoroughly examining what our next target should be, and we will be coming up with the results of our research before 2011.
It's premature at this point to talk about this research, but there is vibrant discussion going on. We have set up a website called inflationtargeting.ca, where some of the research papers are presented, and there is a wiki also where we get feedback from people.
That's the question, the liquidity. What is going to happen if there's a deterioration in the real estate market and if there are some problems with some of the companies going under and there is going to have to be some pension support, whether it be private pensions or public pensions?
Mr. McKay brought up the Caisse. How is that going to affect the liquidity of the market and affect the way the Bank of Canada operates?
There are other sectors. I understand you're also backing the loans and leases on vehicles and equipment. But if you look at what's happening in the States with the insurance companies, huge amounts of money are being invested, and some of the fallback, or some of what is being said, is that when you're throwing $60 billion to support AIG, and a couple of months later people are saying it was a waste of money, and they need another $15 billion, it has to affect the way the Government of Canada operates.
We had the officials from the Department of Finance. My understanding was they don't really have a plan if something were to happen. Now I'm asking the Bank of Canada if you have a plan. You must have a feeling for which sector is going to deteriorate and is going to need some help, whether it be from the Bank of Canada or the Government of Canada, and how you're going to help so the markets don't get affected in a worse fashion than they are already being affected.
Thank you, Mr. Duguay, for your presentation today. I just want to take a moment to recognize the very important work you and your colleagues do at the Bank of Canada. I think the relative strength of the Canadian economy and the Canadian financial system is due in no small part to your guidance and that of your colleagues over the years. So I want to acknowledge that.
This morning you described in your remarks the many things the Bank of Canada has been doing over the last few years to stabilize and increase liquidity in Canada for business and consumer lending. You pointed out there has been strong growth, in fact, in total household credit and there has been limited deceleration in the growth of total business credit. But business and consumers are not borrowing and consuming as much as our economy needs to spark a recovery at this point in time. So psychology is obviously very important.
As you pointed out, the 2009 budget contains a number of stimulus measures designed to encourage consumer and business spending. This morning I heard Mayor Francis of Windsor, Ontario, commenting that his community needs stimulus now, in regard to layoffs at Chrysler. They need it immediately, as soon as possible. Could you comment on the timing of the injection of the stimulus by the government, the non-monetary stimulus measures in the budget, and the effects of waiting too long to put that stimulus into the economy?
Yes, the recession is now, and obviously the sooner the stimulus comes, the better, because in part when people hear bad news, that does affect confidence and the effect on confidence can certainly amplify the problems. When consumers are nervous about their employment prospects, they stop spending. At that point, it doesn't matter much whether credit is available or not; they prefer not to go into debt.
So it's very important to get the stimulus now, to cut this off at the pass, if you wish, so that the people can see that the recovery is coming, that the recession is going to be temporary, and that they don't need to worry excessively about the future. That is important. As I said, it's the confidence-boosting effect of fiscal policy, and monetary policy for that matter, that is helpful here.
Thank you for that question.
Yes, our assets have changed considerably. For the committee I'll mention that our assets are normally about $50 billion, about $20 billion in treasury bills, $30 billion in bonds. With the last operations we've done we've increased our lending through PRA to financial institutes by $35 billion. To make room for that we sold about $10 billion to $12 billion of our treasury bills. The government has sold treasury bills and put some deposits in the bank for the rest. Our total balance sheet has gone up from $50 billion to a little less than $80 billion.
The quality of our assets is still very high. In terms of the purchase and resale agreement, yes, we are purchasing less liquid assets than the government. So banks are pledging that to us. It's not a purchase per se, it's a term purchase and resale. So the institution that is pledging that asset to us has an obligation to come and buy it back from us. In a sense, we can look at this as kind of a loan, if you wish.
Secondly, the assets we accept are longer-term government securities, some commercial papers, bankers' acceptances, mortgage-backed securities. The assets that we accept are still very high-quality assets. And we are having our cut on that, so the lending is less than the value of the assets.
Thank you very much for that question.
I would argue that the longer-term debt-to-GDP ratio, in a sense, is the responsibility of this group and your successors. But what is important is that we are going through a recession; we are going through a period when, because of fear, businesses are spending less, consumers are spending less. And it is absolutely critical, in a sense, to stabilize the economy, to the keep the economy functioning near potential output. Clearly, fiscal policy has an important role to play to stimulate the economy, just as monetary policy does.
There are automatic stabilizers, obviously, in a recession. There will be less tax revenue, so one should not be panicking at seeing a deficit. It reflects the fact that the only way people can save more is that somebody has to use the savings, somebody has to run a deficit. And if there is not investment because businesses are not running the deficit, then the government does, and that helps stabilize the economy.
This is a cyclical deficit. This is a temporary situation. What is important for the long-term fiscal health of the Canadian economy is that it remains temporary, and that the decision-makers' policies stabilize the debt-to-GDP ratio.
In terms of where we are, Canada has probably the lowest debt-to-GDP ratio certainly among the G-7 countries, and beyond that, among many industrial countries. We are in a very, very strong fiscal position with very little risk of long-term deterioration.
You seem optimistic to me, but time will tell.
Mr. Chairman, I would also like to give the witness an opportunity to explain...
I'm going to do it in English so that Mr. Kramp can understand me.
Through you, Mr. Chairman, I would like to invite Mr. Kramp to explain to us how, in his thinking, a national securities regulator would somehow have changed the situation at the Caisse de dépôt. Actually, not only was I a member of the national assembly at the time the law was changed, but I was a member of cabinet. I can talk to him about what happened in the House. I cannot talk to him about what happened in cabinet, but I can tell him that it is on the public record that the rules for the Caisse de dépôt were changed so that the only thing they were looking at was rendement--profitability, how fast the money was being....
So for the asset-backed commercial paper, I was here when Julie Dickson, our so-called Superintendent of Financial Institutions, came in. She denied all responsibility for it. None of the structures in place took care of ABCPs.
Does he really think that ABCPs would be something that a national securities regulator would have taken care of? What about the Criminal Code, which is simply not applied right now? It has all sorts of provisions on fraud. What about the fact that the federal government never took a single prosecution in the Liberal sponsorship scandal? The only prosecutions were taken provincially in Quebec. Someone like Vincent Lacroix is in the slammer right now because provincial securities regulators applied their rules, but the federal government has laid several thousand criminal complaints, and not the first hour of the first day of the first trial on the first charge has ever been held.
So how is this magic national securities regulator going to change the situation at the Caisse de dépôt et placement? I notice the solicitude of our friend Mr. McKay, who wants to bring in the Caisse before his committee, because he's decided that he knows how to handle this 800-pound gorilla. That's going to be fun to watch. But I want to understand from Mr. Kramp what in his mind, in his thinking--if he accepts to respond on my time, Mr. Chairman--a national securities regulator would have changed.
That was unusual. I'm not used to presiding over question period, but that was an interesting discussion.
Mr. Duguay, I want to thank you very much for being with us here today. I'm sorry that in some cases I did have to shut you off. It was in the interests of allowing all members time for questions. We very much appreciate your responses.
There's one thing I would ask you to provide a written response for. In my riding, when the Bank of Canada lowers its rate by 50 basis points, consumers and businesses have a perception that the lower rate is not passed on fully to them by the financial institutions. I know this will be a question we'll have for the banks when they appear before us, but if you can provide a written response to me as the chair, I'll share that with all the members. I know we don't have time right now.
We appreciate your time here today. Thank you.
Members, we will suspend for a minute or two, and then we'll deal with future business.
[Proceedings continue in camera]