THE STANDING SENATE COMMITTEE ON BANKING, TRADE AND COMMERCE
EVIDENCE
OTTAWA, Wednesday, March 2, 2022
The Standing Senate Committee on Banking, Trade and Commerce met with videoconference this day at 6:29 p.m. [ET] to study matters relating to banking, trade and commerce generally, as described in rule 12-7(8); and, in camera, for consideration of a draft agenda (future business).
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: Good evening, senators and everyone joining us online. Welcome to the Standing Senate Committee on Banking, Trade and Commerce. My name is Pamela Wallin, senator from Saskatchewan, and I am the chair of this committee.
Before we begin, I would like to remind senators and our witnesses to please keep their microphones muted at all times unless recognized by the chair, but keep an eye on that so we don’t have too many “unmute” or “you are muted” interjections tonight.
Again, I would like to have as many senators as possible participating in our session tonight, so I would ask both senators and witnesses to keep their questions and answers brief and to the point to ensure that every member can ask at least one question or maybe two during the limited time that we have with our witnesses.
With that, let’s begin. I’ll introduce the members of the committee participating in today’s session. I will start with the deputy chair, Senator C. Deacon; Senator Bellemare; Senator Gignac; Senator Loffreda; Senator Marshall; Senator Massicotte; Senator Ringuette; Senator Smith; Senator Woo and Senator Yussuff.
Today we have the pleasure of welcoming Stephen Poloz, Special Advisor, Osler, Hoskin & Harcourt LLP, and, as you well know, former governor of the Bank of Canada.
Mr. Poloz will address us on the full range of issues that this committee is looking at: crypto-currencies, inflation, housing, labour markets and, of course, business investment. We should also say that he has just published his book entitled The Next Age of Uncertainty, which is, of course, precisely what we’re talking about.
Welcome and thank you so much, governor, for being with us tonight. We really appreciate it.
Stephen S. Poloz, Special Advisor, Osler, Hoskin and Harcourt LLP, and former governor, Bank of Canada: Thank you and good evening. It’s a pleasure to see so many old friends.
The Chair: That’s right. Please go ahead with your presentation.
Mr. Poloz: The wide range of topics that you mentioned are probably not in my opening remarks. I was asked to discuss the outlook for business investment in Canada. I presume behind this question lies a concern that Canadian business investment and productivity growth have been lagging other major economies literally for decades.
My current assessment is that business investment is picking up, as we speak, and it will pick up more this year, and that growth may be sustained longer term. However, despite that, I expect that we will continue to lag other countries in both investment and in productivity growth.
Even in retirement, I continue to spend a lot of my time with actual companies, which is, of course, an advantage over the regular economics where you spend your time with data. I generally find that there are very good productivity stories pretty well everywhere in the Canadian economy, everywhere, that is, except in the statistics.
Measuring investment and productivity is a significant challenge for statistical agencies, especially given the growing importance of what we call intangible investment. That’s investment in knowledge, brands, networks, IT applications internal to the firm. So I suggest that the committee call upon some statistical expertise to help understand the very important data issues that underlie our investment data and, therefore, the productivity data.
There are other reasons why I am reluctant to blame companies for weak investment or to recommend a major government program to promote investment, and that is because there are many impediments to business investment, many of which are under government control.
Perhaps the biggest impediment to investment is the word you used, chair, which is “uncertainty” about the future. Uncertainty, of course, causes companies to hold back, to wait and see before they invest. There are numerous sources of uncertainty today, we just need to look out the window, but let me just highlight a few that governments might have the ability to manage.
International trade uncertainty, unquestionably, held business investment back during the Trump administration. We were well aware of this at that time. Many of those issues remain relevant today. I just ask you to review last night’s State of the Union Address and you will know what I’m talking about.
Geopolitical tensions, in general, affect trade-dependent economies much more than others, so Canada lies right in the way of these kinds of forces much more so than, say, the United States, which has the scale to support big investments whether they rely on trade or not. So we need to manage those international trade risks more proactively than others.
The energy transition that will take us to net-zero carbon emissions by 2050 is a major source of uncertainty for companies. There are many possible paths that we could follow to get us to net zero, and each of these paths has its own business implications.
Some of those paths would see conventional energy sources shut off completely very soon, while other paths would see those sources of energy continue to play a central role in meeting growing global energy needs, probably complemented by carbon-capture technology.
So conventional energy could be an important source of higher investment and productivity for Canada, but only if the path to net zero is thoughtfully chosen and made more certain for the companies.
A third area of uncertainty for companies is the supply of skilled workers. A new investment can only deliver increased productivity if the right workers are available. Canada has a strong immigration plan, but global population aging means that other countries may soon begin competing for those same immigrants. Meanwhile, the fourth industrial revolution could disrupt up to 15% of global jobs. So I expect the business of matching workers to job requirements will become much harder for companies in the future.
In Canada, geographic distance and interprovincial differences in certification for workers, that sort of thing, can hamper this matching process and therefore prevent productivity growth.
Today, households bear all the risk of moving across the country to take a different job. They receive only a tax deduction for moving expenses. It seems to me that we could create better government-sponsored mechanisms to reduce the risk associated with labour mobility, therefore achieving better labour market matches and higher productivity growth in the process.
A fourth area of uncertainty I would like to highlight relates to infrastructure investment. Infrastructure investment is an essential ingredient to productivity growth. You may invest in your company and find that you can’t get your goods to where they have to go on time. Infrastructure is critical to delivering the productivity that we’re looking for.
The government has set out an ambitious infrastructure financing plan, but its deployment has been slow, it has been lumpy and it has been unpredictable. Again, uncertainty.
We must acknowledge that having an infrastructure financing plan is only the first step in the path to higher productivity for the firms that use the infrastructure. There are many ways to streamline that process, ranging from permitting to intergovernmental coordination.
These uncertainties around infrastructure affect the suppliers of infrastructure projects too. Without certainty as to when projects will go ahead, construction companies cannot plan their own resourcing so the capacity of the industry is almost always stretched.
Construction companies must also post performance bonds to bid for projects for infrastructure. For performance bonding, there is limited private sector capacity. The Canadian Infrastructure Bank may be well placed to address this particular impediment to investment and to help bring more predictability to the flow of project work at the same time.
Let me conclude by briefly mentioning a few other government initiatives that could boost business investment and productivity growth without adding to fiscal expenditures.
First, government procurement policies could be changed to favour high-productivity Canadian start-up companies instead of, at the moment, large, safe, low-productivity suppliers.
Second, young growing companies which have far above average productivity are often the ones financially constrained. We have a pretty good system for the start-ups and we have a great system for the big companies, but the middle ones, the ones that are hitting the growth hockey stick, are constrained. This is why the Canadian Business Growth Fund was created. It has performed very well, even making a lot of deals during the pandemic at a time of great stress in the economy. That idea could easily be scaled up significantly by adding more capital to the fund. Of course, not a fiscal expenditure.
Third, red tape and permitting are huge impediments to business expansion. I just ask you to think about this: Suppose Canada was earning an additional $8 billion or $10 billion this year by exporting LNG to Europe at a time of need. That would have added 0.5% to Canada’s GDP this year alone and every year from now on and, of course, it would boost government revenue proportionately. Of course, we did not approve those LNG projects when the opportunities were in front of us.
Fourth — this is my favourite, chair — interprovincial regulatory differences are estimated to cost Canada four percentage points of GDP every single year. Fixing those or even some of those issues would boost the economy, productivity and government revenues at the same time — all at zero fiscal cost.
Thank you for your kind attention, and I look forward to your questions.
The Chair: It’s not as if, as you well know, we haven’t studied interprovincial trade barriers endlessly at this committee. Thank you for reiterating that point.
We want to get to the many, many things you’ve raised there. We’re going to begin our session tonight with Senator Smith.
Senator Smith: Thank you — I’ll call you “governor” because I always have respect for people who have been in the position no matter what. You did a great job for us.
I will go to one issue, which today was the interest rate hike. I know that it may not be tied directly to the five points that you were looking at. However, while the interest rate hike will certainly — or hopefully — slow down inflation, it could prevent buyers from entering into the housing market. There are concerns it will do little to cool down the housing market. A big factor is, of course, the lack of housing supply. Unless there’s a substantial increase in inventory, prices will continue to soar.
According to zoocasa, which is a technical-based brokerage company, higher interest rates mean slower sales but no major impact on price.
Sir, I would like to get a sense of what levels of interest rate would really slow down demand for housing and thereby decrease prices. Or is it simply a function of how much supply there is in the marketplace?
Mr. Poloz: Every interest rate increase, in principle, will slow housing compared to where it is today. The reverse is that by cutting interest rates to zero, we boosted demand for housing. Therefore every move toward some more normal level will reduce the demand for housing.
There’s also the fact of the value of a house. A house generates a stream of returns for you from now to forever. Therefore, the present value of that stream, which is like receiving rent instead of paying rent, goes up when interest rates go down. That means that we’ll also go down, potentially, when interest rates rise.
None of these things are cast in stone. I disagree with much of your premise. In fact, the most important answer is that nobody really knows the answer to this question. However, we do know directionally that low interest rates boosted the demand for housing, therefore higher interest rates will enlarge and begin to reduce the demand for housing. In the background, population growth will continue to drive that base.
I think the most important fact — and the fact that you mentioned — is that we have not built enough houses in the last decade to accommodate the people — the new arrivals — into Canada. I shouldn’t say “houses.” I should say “housing,” because it’s not just houses, of course. It’s all forms of lodging.
The bottom line is that interest rates are an important part of that story, but prices are likely to continue to rise.
Senator Smith: As we look at the housing market and interest rates, I accept exactly what you said. Where do we go from here? If you had to do a guesstimate — I hate asking people for forecasts — we had a lot of talk from the government about increased building and housing, whether it was single units, multiple units or apartment buildings, et cetera. Do you see a strong move by government as a fuel for this, or will this be done by entrepreneurs and major corporations and major builders? Who will participate in this evolution?
Mr. Poloz: I think that the supply of housing has not been constrained by not having enough buyers or enough builders. I think it’s been constrained by red tape. It’s constrained by municipal rules around permitting and opening up new land and other restrictions for densification in traditional neighbourhoods.
That’s very well identified in the Ontario Housing Affordability Task Force report, which was just published a couple of weeks ago. They do a really thorough job on this, and their main conclusions are that.
So you should relax the rules that prevent higher density. That’s one of the most important things. There would be a spontaneous expansion of housing in traditional neighbourhoods if you changed those rules. That’s exactly what I’m talking about on investment. It’s government rules that stand in the way of the private sector solving many of our problems.
Senator White: We’ve worked hard over the years in trying to reduce red tape and telling the government to do that. However, successive governments have had trouble doing that. Sir, thank you very much.
Senator C. Deacon: Thank you, best-selling author Stephen Poloz for being with us —
The Chair: You can hold up your book now, governor.
Senator C. Deacon: Yes. My copy is at home.
One of the things you didn’t mention was how we manage competition in Canada. Our Competition Act and competition policies are distributed across many, many departments and the way we can level playing fields so that new entrants, especially in the digital era, have an opportunity to compete against incumbents in a manner that pushes not only business investment and productivity growth within the incumbent but rewards the business investment and productivity growth in the new entrant.
Could you just explore that area? I noted it missing from your list. I have such respect for your views that it really stood out to me. There must be a reason.
Mr. Poloz: The simple reason may be that I simply wasn’t encyclopedic in my opening remarks. I tried to focus on half a dozen things that I hoped would get your attention. There are things that I think are above the line.
You’re right, we do have a number of sectors in the economy that suffer from low levels of competition, if that’s what you’re getting at. I certainly would agree.
One of the most important areas where that’s true is in the financial sector. I pointed to one of the things that constrains growth in new companies. Young companies — not necessarily small companies, but young companies — that have faced that hockey stick stage are often constrained for financing. So we probably need to break up that logjam if we can.
As I said, the Canadian Business Growth Fund was a great idea. I helped contribute to creating that. I think it needs to be bumped up, so that it can scale. It’s close to having used the resources. That is private sector money. The government, though, could put more money into it to spark another wave.
The other thing is that government procurement works exactly in that same space that you’re talking about. When you ask if a new company has that ability to compete, the answer is no, not to a bureaucrat who must make a low-risk decision on what to buy. Here’s a brand new company with what looks like a fantastic service or product, but, gosh, this is a really big contract and I think we’ll go with this established — often American, actually — company for that. Other countries don’t do this. Other countries say no, no, it’s Canada first. You just heard it last night in the State of the Union Address.
We just don’t do these things, and I think we should. We should make exceptions for young companies. That’s not the same as saying small companies. That’s a really important thing, because we have a lot of small companies that are old. They are not trying to get big; they just are.
I’m talking about young companies that show the growth characteristics. Those are the companies that have been financed by the Canadian Business Growth Fund. I’m not saying that the system is broken, but it’s not as good at it as it should be.
Senator C. Deacon: If I can expand on that. I think when you say red tape and some of the challenges that can be managed, a weight of regulations that could be managed by a larger business with a bank of lawyers to deal with issues where a small company can’t break into that market, I view that as an anti-competitive regulatory environment.
Let’s look at business investment. We’ve seen a huge amount in some of our fastest growing companies — our unicorns — in the last year and a half, a huge amount of that money is now coming from the United States. The source of capital, you’ve rightly said we need to focus on making sure we have more available capital for investment in these companies, but what about the aspect of having a greater diversity of doors to walk through and having those doors be where decisions are made in Canada versus based somewhere else?
We’ve seen a narrowing of our markets down to a smaller number of players. What do you see as being the important part of having more investment sources that are expert investors who are Canadian-based?
Mr. Poloz: As I mentioned, I think in the venture end of things we actually perform pretty well. That’s been my experience anyway. Brand new companies seem to do pretty well to get those first stages of financing.
When they need not a $5 million but a $50 million move, that’s when we kind of breakdown. When they go out looking, they could end up talking to either funds or investment bankers who will go around and find some money for them. They are sniffing everywhere for the money, and there’s very little of it here. That’s why they’re sniffing everywhere.
We are a small place, so we’re going to always have that risk that it’s going to be a U.S. investor or somebody that finances one of our best ideas. But I would rather see that happen and still see the employment and the economic growth happen here even if it’s mostly or partly owned by an external investor. I would still rather see it happen than have it not happen. If we create a bunch of structure around that and then they still don’t get financed, that’s not any good to us.
I do think the U.S. door must remain an important door for us. It always will be. That’s just a great pool to tap into.
Senator C. Deacon: Thank you very much.
[Translation]
Senator Gignac: It’s a pleasure to have you back, Mr. Poloz. Congratulations on your new career. Your book is already number two on last week’s best-seller list. With thousands of people tuning in live or playing a recording of the meeting, you’ll likely be number one in the coming weeks.
Again, much like when you held your previous position, I must reread your opening remarks two or three times. Your remarks are always very complex. There are many ideas, and I want to understand all the subtleties.
I want to talk about the energy transition. In a previous speech, I believe at the True North Free Trade Forum, you spoke about the energy transition and you also referred to the carbon tax. Given that consumers are being compensated, perhaps businesses should be compensated as well. The government is planning to increase the carbon tax significantly in April.
Can you share your vision for this energy transition? The energy transition is necessary. However, there seems to be a split in Canada right now. It isn’t always a good idea to compensate companies with tax credits or tax holidays to ensure the success of this transition.
Mr. Poloz: Thank you for your question, Senator Gignac.
[English]
The energy transition, I mentioned that there are many paths that we may end up taking to net zero. That’s a really important point. Honestly, no one really knows how we’re going to get there except we believe, anyway, that carbon taxation will continue to rise. That’s one thing that you hear a lot of companies mentioning. They take it for granted that that will continue to happen.
The transition is really being forced mostly right now by investors. The carbon tax helps put dollars and cents against the move you make. In other words, the CEO can get convinced about doing the energy transition because the shareholders and, actually, employees are demanding it. So there’s pressure there that they would do things as if they’re paying a carbon tax. They’re doing things just because they think shareholders will dump their stock if they don’t do those things.
So we see some pension plans saying, “We’re not going to hold that stock anymore because that’s a high-carbon business.” Other pension plans are saying, “No, we’ll hold that stock, but we’ll monitor the progress of that company as we go through.” Either way, I think we’re going to go there by this mechanism, but it is a transition and what we need is a bit more realism in the political conversation.
The realism would be that global demand for energy will rise by 50% or 60% between now and 2050. How are we going to accommodate that? If the world invests only in green energy starting today, they might be able to accommodate that growth, but there will still be around half of global energy needs coming from traditional fuels.
We’re going to need to use carbon capture in order to offset those carbon emissions. Therefore, Canada, being a leader in energy production for the world — high-quality, best behaved in terms of carbon — should be a leader in energy provision for the world forever. To do so, it also needs to be a leader in carbon capture. That’s the only way to square that circle.
I think we as Canadians should be putting a lot of resources into becoming that leader in carbon capture. That will mean that our brand for our natural gas and our oil, those energy sources will continue to be relevant for the world for a very long time.
Senator Gignac: Do you believe that this current unfortunate war in Ukraine could be a game changer? Over the last few years, the pension funds worldwide using ESG as a base — in fact, I focus on the first two letters, E and S, not necessarily on G — we have noticed BP and Shell phasing out oil sands, and energy in Canada invests a lot in Russia and now you see that they realize that the governance matters, not only the environment, but governance matters as well.
Do you think that you can see a repositioning of the pension funds and that this could be more positive for Canada as a net exporter of oil and gas? In fact, technology has improved, as you know, with carbon capture. Do you see that this tragic event that we see in Ukraine due to Russia could be a game changer and could help this transition and social acceptance and that Canada could play an important role?
Mr. Poloz: I agree with you, senator, although I would say it was a trend that was emerging before Russia-Ukraine. During this winter, there have been a lot of tensions around energy security in Europe. What has happened is this is a question of what path you take to 2050. If on one path you are saying we must have this green energy and this green energy and this green energy and, by the way, we need to close all these coal-fired power plants, that’s all part of it, it’s very lumpy decisions and it’s not all coordinated in a smooth plan.
What happens is we have forgotten a little bit about energy security. So when something happens like this winter and now with the Ukraine-Russia situation, it’s making it even worse. The risk is that we will not be able to heat our homes, for example, in Europe.
We need to make sure that energy security is there, and that means that the transition is conscious that these energy sources need to still be there for us.
But if we say to people, flippantly, “Oh, we’re just going to leave that stuff in the ground,” which is what I hear, then they stop investing. And, by the way, productivity drops immediately, too. So they stop investing and that means that stuff isn’t there to keep us warm during the transition.
Clarity on that transition path is absolutely critical to getting the right level of investment in traditional energy sources. I believe that if we invested heavily in carbon capture that it would solve the big problem. It would allow us then the relaxation of timing. The timing could be much more our timing as opposed to being forced upon us.
The Chair: Do you agree that we might add nuclear to that list as well?
Mr. Poloz: Absolutely. That is green energy, for sure. Of course, its reputation was hit by a couple of incidents and they matter, but those risks, I think, are small compared to the existential risk associated with global warming. We have to put these risks in perspective. We can’t just say, “Well, we have to have zero risk here.” Say nuclear. In some countries, they just say no nuclear whatsoever because they have decided it’s too risky. Yet they are taking the risk that we won’t have enough energy to get to 2050 or that somehow global warming will continue and we’ll have an existential problem. These are all risks. They matter, but they can’t be ground to zero.
Senator Woo: Nice to see you again, former governor.
Mr. Poloz: Likewise.
Senator Woo: Thank you for your opening remarks. Very stimulating. I wanted to pick up on your opening comments, which were very tantalizing. You talked about how it’s unclear, the path of productivity growth in this country. You encouraged us to talk to specialists about the challenges in measurement and so on. But you didn’t quite tell us whether you thought that productivity growth was overstated or understated in Canada. Would you care to tell us which direction you think the bias is and maybe why you think that way?
Mr. Poloz: I think it’s understated, so is investment understated. Let’s begin with investment. I mentioned the growing importance of intangible investment. Let’s just take an example, such as an insurance company that has a large IT staff. That IT staff is creating apps for your phone and to speed up your service processes and those kinds of things. These are obviously investments. They generate returns from now until kingdom come. Yet they are recorded as an expense because those 40 people in the IT department, they just work there.
We invest in intellectual property; some of that is tracked, but a lot of the supporting roles do not capture it.
The book by Jonathan Haskel and Stian Westlake, Capitalism Without Capital. You’re nodding so I think you must know the book I mean. It shows that, actually, intangible investment in the U.S. is now more important than traditional machinery and equipment and physical capital. That trend line just crosses. That’s not measured properly.
Productivity, as you know well, is even harder for statisticians to measure. For instance, in the U.S., there is so much more private health care. That’s a high productivity business. If you just watch “Grey’s Anatomy” or something, you know they are making lots of money by making the hospital more efficient. In Canada, where health care is primarily publicly provided, we measure output by the number of beds. There is no productivity coming from that whole sector that is measured in our GDP statistics, and yet it matters tremendously.
Those are just a couple of the examples. I am not an expert. I suggest you bring in someone from Statistics Canada to help you understand that it is not black and white, the way it’s described in the traditional charts. It just isn’t.
Senator Woo: That leads me to my follow-up question, if I may. There are many who argue that these intangible productivity gains are really a function of what they call financialization of the economy, which is illusory. We know from the collapse of the London financial sector, after the great financial crisis of 2008, that many of the so-called productivity gains of the City of London weren’t real. Do you know what I mean?
Mr. Poloz: Yes.
Senator Woo: They were just bubbles. I do not mean bubbles in the sense of financial markets, stock markets, but the gains that were there, including some of the things that you have described, were not really contributing to the real economy.
I want to get to the question of this study, which is why is business investment lagging other types of investment? Could it be, former governor, that the economy, and our economy in the West particularly, has become so hooked on financialization that capital is being sucked away from the real sector into the money sector and into what you might call consumer internet? It kind of feels good, and we love being able to buy things on Amazon very quickly, but it’s not really clear that we’re improving our standard of living.
Mr. Poloz: Well, that’s a very interesting way to portray it, senator. I would just say be wary of making that clean of a distinction because, of course, innovation in the financial sector does produce productivity throughout the economy. I save a lot of time driving around comparing prices and so on. In fact, I don’t drive around at all now. I just check the various things on the web, and then one person drives everywhere in the neighbourhood and drops off the packages. We’re saving gas; we’re saving time. That’s my productivity.
The financialization of this has positive elements, but you’re right that in the financial sector itself things get puffed up. Then that kind of gets measured as GDP, which is not really GDP. That could very well be one of the reasons why U.S. productivity tends to look higher than ours — because it’s more puffed up there than here.
That’s exactly why I think some examination of the statistical side would be worth it for your committee to understand that better, so that people weren’t so glum about Canada’s performance.
In the past, I know — take for example the aerospace sector. Well, the statistician now is comparing productivity at what we used to call Bombardier — now Airbus — to productivity at a huge aircraft manufacturer, like Boeing, in the United States. They aren’t the same business at all. But if we compare the data, there is productivity from aerospace for both countries.
But if we take things that are the same, such as paper production, what you discover is the productivity is identical in both countries. The technology is the same. The scale is very similar, and they are competing head to head.
This is what I mean when I say that when I go around the economy and visit with companies, they are always telling me great stories about their increases in productivity. It really is everywhere except in the statistics. I do think that the situation is better than it seems. I think you need to allow for that from the statistical agency to get a better fix on their limitations of their data, so at least you know what is fragile about them.
The Chair: Believe me, we are going to do just that. Thank you, governor.
Senator Loffreda: Thank you, former Governor Poloz for being here. Nice to see you again.
I would like to look at it from another angle, where we are performing well. What best practices or policies or creative ideas do we have on that side that we can bring over to the business investment side? We have all seen, on the business investment side, what is most worrisome also is the lack of investment occurring in manufacturing equipment, intellectual property, where technology plays a large part.
I do have Governor Macklem’s recent speech where he is in agreement with a lot of the points you raised: We should have more favourable tax treatment. Capital gains are treated differently. I can go on and on — infrastructure, property taxes. But according to the Global Affairs Canada website, Canada had the second-largest foreign direct investment stock-to-GDP ratios among G20 countries over the 2016 to 2020 period, which is almost the identical period where business investment was at its lowest since 1970.
Yet we still hear — and we have heard it so many times — that Canada is becoming an increasingly unattractive destination for foreign investment because of the reasons that you mentioned in your opening speech and that Governor Macklem mentioned.
What are your views on that? Are there any policies or best practices or is that surprising to you that we are among the leaders when it comes to foreign direct investment stock-to-GDP ratio? What can we bring forward or what other ideas can come out of that besides what we have already mentioned?
Mr. Poloz: Well, you’re absolutely right that Canada traditionally has been a great destination for foreign investment. Thank goodness because for an economy our size, we probably could not generate the levels of investment that we needed. That’s one of the things that small economies like ours generally rely on: a flow of investment in. Therefore, they carry a current account deficit. It’s the financing of that deficit which is the counterpart of that flow.
I think a lot of the disappointment that emerged in the last six or seven years, maybe a little longer, has primarily been because of the energy sector, and it came in the wake of the collapse in energy prices in 2014 to 2015. That caused a scaling back, and a number of foreign investors, as Senator Gignac mentioned, decided to leave the oil sands, for example. Of course, investment is naturally going to be lower when you think, well the production from there is not going to continue to grow because of ESG concerns. We have all those things happening all at the same time.
Well, now prices are $100 again, just like they were back in the 2010, 2011, 2012 period. Right now, I don’t know if anybody believes that will persist. My guess is it won’t, but even if it did, there would be a point at which maybe we would get a little more investment. I think the most important way we can do that is to clear things up for people so that they understand there is a legitimate future. These are very long-range investment plans. You’re not going to bet the farm and then have somebody say, no, we have decided you’re going to have to leave all that stuff in the ground. That’s billions of dollars wasted.
You need that clarity, otherwise those investments won’t occur. They won’t occur if you can’t get the product out to the world either. Okay? That’s the infrastructure point.
Senator Loffreda: I would like to look at the other side where back in my banking days, on the knowledge-based industries and companies that were growing, there were numerous surveys from accounting firms that found once the company does reach a certain level of EBITDA, many entrepreneurs would rather sell their company than grow their company. The numbers were astounding and surprising. Without mentioning the accounting firms or the surveys, I am sure you have seen those and you’re aware.
What can we do to entice the entrepreneur to keep the companies in Canada and invest? Because what happens is foreigners come in, purchase those companies and investments don’t occur back here in Canada, they occur back home in their head offices and what have you. Jobs are not created in Canada. Any quick fix on that or your impressions on that?
Mr. Poloz: Well, I will offer a couple of ideas and move along. We have a habit of doing a lot of things to encourage small businesses. We do very little to encourage growing businesses. In fact, what we do is we begin to tax them really hard as soon as they grow to a certain stage.
The big winnings from starting a new company are in that first part. There is a bias there. You can really cash in and then start another one. That’s why you get these serial entrepreneurs. The model I would prefer to see the growth stories happen — as I said, there is an important gap in our financing structure at that stage. We have ways of addressing that. We do not have a very competitive banking sector. We know this.
We maybe need a little bit of disruption there. The Canadian Business Growth Fund is kind of a type of that kind of disruption. It’s not the only idea.
The other thing is to put in things that encourage companies to grow such as tax breaks. The more jobs that are created for example, that’s symptomatic of growth. Right now, you find other ways to tax them because they are getting bigger.
Senator Loffreda: Tax once again. Thank you for that.
[Translation]
Senator Bellemare: Welcome, Mr. Poloz. It’s a pleasure to have you with us today. I’ll ask you my question in French, but you can answer it in English. I’ll try to get right to the point.
In your book, which is about the age of uncertainty, you said that one of those uncertainties concerns the workforce. When you live in a period of uncertainty, you must know how to adapt. That’s the key. We know that today, even the banks emphasize the human factor and skills. These elements pose a significant challenge in terms of adapting to uncertainties. Even at the Davos forum, there was talk of —
[English]
— skills as the currency of the 21st century.
[Translation]
In Canada, we know that companies and governments don’t invest much in workforce training. They invest heavily in education, but not in training. Should we leave things that way, or should we take the bull by the horns with respect to workforce training and ensure more public and private investments? If we fail to do so, companies will. IBM, for example, has developed application frameworks and short courses. However, this isn’t enough in these uncertain times.
[English]
Mr. Poloz: I agree with you. We will need more tools or at least more resources dedicated to this because, I think as I mentioned, the World Economic Forum suggests close to 15% of people will have their jobs disrupted by the next technology wave, which is the artificial intelligence wave.
That means then that those people will be moved to the bottom part of the K-shaped trajectory. Finding a way to the top will be quite an incentive for companies themselves to help their employees to do this, as the IBM example suggests. There is an internal learning.
I think they will be wanting to do this because there will be a shortage of workers as the aging progresses. In effect, in the market, the power will shift from the employer to the employee, and they will look for more protection and more safety nets and more risk mitigation. That’s why I mention helping people draw on a fund in order to move. When the job is in Guelph but you’re living in Saskatoon and it’s a big job to move there, why is all the risk on the household? There is no risk mitigation measures from us.
There are lots of training programs at the provincial level that work really well, including apprenticeship programs. We have the basic infrastructure there, but the individual takes all the risk. That’s my concern.
Senator Bellemare: That’s a problem.
Mr. Poloz: Yes.
Senator Bellemare: Don’t you think if the government were investing more, then it would help the transition and also it will be leverage for the private investment and even some leverage for investment in machinery and equipment? There is a link. There is a correlation on those big variables.
Mr. Poloz: I agree with you. From the point of view of the firm, if the government’s doing something to reduce that tension or the risk for the worker, that makes it easier for the firm to get the job done. To make an investment, have the people there, then the productivity comes next.
I agree completely. How do we do that? Is it going to be really hard for them to find the match? What do we do to make it easier to find the match? That would make it easier for people to move. My son is a renovator. He can obviously work in Ottawa, but he can’t work across in Aylmer, Quebec; however a renovator in Aylmer can work in Ontario. Those are the kinds of interprovincial things that make no sense in all vocations.
Senator Bellemare: Thank you.
Senator Marshall: Welcome, Mr. Poloz. It’s nice to see you again.
I want to talk about your opening remarks on the lagging business investment in Canada. You were listing off all the factors — international trade, interprovincial trade, infrastructure and energy transition. I agree that we will have an issue with energy security. You talked about government procurement, red tape and the increasing taxes on growing businesses.
It sounds like a lot of those problems or factors are within the purview of government, and they should be able to do something to fix it. It seems like part of it is that government has a stranglehold on businesses. We know what a lot of the problems are, and you have identified them. Some of these issues have been around for quite a while, and we had a lot of red tape reduction initiatives that have been unsuccessful. Government procurement has been studied to death. What is the solution? How does government get out of this? What would be your advice to government?
Mr. Poloz: Well I could go on at some length, but I know the chair would not appreciate it. I will say that these problems that you just mentioned are easy to fix if you just say that must stop as of now.
If it requires collaboration with provincial governments — and sometimes that’s the case. If you get in a room with the finance ministers of the provinces, territories and the federal government — out there in the world, people are concerned that we have a lot of debt after the pandemic and somehow it has to be paid. They are concerned there is going to be higher taxes somehow to pay for this. What if you could emerge from that room and say, “We have all agreed we could get rid of all these impediments to growth and we don’t have to raise taxes at all. The deficit is going to go away by itself.” Wouldn’t that be a great announcement? It’s because economic growth will be higher.
It seems there would be a lot of political win, win, win in that kind of a meeting. I fail to understand why it can’t be done. I keep hearing it’s politically impossible. I’m sorry to be disappointing, and it’s not an easy answer. Last night, President Biden said that they are going to do all of this and they’re doing it with American workers. We don’t even do that for procurement. We are in charge of our own procurement. But we have a policy that says you have to go through a process that has the lowest price and the lowest risk and that’s it. That is the license that the procurer has.
Senator Marshall: It is very discouraging, Mr. Poloz, because we remain hopeful. But now, after hearing you, I’m not so hopeful. Thank you. I appreciate your honesty.
Senator Massicotte: Mr. Poloz, thank you for being with us. When you listed all the impediments to trade, I thought your conclusion would be that we can’t beat expectation and we can’t seek any growth, but you came across differently. We all acknowledge that. It’s hard to measure productivity. We have tried for decades. You’re right about that.
Let me ask your opinion as to why you’re the optimist and think we could have significant GDP growth and, therefore, increasing debt without difficulty? Some of your colleagues, and David Dodge in particular, are quite concerned by the increasing debt and that a Canadian government is being somewhat lazy by basically providing funding to the consumer, to the Canadian citizen, as opposed to finding ways to stimulate trade or productivity. Do you have any comments on that? Obviously, you will probably disagree, but could you comment on that?
Mr. Poloz: The fact is that we have the conditions in place that I would consider to be the minimalist conditions for sustainability, that interest rates will remain low, growth should be just enough so that the debt-to-GDP ratio can trend downwards through time.
If that is deemed sufficient to have us ready for the next bout of volatility or crisis, I think that’s a political question. It’s not up to me. I think a lot of people think we should try to get back into a stronger, more resilient fiscal position sooner to be ready for the next big event. I probably would be among them.
I think the way to do that is to address some of these impediments so economic growth goes up. We will get huge returns from those changes, and we won’t even have to spend any money to do that. I don’t think it can get any smarter than this. But, if that’s too hard, then we’ll have to muddle our way through, and I think we can more or less barely muddle our way through on the current trajectory. It’s not necessarily the one you or I would choose.
Senator Massicotte: Thank you.
Senator Yussuff: Thank you, governor, for taking the time to be here this evening, and thank you, of course, for your years of public service.
You have described some challenges. I want to focus on two. One is the energy transition that is happening. Of course, we have seen a tremendous amount of jobs lost in the sector and, as we know, the majority of pension plans are very hesitant about their long-term commitment to invest in this sector. I recognize what you’re saying about carbon capture, but there have been assessments made by many pension investments that they need to move their money in another direction, at least the company, to show more commitment on how they can get us to net zero between 2030 and 2050.
The last point is we have an aging workforce in the country. You spoke about the mobility challenge we face. We have a lot of workers who have skills but, for a variety of reasons, they can’t go to a place to put their skills to work. I know you and the governor of the bank provide a lot of advice, yet we have not been able to solve this problem. Here we are in 2022 and the problem is worse today than it was two or three years ago.
Mr. Poloz: The energy transition — you’re right that the uncertainty is already playing a role there in levels of investment and therefore employment. You’re right about the investors. Many investors take a binary mindset to this and say, “I’m under pressure to demonstrate my ESG credentials, so I’m going to stop holding that stock in your portfolio.” And the investor or the individual investor is demanding this either of their pension plan or of their person managing their money.
What is going to emerge, though, is as companies lay out their concrete plans — and most of them nowadays are — a trajectory that gets them to net zero and proving it along the way, and indeed even connecting executive compensation to the outcomes and floating bonds that will only pay off for them if they meet their ESG objectives — this is pretty rigorous stuff that is emerging. But it’s the measuring of the performance through time that is still a little hard. I think there are many shades of green, and the investor can’t really make them out without doing a lot of work.
But imagine a world — which we’re headed for very soon — where not only do you have an ESG framework, your auditing firm is going to attest to your outcomes. The way they do with your financial numbers, your auditing firm is going to say they have checked on the ESG targets and they have achieved them and they have a good plan.
That transparency is going to allow investors to choose more carefully shades of green for their portfolio. That’s the level of transparency that is coming just like we have today on financial results. When that happens, the transition will be easier to imagine. We can just focus on scope 3; in other words, the actual consumer of carbon intensity. That’s what carbon taxation is designed to deal with.
The Chair: Thank you very much, former governor Stephen S. Poloz, Special Advisor at Osler, Hoskin and Harcourt LLP and the author of his best-seller The Next Age of Uncertainty. We will take your advice and some of the guidelines you have given us. We really appreciate your time tonight.
Mr. Poloz: Thank you. It was a pleasure.
The Chair: We will get a copy of the governor’s remarks or at least his notes. We will try and distribute that so people have a reference point.
So thanks again, governor.
We now have the pleasure of welcoming Peter Routledge. He is the head of the Office of the Superintendent of Financial Institutions Canada — you hear people refer to this as OFSI. He has a private sector background as well. We want to discuss several issues, including everything up to the process of freezing accounts, both through the Emergencies Act and SWIFT, and all of the things that we are discussing at this committee.
Thank you very much for joining us tonight, Mr. Routledge.
If you have some opening remarks, please go ahead.
Peter Routledge, Superintendent, Office of the Superintendent of Financial Institutions Canada: Thank you for having me, Madam Chair.
I’ll try to be brief. Good day, Madam Chair and honourable senators. Thank you for the opportunity to appear before this committee today. I look forward to sharing my thoughts on the issues of housing finance, digital money and recent events. With those in mind, before I do my land acknowledgment, I’ll also acknowledge that there are many Canadians worried about their friends and loved ones in Ukraine tonight. We have a few of those Canadians at OFSI, so a shout-out to my colleagues.
[Translation]
First, I want to acknowledge that I’m speaking to you from the unceded traditional territory of the Anishinaabe people. I’m grateful for the opportunity to be here on this territory.
A key factor in ensuring a sound housing market is a stable housing finance system that provides reliable access to credit at a conservative and risk-based price. As a result, OSFI’s role is specifically to safeguard and protect access to quality credit so that Canadians can buy and sell homes.
[English]
Our strategy is to ensure that the housing finance system — and the Canadian financial system as a whole — has sufficient buffers to absorb bouts of volatility, the timing of which is uncertain but the arrival of which, as we’ve learned in recent weeks, is not in doubt. Having these buffers in place helps to ensure credit remains available to support economic activity in times of economic expansion and contraction alike.
Innovation in financial services has accelerated in recent years and, in particular, is encroaching on the multi-faceted concept of money. We call some of these innovations crypto-currencies, others stablecoins and still others decentralized finance, or DeFi. Each innovation has a potential to add value to Canada’s financial system and to Canadians, and each brings with it less well-understood risks similar to those which have tripped up financial innovations in the past. How to respond to digital money innovations is one of the questions that faces the federal financial safety net in which OFSI plays a critical role.
When the current Governor of the Bank of Canada appeared before this committee, he was asked about the bank’s work on this issue. I can tell you OFSI is leveraging the bank’s work by adapting how we might evaluate the safety and soundness of financial institutions as digital money proliferates.
In Canada, we’re fortunate to have a number of government partners working together to analyze and assess the implications of digital money innovations, such as crypto-currencies, on our regulatory frameworks. OFSI is proud to play a part in the development of a federal financial oversight framework that continues to evolve and serve the needs of Canadians.
I look forward to contributing to the committee’s study and to answering questions.
The Chair: Thanks very much for your remarks.
Senator C. Deacon: Really wonderful to see you again, superintendent. A recent report that you did with Bank of Canada interested me — [Technical difficulties]. Your report seemed to say that there was increased risk in delaying action. I’m wondering, as it relates to decentralized finance or crypto, broad stroke, and the lack of regulation and response by regulators so far, does that present a similar situation? Are we risking increased financial risks and economic consequences by not taking a proactive approach to how we are addressing these products? They are already growing in use. We are seeing bitcoin emerging as a payment rail with the Lightning protocol. What are your thoughts in that regard?
Mr. Routledge: Thank you, Senator Deacon. I’m happy to talk about climate, but I think your question is more on digital money and crypto-currencies. I think it’s fair to say digital money forms are growing exponentially, so crypto-currency valuations are around $2 trillion of Canada’s economy — wasn’t that much five years ago. Stablecoins are about $170 billion. It’s growing at a rate that will be, if we meet again in a year, probably two or three times larger.
I think it’s fair to say that the growth rates of these innovations are very fast, and if we don’t as regulators turn and face those risks and begin to adapt to them, then the build up of unregulated financial system risk will continue. History teaches us that that doesn’t end well.
Now, fortunately, we are involved with the Financial Stability Board and the Basel Committee on Banking Supervision, and we can work with our international peers to help us. In some places, innovations are faster and further ahead than they are in Canada, so we can get hints and ideas from that partnership.
At the end of the day, if you look at these innovations, they have tremendous potential to add value for Canadians because they will remove the inefficiencies that exist within our traditional fiat money system.
Some enthusiasts are of the point of view or of the perspective that these forms of digital money and these innovations are a replacement to the fiat system. I don’t subscribe to that point of view, and I think that is a danger.
My overriding goal and aspiration is to ensure our regulatory system incorporates these innovations very quickly within the regulatory parameters and brings these innovators within the regulatory perimeter quickly. The challenge we have is it’s hard to get into the regulatory perimeter right now. We have to think about ways to widen that perimeter and lower the barriers in a way that doesn’t detract from financial resilience.
Senator C. Deacon: Thank you very much for your answer, superintendent.
[Translation]
Senator Bellemare: Welcome, Mr. Routledge. I have a somewhat naive question about crypto-currencies and Ukraine, specifically regarding Russia and the SWIFT financial system. This system was just cancelled for transactions in Russia. Do you think that, given the situation in Russia, there will be an attempt to mitigate the issue with bitcoin or other currencies in order to conduct transactions abroad? Is this a danger? Is it a possibility?
Mr. Routledge: Thank you for your question, which requires a great deal of technical language. I’ll answer the question better in English, if that’s okay.
Senator Bellemare: Yes, absolutely.
[English]
Mr. Routledge: Crypto-currencies, generally, are not as highly regulated as the fiat financial system; SWIFT would be an example. They are not entirely unregulated. I think it would be an exaggeration to say that the sanctions that the Western world and NATO are currently putting in place in response to the invasion of Ukraine by Russia could be easily circumvented by using crypto means.
Enough of the system has some form of regulatory oversight. If authorities take prudent and urgent action, I think they’d be able to attenuate a lot of it.
Having said that, if these technologies are set up the wrong way, they can go peer-to-peer and that peer-to-peer exchange of crypto-value or crypto-currency is harder for regulators to track. We’ll have to be quite vigilant to ensure the maximum effectiveness of the sanctions.
The Chair: We’ll just move on. We’ll come back if there’s an opportunity.
Senator Ringuette: I have a quick but important question in regard to our financial institutions.
You seem to be comfortable with regard to the fiat value, but are you as comfortable in regard to the risks that our financial institutions are taking with crypto-currency?
Mr. Routledge: Senator Ringuette, to a certain extent, I’m paid to worry all the time and to never be comfortable. That is the fundamental job of a superintendent, to always turn over every possible rock and look for risks that maybe others don’t see.
Having said that, the institutions that we supervise here in Canada that fall under the Office of the Superintendent of Financial Institutions’ regulatory purview have been quite diligent, prudent and measured in their response to these innovations. Therefore, we don’t see any significant risk building within Canada or within our financial institutions.
Later this year, we’ll put out draft guidance on how to risk rate crypto-currencies based on what we’ve seen from the Basel Committee on Banking Supervision. That will be timely. It will not be too late.
The fortunate thing is we do have a well capitalized, profitable system, and the largest players have very valuable franchises to protect. They tend to act first with an eye toward preserving those franchises and take more measured risks. There’s always the exception, and we’re always on the lookout for it, but that’s generally true.
The Chair: Can you give us some idea when you might put that advice out? You said later this year.
Mr. Routledge: Probably in the fall.
The Chair: In the fall. Thank you.
Senator Loffreda: Thank you, superintendent, for being here. From my years in the banking industry, I do know our banks are very disciplined and they rigorously monitor their loan portfolios, asset portfolios and their diversification.
Given the current housing market, do you see any additional risks? From a regulatory perspective, are you satisfied with the status quo? We talk about the housing market. There’s a major supply issue. Interest rates have increased, and that was part of the cause of this affordability crisis or targeted tax policies. How would you rank them? What’s most important, and is there any other area you would look into to make the housing market more affordable for most Canadians?
Mr. Routledge: I’ve talked about this a few times in the past. In terms of the overall credit quality of the housing finance market in Canada, so the credit quality of mortgages, it’s as strong as it’s ever been. There are about 5 million mortgages outstanding with the largest banks, and about 8,400 of them are in delinquency status. That’s an extraordinarily low number.
The reason why credit quality is so strong is that — certainly, house prices have been going up for a long time, I don’t mean to dismiss that — over the last decade, we’ve put in place a number of measures designed to improve the quality of mortgages.
The stress test is a notable one that people talk about a lot. In 2012, we also put in place a long set of underwriting guidelines we expect banks to adhere to. This is the blocking and tackling of underwriting between proper property valuations and proper income checks, et cetera. We’ve generally required higher down payments and shorter amortization periods over the last decade. All of that is producing unusually strong credit quality — at least by historic standards — so I don’t worry about credit quality.
I do worry about the structural mismatch between supply and demand in Canadian housing. We have new Canadians arriving and young Canadians leaving home and creating households, with about 250,000 households being formed every year in Canada. However, we’re probably completing 200,000 to 210,000 houses every year. That is a structural mismatch that adds to price acceleration, which can produce sudden price changes that can then lead to negative equity, which is a very hard burden for folks to bear.
It also makes it harder for younger Canadians to get in. That’s why I’ve said the biggest prudential risk in the Canadian housing system is this mismatch in supply and demand. It also, by the way, is the kindling for the speculative aggressiveness that we see in the housing market today. Speculators know that there’s a shortage of housing. It means they will be more likely to take risks to buy and flip homes. That’s the biggest prudential risk I worry about.
I don’t worry about that risk metastasizing into a crisis that harms the capitalization or resilience of the financial system. I think what we’ve done over the last decade will mitigate against that coming to pass.
The Chair: Thank you very much.
Senator Marshall: Thank you, superintendent, for being here. I’m going to carry on with Senator Loffreda’s questions regarding housing.
Do you think that the increase in the interest rates announced today is going to cause any vulnerability in the housing market, or do you think that the buffers — I think you used the term buffers in your opening remarks — are rigorous enough to withstand what we see in future rate increases?
Mr. Routledge: I’m going to answer yes to that, but let me give you more than just a yes.
I’m quite confident that the system will absorb rising interest rates. The buffer we talk about, in this case, is the minimum qualifying rate for mortgages, so insured mortgages and uninsured mortgages. That is a basic algorithm or formula: It says take your contracted rate and add 200 basis points to it, and then compare it to 5.25%. Then, take the greater of those two. That’s the rate the banks will qualify mortgagors on and against their income when they go in to obtain a mortgage from a financial institution.
Canadians who have bought homes in the last four years — and that’s the cohort of homeowners and mortgagors that you’d be most worried about, the people who’ve bought homes most recently with credit — have been qualified at a rate of at least 200, and for many 300, basis points or 3 percentage points above their contracted rate. As rates go up, they should have the income to absorb that. I don’t look at the rising interest rate environment as material credit risk. I worry about rising rates in the context of higher-than-normal inflation and how that might impact consumption over the long term. Again, the system has the resilience to absorb those strains.
Senator Marshall: Where does your area of responsibility end? Is it with the financial institutions? I’m looking at government as a whole — CMHC plus the Department of Finance — and I know that the federal government is in for billions of dollars in the housing market, with mortgage insurance and other things.
Are you just concerned with the banks? They will be looking to the federal government to pick up the pieces if anything happens. What’s your area of responsibility?
Mr. Routledge: Senator, by that do you mean you’re concerned about mortgage insurance backed by the government ultimately?
Senator Marshall: Yes. You say the housing sector is strong. What if there is a crisis, something happens? It’s like dominoes, and at the bottom of the heap is the federal government. They’re the ones that are going to have to pick up the pieces, CMHC and the federal government. That’s where my concern lies.
Is that within your area of responsibility or are you saying the banks will be strong and never mind what happens with the federal government?
Mr. Routledge: In part because of the federal government’s risk exposure, which is what you’re talking about, in 2012, as part of a broader decade-long trend to improve underwriting in Canadian residential mortgages, we introduced something called B-20 or guideline for residential mortgage underwriting. Our responsibility directly is, at the institution level, to apply that guideline and the expectations therein to every institution in the federal sector that lends money to Canadians to buy homes.
That guideline will set expectations around how to do income checks, how to do property valuations. Those are the blocking and tackling, the operational things that, for example, in the United States in 2005, 2006 and 2007, banks missed. Our responsibility is to make sure they don’t miss it. We do annual reviews, and they have to prove themselves before these expectations.
The CMHC and private mortgage insurers do provide mortgage insurance to the banks to absorb losses on defaults of homes with down payments less than 20%.
Most of the capital and funds to absorb defaulted mortgages will come from the premiums that the mortgagors pay into those institutions. It won’t come from the federal government. CMHC and its two private sector peers have strong capital right now. That capital will be there to absorb losses, not necessarily the taxpayer.
However, the exposure for the federal government is not small. I’d have to get you the number — I’m drawing a blank on it — but it has been declining for about the last decade.
After the government put in the million‑dollar cap for insured mortgages and house prices in Toronto and Vancouver in particular rose above that, the share of mortgage insurance has fallen quite significantly over the last decade.
The Chair: It would be great if you could get us that number on exposure.
[Translation]
Senator Gignac: Given that this is my first chance to see the superintendent since his appointment, I want to congratulate him. Canadians are fortunate to have someone with his skill level and experience in the Department of Finance and the private sector. He knows a great deal about the situation in the financial market. I’ll ask my question in French.
[English]
Feel free to answer in English if you want.
[Translation]
This occurs when lenders combine mortgages with lines of credit. Yes, you have macro-prudential measures when it’s time to lend. However, across Canada, especially in the larger cities where the market is hotter, I’m seeing housing prices rise significantly. Homeowners are using this opportunity to have their homes reassessed in order to obtain a higher line of credit.
[English]
This is the issue of the HELOC with the mortgage.
[Translation]
Do you plan to look at this issue more closely? It seems that 80% is good protection. However, when we see real estate bubbles in certain cities, we can conclude that the protection may not be as strong as we think.
[English]
Mr. Routledge: Thank you, Senator Gignac. We are looking at this very closely. The mortgage product that enables that kind of investment behaviour is something called a combined mortgage and HELOC product. That’s a product where you buy a home, and you begin to pay down your mortgage through a normal 25-year or 30-year amortization. As you pay down principal through a HELOC product that’s part of that combined mortgage-HELOC instrument, you can take back the principal paid down and therefore keep your loan to value ratios closer to 80 than a normal amortization would allow.
That’s a fragility in the system that we worry about, and we’ve made some public comments on it. We’re working with the financial institutions to understand that product and attenuate that behaviour. You’ll hear more about that from us throughout the course of the year. There’s a consultation going on right now.
It’s important and interesting to note that although the credit availability for HELOCs is generally rising, Canadians aren’t using it. One of the interesting outcomes from the stimulus and the sudden return to growth of the economy post-pandemic or immediately after the arrival of the pandemic is this wave of savings.
I’m not saying an individual Canadian isn’t capitalizing on the leverage in that product. I’m saying if you look at it in aggregate, Canadians are actually saving more and they’re not capitalizing on their rising HELOC balances. That can change in a minute. We’re doing what we’re doing because of that, but it is not a flashing-red risk at the moment.
[Translation]
Senator Gignac: In the United States, the home equity lines of credit were a big issue.
[English]
People use that as an ATM. I’m surprised by the pattern that we see in Canada contrary to the U.S. 10 years ago.
The Chair: That is a good point.
Senator Massicotte: Thank you for being with us this evening.
I want to go back to the crypto-currency and this whole risk aspect. We all agree there’s a lot we don’t know, so we’re assuming there’s a higher level of risk. That concerns us.
Give me the big picture. We can always eliminate that risk by saying we don’t permit it. Give me the big picture view. What is it that we gain if we assume this risk? Do we have any sense of our numbers relative to the risk and the potential cost of allowing this form of currency? Could you help me out there? Everybody says there is a big benefit. Obviously, it would increase competitiveness of our financial system, but is that what we’re talking about or is there something else of significance that we must compete and gain right away?
Mr. Routledge: That is a great question. Bear in mind that crypto or digital money means different things to different people.
The cool innovation in crypto is — there are many cool innovations in crypto that could add value — it offers a means of transacting that is also lest onerous. Through distributed ledger technology and crypto-algorithms, you can transact value more easily than through a standard financial system.
As well, crypto creates an asset that people value that has scarcity value. It adds to a portfolio of assets that investors could hold. You or I might not understand why someone would pay $38,000 for a bitcoin token, but the point is someone will. They do put genuine value associated with that. It has an accepted value.
That adds another asset class for store value. If well regulated, both in terms of financial systems and consumer protection, it can add value to the system in that way, by adding diversification benefits.
Stablecoins, again brought into the regulatory perimeter, could be an avenue for innovators to come in and challenge our established financial institution.
Former Governor Poloz mentioned that banking wasn’t very competitive. Stablecoins would offer a way for innovators that may not have the geographic branch network of a large Canadian bank to innovate through online strategies and take on the Canadian banks and compete and draw down prices with different banking products. That’s why it’s worth embracing the innovation as an opportunity to bring value into the Canadian financial system.
The key thing is to bring it within the Canadian financial system; don’t let it build up outside. That, to me, is the risk. If it continues to operate as an alternative, then the probability that risk that is difficult or painful to unwind rises.
Senator Woo: Superintendent, I hope we take the last two sentences of yours and underline them and make them one of the highlights of our session tonight. It’s a really important point.
I want to ask you about the debt crisis that is already taking place now in emerging markets. There is principally a sovereign debt crisis in a number of developing countries, in Africa, Latin America and parts of Asia as well. You know the story. COVID borrowing, coupled with the unwinding of quantitative easing and now a spike in oil prices, another oil shock. I’m sure you thought about this. But is there any worry about spillover effects into Canada narrowly and North America more broadly? What are your thoughts?
Mr. Routledge: I have a number of thoughts. One, you should always be worried about spillover effects of debt crises anywhere in the world, significant debt crisis anywhere in the world, particularly now because capital markets are so integrated. Our pension funds, our mutual funds, our exchange-rated funds — some of them, not all of them — do have positions in emerging markets, significant ones, and those funds could suffer losses which would then flow through to Canadians.
Second, there is the confidence channel. If something is going wrong in one country and it goes to another, it could hit Canada. That particular risk is lower today than it was 15 years ago because of all the capital buffers we have built up in Canada in our financial institutions. I would say we have added about 2.5 to 3 times the capital we had in 2007 to our system. It’s important to note globally that the financial institutions and banks have added the same degree — in fact, more — because they weren’t as well capitalized as Canadian banks in 2007.
So why is that important? Let’s say Canada doesn’t have a very high exposure to a particular emerging market that is having trouble, but one of the banks that Canada trades with does have pretty sizable exposure. Two degrees of separation and all of a sudden the Canadian bank could have a problem. The key thing to remember is that there are buffers in the system globally that weren’t there before. That’s why the international forums we participate in are so important because they have been a mechanism for sound Canadian banking principles to become contagious and spread to other countries.
That’s my answer.
Senator Woo: That is a good contagion as opposed to a bad contagion.
Mr. Routledge: Exactly.
The Chair: Can I follow up on that briefly? The finance minister said today that we should be prepared for a blowback from the imposition of sanctions, and that is coming with some of the other things you have mentioned — inflation, interest rates, sticker shock and debt and all of these things. The Organisation for Economic Co-Operation and Development is saying that economic growth in Canada is expected to be dead last among developed nations.
Do you see that we’re headed into a greater period of risk — that stuff that you’re paid to worry about?
Mr. Routledge: I want to give you two answers. One, I have operated on the principle that to the prior guest’s great book, uncertainty is the new normal. We’ll have recurring and more frequent bouts of volatility and Canada will be resilient to that volatility. However, what has happened in Europe is the first time since 1939 that one sovereign European state has invaded another. So to say that the risk environment is the same, it would be folly. It has gotten more intense in the last week. We have to be more on guard for it.
The risks that we have been focused on over the last week or so, I would put them in three immediate categories. There will be others to come. But the three are: market risk, so prices fall and our banks get hurt by that or our insurance companies get hurt by that; liquidity risk, markets seize up and transactions don’t flow; and then cyber risk. The good news is the market and liquidity risk has largely been more muted than we thought. Now we have to be careful, and we have to be mindful of that. That can change, but so far we have been pleasantly surprised that market and liquidity risk impacts have been more muted.
Cyber risk. There are reports of more cyber activity, more cyber attacks that institutions across the world, including Canadian institutions, are halting or stopping. But if you ask me what is the risk that keeps me up at night associated with what is going on in Europe, it is cyber risk. The good news is just about every board and CEO in our system would certainly tell you the exact same thing. Our cyber defences are better than they were a year ago and so far so good.
Senator Yussuff: Thank you for being here. At the beginning of the pandemic, there was a huge worry that pension fund solvency was going to be exaggerated in terms of where we might end up with the pandemic. I haven’t checked most recently to see what the solvency ratio is. Maybe you could tell me where it’s at because it’s such an important part of the transaction on a day-to-day basis. So I’m hoping it’s healthy, but I haven’t checked myself.
Mr. Routledge: Just to be clear, we regulate private pension plans.
Senator Yussuff: Yes.
Mr. Routledge: I’ll get you the quantitative numbers because I don’t have them at my fingertips.
What happened during the pandemic is a sudden shock in asset prices that would cause you to worry about pension funds from a solvency perspective but then a sudden bounce back. In fact, asset prices are well above where we were pre-pandemic. Interest rates are rising, and that’s also good for pension funds. So solvency is stronger than it has been for quite some time.
There are the occasional private pension plans we worry about, but that number is at cyclical lows. Again, when asset prices rise like they have over the last few years, the pension plans that hold those assets tend to see their solvency conditions improve. Senator, I can get you the numbers. I just don’t have them at my fingertips.
The Chair: You can send those along later. That would be fine.
I’m changing topics, but not really because it’s about risk.
I want to ask about the sanctions that we saw imposed — it’s not quite the right word — during the Emergencies Act where financial institutions were required to monitor, perhaps even freeze, assets. It seemed to come with such speed and a lot of the institutions weren’t sure what they were supposed to do.
First, is there a system in place? Second, does that system work when unrolling it so quickly? The other side of that is the sanctions against Russia and perhaps freezing assets of Russian oligarchs or businesses that operate in Canada. We have lots of big operations. How do you associate risk with that? Do we have a proper system in place to follow those instructions that come from governments and emergency acts?
Mr. Routledge: Senator, you’re correct that the restrictions put in place during the period of time the Emergencies Act was in force was very short. The actual number of accounts affected was very low — in the dozens. I would preface this answer by saying I encourage you to talk to the head of the Financial Transactions and Reports Analysis Centre of Canada, or FINTRAC, Sarah Paquet, who was directly involved in this. However, my understanding, from the institutions we talked to, it was a relatively short and manageable process to work through with the government.
Most importantly for us, it didn’t really result in any material impact on banks’ liquidity or funding. It was, to be quite plain-spoken, a non-event from an OSFI perspective where we worry about liquidity of the financial institutions.
The Chair: I didn’t really think about the amounts. It was more the system. Is there a system in place to do that?
Mr. Routledge: My understanding is that the banks had to innovate on the fly, but it wasn’t an enormous operational challenge; it was a manageable operational challenge. Again, I think Ms. Paquet or some of the bank executives could probably go further.
The Chair: And on the other side, when it comes to external activities like freezing the accounts of businesses functioning in Canada?
Mr. Routledge: Canadian financial institutions don’t have very significant or even more than de minimis Russian counterparts. They simply don’t do business with businesses and individuals from Russia in great numbers, even those institutions with European or American platforms.
They do business with banks which do business with banks who do business with Russians, but that’s not generally something you have to worry about. There are some minor things that the institutions will work through — minor in the sense of not very sizable exposures or relationships — over the next days and weeks. Like with the Emergencies Act, the problem is so small that, operationally, I don’t anticipate it being a challenge.
The Chair: Great. Thank you for that.
Senator C. Deacon: Thank you again, superintendent. It’s so nice to have you worrying on behalf of 38 million Canadians, and you do it so well.
I just want to go back to the decentralized finance and crypto world as such and ask you about the process of bringing entities in that sphere under the umbrella or into the tent of regulation. The propensity of Canadian regulators, in the past — the OECD ranks us as best in the OECD in putting in place command-and-control regulations. Those are the sorts of regulations that eliminate opportunities for innovation because they say how you must do something versus what you must accomplish.
How do you see yourself managing that? Because it is a problem in Canada. We sort of tend to define out innovation by how we regulate in too many sectors. How do you see managing this process? It’s a delicate one because we don’t want to get rid of innovation. We want to benefit from innovation and have Canadians benefit from innovation, but we do want to make sure that we continue to protect our system from risks that might keep you up at night on behalf of Canadians.
Mr. Routledge: With respect to the financial system, if you look at the last 25 years of our history in the Canadian financial system, you’ll see a revealed risk preference. The revealed risk preference is we prefer innovation to flow through incumbents who are well capitalized and profitable, as opposed to new entrants, because new entrants introduce the risk of failure into the system.
To give you an example, since the financial crisis of 2008-09, there were 489 U.S. banks that failed, according to the Federal Deposit Insurance Corporation, or FDIC. In the same time period for Canada — zero. That’s a revealed risk preference.
Up to this point, that was the right decision, demonstrably. Canada does have the world’s soundest financial system in part because of that risk preference.
The intensity of innovation has risen to a level where we would do well to consider that risk preference and consider whether a bit more innovation from non-traditional players might add more value to the system than it would remove if ten showed up and five succeeded and five failed. That’s the risk preference we have to talk through.
I’m not here to make that decision. That’s a decision made by the government, principally through the Department of Finance, but I think that’s the question we begin to ask. Where are we in our system? Do we have the resilience now built into the system that gives us the opportunity to bring more innovation from non-traditional players? That’s a good question to start talking about.
Senator C. Deacon: Thank you very much, superintendent. Great insights.
Mr. Routledge: Thank you, senator.
Senator Gignac: Superintendent, let’s talk more about pension funds. Pension funds, private and public, represent more than 150% of GDP in Canada. It’s more than the U.S., more than Europe, more than Japan. Canada is number one in the G7. In fact, we are ranked number three by OECD on importance of GDP pension funds. Very important.
OSFI has some oversight on the private pension plans, but they have a limited role, I think, on oversight on the public and private pension assets or management.
Here is my question: Using March and April 2020 as an experience, when we had a problem of liquidity, it was the same as the financial crisis in 2009-10. Pension funds suddenly have liquid assets. They worked a little bit behind the scenes, as you know, with the Bank of Canada because they have a problem of liquidity but were not really regulated.
Since we have already had two experiences in the last 15 years, is it time to have, let’s say, a minimum of oversight on the public and private pension funds? Because when things turn wrong, it seems that the Bank of Canada and Canadians are backstopped to these pension funds.
Mr. Routledge: Just to clarify, we look at principally the solvency state of private pension plans. We won’t look at, for example, the public pension plan, the CPP. I should mention that our chief actuary does do actuarial analysis every year and does a triennial review every three years on the solvency of the CPP. Generally, we don’t regulate it.
Senator Gignac: Let me interrupt you. Solvency is one issue, but stress testing is another issue. Banks have stress tests; insurance companies have stress tests; but there are no stress tests for what happens to the management or the portfolios if suddenly the stock market declines by 30% in 10 days, for example. Correct me if I’m wrong; I think we have no stress tests regarding pension funds.
Mr. Routledge: As part of our supervisory process, we will ask the private pension plans that we regulate to conduct those types of tests, but it’s not as invasive, honestly, as what we do with the banks and insurance companies. Certainly, that is something we could look at, and it might be wise to look at it.
The other risk I’m hearing in what you said is the systemic risk that comes from a market shock and how that might impact pension funds and how their liquidity issues, in those scenarios, might lead to asset-value destruction. That’s a systemic issue, and that is not in OSFI’s purview. I do know that the Bank of Canada, through its market support activities, is thinking about that issue. I encourage you to bring some folks in from the Bank of Canada to talk that through. It’s an important issue, though.
Senator Gignac: Thank you.
Senator Yussuff: Briefly, to pick up on Senator Gignac’s point, just from knowledge of the last financial crisis, the Canada Pension Plan was one of four major pension plans around the world that fared extremely well when we look at the shocks that our pension plans were struggling with. The data was quite amazing on how diversified the fund was and, more importantly, how it was able to perform and withstand huge shocks from which many pension plans took a long time to recover. I am stating that for my own edification, but it was something that I was deeply involved with at the time.
Mr. Routledge: Thank you. Empirically, I would agree with that characterization. They did very well on a relative basis certainly.
The Chair: As we wrap up here, Mr. Routledge, I want to ask this general question. The banks are often criticized for not taking enough risk when it comes to supporting Canadian business, particularly small and fledgling and young businesses and all of that. Do you see that? Is there something about the oversight process with which you’re involved that you think makes them play too safe?
Mr. Routledge: Empirically on the numbers, the loss ratios on commercial loans, particularly smaller commercial loans, tend to be higher than other parts of their loan portfolio, so it tells me the banks are taking some risk. Not directly. Indirectly, our job is to make sure institutions are well capitalized so they survive the ups and downs. That means we ask banks to judge the risk characteristics of prospective loans, set aside capital for them.
New start-up businesses, there is a track record you can look at. Banks will all have their historic track records and they risk rate on the basis of those track records, in part because we have expectations about how they do that. When they do that, that means when loans attract higher capital allocations, banks charge for that. The interest rates go up and that, de facto, makes it harder for smaller businesses to get capital.
From our perspective — we see this with housing, we see this with all asset categories — our job is to make sure that banks operate through good and bad times and they are always there to serve Canadians. We ask for conservatism in the way banks underwrite lending, and sometimes that conservatism means it’s harder to get credit for businesses and for other Canadians. For example, they want to buy a home, are young and their incomes aren’t quite at the right level or savings aren’t at the right level relative to the price of a home. Our job is to be a bit of a resistor to excessive credit growth. It would be dishonest for me to answer it any differently.
The Chair: I really appreciate your frankness on that. It’s very true.
Senator Deacon, did you have a comment?
Senator C. Deacon: Superintendent, one last question in terms of bank share buybacks as an approach. Looking at the business investment climate of Canada and the opportunity for banks to be investing in Canada versus investing in themselves, what are your thoughts looking forward on that issue? I’ll leave on that note. Thank you, sir.
Mr. Routledge: The risk or issue you’re talking about is banks will buyback their own shares instead of using the capital to make more loans. The market convention that we’re quite happy with is the convention whereby banks won’t buy any more than 2% of their shares outstanding back in a particular year, and that will not retard credit growth at financial institutions. If they are buying back 10 or 15% regularly, quite honestly, it might. Because they have restrained themselves to that 2% figure, and we tend to favour that, we don’t see share buybacks really constraining credit.
Senator C. Deacon: Thank you very much.
The Chair: Mr. Routledge, thank you for your appearance here tonight and you sitting through the governor and listening to all that. We really appreciate your time and your thoughts on this because you have covered a lot of turf. Peter Routledge, Superintendent, Office of the Superintendent of Financial Institutions Canada. As Senator Gignac said, a very well‑qualified person in that office and we’re all appreciative.
Senators, that is our session for this evening, but I am going to ask you to stand by and we’re going to go into a very brief off‑the‑record session here. I’ll pause as we suspend for a moment.
(The committee continued in camera.)