Posted: 14 May 2020 5 min. read

Canadian banks weather the COVID storm, while the same cannot be said for manufacturing

The Bank of Canada published its semi-annual Financial System Review (FSR) today. The document assessed the impact of COVID-19 on the Canadian financial system and highlighted its potential vulnerabilities. The main message was that major Canadian banks should weather this economic crisis. The resilience is a by product of their strength prior to the downturn, with strong capital and liquidity buffers, a diversified portfolio of assets and a large share of mortgages insured by the government. The financial system is also being supported by sound monetary and fiscal policies deployed to ensure credit access, sufficient liquidity, and efficient price discovery. In my opinion, shoring up access to credit and increasing flexibility in settling financial obligations have been key in limiting the economic fallout and supporting consumer and business sentiment.  

The FSR highlighted the enormous income shock to households and businesses, the initial impairment of liquidity and the potential increase in credit risk, arguing that policy was aimed at tempering these risks. Implementation of income support and credit access, as well as easier monetary policy, both helped support households and nonfinancial businesses. On the other hand, liquidity facilities, asset purchases and regulatory changes addressed issues faced by financial firms in Canada. 

In one of the supplementary boxes, the bank outlined how lessons from the Great Depression were informing the current dramatic policy actions–worthwhile and relevant commentary. 

Although the FSR had a positive tone, the underlying narrative is that the Canadian economy will not avoid a deep recession and the significant economic and financial toll that comes with it. Already, we are seeing significant labour market dislocation that will reduce household income. Then, there is a risk of a housing market correction. This all comes at a time that households are heavily indebted. The bank noted that some 1-in-5 mortgage borrowers have just enough liquid assets to only cover two months of mortgage payments. While risk of default is being reduced by policy actions, the bank stresses “despite the deferrals and added borrowing, some households are likely to fall behind on their loan payments. This typically appears first in missed credit card payment and auto loan payments and later in mortgage payments.” Evidence of this is already apparent in Alberta and Saskatchewan, which is worth noting reflects not just the impact of COVID-19 but also the economic fallout from the energy shock. 

The FSR emphasizes that the loss of revenues caused by the recession and economic lockdown will make it difficult for many businesses to meet their financial obligations, including debt payments. The policy actions will reduce some of the financial strain, but the cash flow shock could lead some to insolvency. 

The bank applies the economic outlook outlined in their last Monetary Policy Report to assess the financial vulnerabilities. The highlights are that mortgage arrears could, by mid-2021, rise to as much as 0.80 percent from their current level of 0.27 percent. Arrears should decline thereafter, but remain elevated near 0.40 percent in the post-COVID-19 environment.

Non-performing business loans are projected to rise from around 1 percent to above 6 percent late this year, before gradually trending lower over the next two years. 

Importantly, charted bank capital buffers are adequate to absorb the projected losses under such financial assumptions

In other news, weak demand and COVID-19 related shutdowns caused manufacturing sales to plunge by more than 9.2 percent in March. Excluding price effects, the volume of manufacturing shipments dropped by 8.3 percent. Sales were down in 17 of 21 industries, particularly in transportation equipment and petroleum and coal products. Manufacturing sales were up in food, paper, and beverages, as households hoarded groceries and toilet paper while turning to drinks to lift spirits. 

The Statistics Canada survey revealed that 78 percent of manufacturing firms were impacted by COVID-19. Issues related to supply chain shutdowns of physical distancing requirements were reported by most furniture and transportation equipment manufacturers. Moreover, seven out of eight firms in the printing industry reported lower demand due to the closure of restaurants, schools and sporting events.

Sales in the transportation equipment industry fell by a whopping 27 percent during the month. The largest declines were in the automotive sector. During the last two weeks of March, all Canadian assembly plants and several motor vehicle parts suppliers in North America lowered production, foretelling even more weakness in next manufacturing sales report for April. 

Sales declined for the third consecutive month in the petroleum and coal product industry, falling by nearly one-third. The large drop reflected both reduced prices and quantities, as drivers drastically reduced their travel amidst a decline in prices.

The report was largely in line with our expectations, and is factored into our base case view of declines to the tune of 10 and 40 percent (annualized) in the first and second quarter, respectively, with the economy beginning to claw back lost activity thereafter. 

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A regularly updated snapshot by Deloitte Economics that provides commentary from Chief Economist, Craig Alexander on the latest developments shaping Canadian and international economies including, economic growth, business investment, trade, and market activity. Deloitte analysis gives you the knowledge to tackle the most challenging business issues of today.

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