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Eurozone Crisis a Threat to Canadian Banks: BOC .

Although Canada’s economy has received a slight hit from the turbulence that continues to swirl overseas, Mark Carney warns that the damage could be much more substantial if European leaders do not contain the crisis.

“The possibility that these sovereign strains could intensify remains the most important risk to Canadian financial stability in the near term. This risk is very high and has risen since June. So far, spillovers from the European financial turmoil to the Canadian financial system have been limited, because of the relative strength of Canada’s businesses and financial sector, the low direct exposures of domestic banks to the most vulnerable sovereigns, and Canada’s modest trade links with the euro area.

Nonetheless, the risk is very high that a further escalation of tensions in the euro area could adversely affect domestic financial stability, particularly through a general retrenchment from risk-taking, funding pressures and confidence effects.”

Although Canadian banks are not overly exposed to the trouble in the Eurozone economies, it does not mean that they are immune either, as the Bank of Canada pointed out in its’ December Financial system review. The BOC says that, in an export driven economy like ours, links exist. For instance, we trade closely with the US- and the US is far more vulnerable to the trouble that continues to build and threaten global economic stability. By association then, Canada is still at risk.

The BOC raises concern about confidence, both from a market and from consumer levels, simply because of the lack of speed and decisiveness of action on behalf of the European leaders to contain the crisis. Several countries, including Greece, have had ample opportunity to turn the tide, but Eurozone leaders for the most part, remain inexplicably complacent.

The BOC suggests that, while steps taken on Oct 26 are welcome, but may be a case of too little, too late, at least in terms of building back confidence.

“While these measures are steps in the right direction, and elicited a favourable initial market response, doubts have quickly resurfaced. The credibility of the package was undermined in particular by uncertainties surrounding the “voluntary” writedown of Greek debt, concerns over the procyclical effect of the deleveraging resulting from the bank recapitalization scheme and disagreements regarding possible methods of expanding the lending capacity of the EFSF. Tensions have thus continued to intensify in government debt markets for some of the region’s larger economies, especially Italy and Spain.”

The longer this goes on too, the greater the threat to the Canadian banking system, Carney warns.

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