Whose Banks Are Riskiest: A Surprising Answer From The BIS

When one thinks of unstable, risky banking systems, the first thing that comes to mind are visions of insolvent, state-backed building - with or without long ATM lines - in China, Greece, Italy or, in recent times, Germany. However, according to the most recent report by the Bank for International Settlements, the country with the riskiest banking system is neither of these, and is a rather "unusual suspect."

As part of its latest quarterly report, the BIS looked at highlights of global financial flows, and found that after a modest slowdown in 2015, growth in both claims and international denominated debt securities resumed its rise in 2016, leaving banks even more exposed as counterparties to international issuers, especially should the world hit another "Dollar margin call" situation, where borrowers are unable to make payments on their obligations due to a surge in the global reserve currency.

However, cross-border international debt flows is just one aspect of bank riskiness. As part of a separate excercise profiling the domestic banking systems of some of the most prominent Developed and Emerging nations, the BIS looked at four distinct "risk" or crisis early warning indicators: i) Credit-to-GDP gap, or the difference in the current ratio from the long-run trend; ii) Property Price Gap, or the deviation of real residential property prices from their long-run trend, iii) Debt Service Ratio (DSR), which also is the deviation in the current DSR from the long-run average, and finally iv) DSR assuming a 2.50% increase in interest rates.

What it found is that the early warning indicators for financial crises continue to signal vulnerabilities in several jurisdictions. Here is what it found:

relative to previous readings, the set of countries showing large and positive credit-to-GDP gaps remained the same (first column). The credit gap for China remained high at 26.3% of GDP, well above the threshold of 10%.9 Canada, as well as a group of Asian countries, saw increases in the credit gap since September 2016. The size of the property price gap (second column) remains in line with historical trends in many jurisdictions, with the exception of Canada, Germany, Greece, Japan, Portugal and a group of central and eastern European countries, for which the gaps remain relatively large. However, a high reading need not indicate accelerating price growth - for Greece, Japan and Portugal, the high property price gap does not necessarily indicate vulnerabilities, as it is driven by property price growth returning to normal levels after long periods of decline.


The last two columns of Table 1 present two alternative measures of debt service ratios, which aim to capture aggregate principal and interest payments in relation to income for the total private non-financial sector. For most countries, debt service ratios stand at manageable levels under the assumption of no change in interest rates (third column). Under more stressed conditions - a 250 basis point increase in rates - and assuming 100% pass-through, the numbers point to potential risks in Canada, China and Turkey (fourth column). However, the figures are meant to be only indicative, and are not the outcome of a proper stress test: a rise in rates would take time to translate into higher debt service. The degree of pass-through depends on the share of debt at floating rates, debt maturities and possible changes in borrowing behaviour.

The table below summarizes the early warning indicators for domestic banking risks produced by the BIS, with data up to Q3 2016 for most countries.  But what is most surprising is which country has triggered 3 of the four "financial crisis early earning indicators", and is on the verge of tripping the fourth one as well: as we said above it's neither China, nor Greece, nor Italy or Germany, but, drumroll, Canada.

Regular readers are well-aware that Canada is very touchy when anyone suggests that its banks may not be... in pristine shape. Good luck brushing it off, however, when the source is none other than the central banks' central bank.

Source: BIS