OSFI casts a watchful eye on risks associated with a prolonged, uneven global financial recovery

Canada’s solvency regulator, the Office of the Superintendent of Financial Institutions (OSFI), is casting a watchful eye on the interconnected financial risks associated with a prolonged global economic recovery.
In response, the regulator has made it a priority to address capital requirements associated with a weak global economic recovery. In its Plan and Priorities for 2011-2014, posted on its Web site, OSFI said one of its priorities is to “improve the risk sensitivity of the Minimum Continuing Capital and Surplus Requirement (MCCSR) and the Minimum Capital Test (MCT), as well as to incorporate changes due to IFRS, while maintaining the integrity of the existing capital tests.”
OSFI stressed the importance of capital testing in light of the prolonged, uneven and uncertain financial recovery after the 2008-09 global recession.
“Although the global financial system continues to recover gradually from the significant dislocations experienced in recent years, downside risks remain,” OSFI says in its Plan and Priorities document.
“With the global economic recovery expected to be prolonged, the process of repairing the international financial sector is likely to be protracted, and achieving a sustainable fiscal position will pose a significant challenge for several countries.”
These challenges include “intensified” sovereign debt concerns in several countries, which potentially could lead to wider turmoil in the international financial system.
“As well, with weaker growth, interest rates may remain at relatively low levels for a period, potentially creating additional sources of vulnerability in the financial system over time,” OSFI noted. This could lead to “the potential for excessive risk-taking behaviour arising from a prolonged period of low interest rates in some advanced economies.”
Tension in currency markets is also an issue, since some countries are recovering more quickly from the global recession than others. This may lead to price adjustments, said OSFI.
“A feature of the recent recovery is the uneven nature of economic activity across major economic regions, with modest, relatively slow recovery in many advanced economies, particularly in comparison to more rapid recovery in emerging-market economies,” OSFI noted. “The global environment is also associated with large current account imbalances.
“After narrowing during the recession, these imbalances have widened again with the recovery, leading to tensions in currency markets and increasing the risk of a disorderly adjustment. More generally, these factors imply corresponding relative price adjustments, such as (but not limited to) exchange rate adjustments, which the global economy will need to work through.”