article review on financial institutions in ethiopia

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10 Ethiopian Financial Sector Development

Yohannes Ayalew Birru, PhD, is the vice governor and chief economist of Ethiopia’s central bank (National Bank of Ethiopia). He is a member of the board of directors of the National Bank of Ethiopia and chairman of the African Trade Insurance (ATI), among other responsibilities. He has over twenty-eight years of cumulative experience in the areas of finance, monetary policy, and economic growth. He holds a PhD in economics from the University of Sussex.

• Published: 11 February 2019
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Financial sector development has played a key role in Ethiopia’s economic development, particularly since the launching of the first Five-year Growth and Transformation Plan in 2010. The gradualist approach that Ethiopia followed in reforming its financial sector seems to have borne fruit as no single commercial bank has gone bust so far, unlike the case in neighbouring countries. Though Ethiopia’s financial sector growth was following output growth in the first two phases, government has started to play a key role in accelerating the sector’s growth through active interventions, such as encouraging branch expansion, and introduction of new financial instruments such as the Grand Ethiopian Renaissance Dam Bond, a housing saving scheme, and the private pension fund. Consequently, the number of bank branches expanded from 681 to 4,257 between 2010 and 2017 while the deposit-to-GDP ratio went up from 25.9 per cent to 31.4 per cent in the same period.

10.1 Introduction

Ethiopia has become one of the few countries in Africa that has built resilience to both internal and external headwinds and has been able to sustain a high-growth high-investment scenario. Even after the 2013 international commodity prices collapse and the 2016 drought, the country managed to sustain economic growth at near pre-commodity-price-collapse levels despite experiencing unprecedented declines in almost all prices of its major export goods and a major drought that affected about 14 million people nationwide (IMF 2017 ). Such resilience could partly be attributable to the financial sector, which played a key role in making the country’s transition to a high-investment high-growth trajectory possible, without letting the hard-won macroeconomic stability be sacrificed. 1 For instance, as investment demand surged from 24.3 per cent of GDP in 2003 to 39.0 per cent in 2017, domestic banks expanded total outstanding credit as a percentage of GDP from 20.8 to 31.0 per cent in the same period, which was largely financed by deposits mobilization. Banks managed to expand their deposit mobilization capacity from 27.8 per cent of GDP in 2003 to 31.4 per cent in 2017.

Nonetheless, by the standards of East and South-east Asian countries during their heyday of growth, Ethiopia lags behind in terms of financial deepening and addressing the challenges of domestic savings mobilization. For instance, between 1970 and 1984, Malaysia managed to increase its M2/GDP ratio from 40.9 per cent to 102.1 per cent and its savings-to-GDP ratio from 26.9 per cent to 32.6 per cent, while in South Korea, domestic savings surged from 16.6 per cent in 1970 to 33.1 per cent in 1984. On the other hand, Ethiopia suffered from demonetization between 2004 and 2010, as commercial banks continued to shed non-performing loans that were mounting up in the pre-2003 period and the tight monetary policy pursued between 2006 and 2008 following the international food price crises. As a result, the broad money-to-GDP ratio declined by more than 12 percentage points in just six years, between 2004 and 2009, from 37.5 per cent to 25.4 per cent. During this period, the domestic savings-to-GDP ratio remained at its lowest level, hovering around 9 per cent on average. The trend was reversed with the launching of the first Growth and Transformation Plan (2011–15) in 2011 and the government started to play an active role in financial sector development. Consequently, the broad money-to-GDP ratio and domestic savings-to-GDP ratio surged to 31.4 per cent and 24.1 per cent in 2017, respectively.

Performance in the Eastern Africa region has been mixed. Kenya, which managed to increase its broad money-to-GDP ratio from 38.2 per cent in 2002 to 42.2 per cent in 2017, failed to translate its achievement in financial deepening into domestic savings, unlike its East Asian counterparts. Kenya’s gross domestic savings-to-GDP ratio remained one of the lowest in the region, hovering around 8 per cent in the last twenty years, between 1996 and 2016. In contrast, Tanzania registered significant improvements both in financial deepening and in translating the latter into domestic savings. Between 2000 and 2015, the broad money-to-GDP ratio increased from 17.1 per cent to 24.3 per cent while the gross domestic savings-to-GDP ratio surged from 10.1 per cent to 23.2 per cent (World Bank 2017 ).

Against this background, this chapter analyses the recent development of the financial sector in Ethiopia, particularly the banking sector, and its contributions to macroeconomic stability and growth. The chapter focuses on the post-2003 period, the landmark year when Ethiopia embarked on a rapid economic growth trajectory. Section 10.2 presents a brief historical background of the financial sector, followed by an outline of the theoretical underpinning behind the Ethiopian financial sector reform strategy. Developments of the financial sector in the last twenty-six years since the initial reform in 1992 are explored in Sections 10.3 – 10.6 , which also present an analysis of the financial sector’s contribution to macroeconomic stability and economic growth. Section 10.7 offers conclusions.

10.2 Historical Background

Prior to 1992, the financial sector was part of a command economy system. Zeidy ( 1993 ) noted that monetary and exchange rate policies were relegated to secondary importance. The National Bank of Ethiopia directly determined the level and structure of the interest rate and exchange rate. Credits were allocated according to the central plan. The financial sector was closed to the private sector until 1994. Before the partial opening of the sector there were only three government banks, one commercial and two specialized banks—the Housing and Saving Bank and Agricultural and Industrial Bank of Ethiopia (now the Development Bank of Ethiopia). Outside the banking system, the financial sector included only one government-owned insurance company and a post office 2 until 1995.

Unlike most other sectors, after the overthrow of the Derg and the formation of the EPRDF-led transitional government in 1991, government adopted a gradual approach in the financial sector. The sector’s reform began with the streamlining of monetary and exchange rate policies. Between 1992 and 1995, the NBE took a series of measures reforming the interest rate policy. The Bank transited from a sector-by-sector discriminatory interest rate structure to setting only a minimum deposit rate and a maximum lending rate. In 1995 the cap on the lending rate was lifted, and the Bank began to set only the minimum deposit rate. As noted in Ayalew ( 1993 ), in the foreign exchange market, the birr was initially devalued from 2.07 to 5 birr per US$ in October 1992 to correct the exchange rate misalignment. Then, in a move to allow the market determination of the value of the birr, a wholesale auction system was introduced in May 1993 which served for the next five years until it was finally replaced by an interbank foreign exchange market in 1999. A harmonized system of import tariffs was introduced in 1993 (Ayalew 1993 ).

In a move to strengthen the private sector and invigorate the market system, the financial sector was opened to Ethiopian nationals in 1994 and the remaining restrictions on the current account of the balance of payments, such as ex ante import and export price controls and import quotas, were removed. Nonetheless, in line with its gradualist approach, the government keeps the capital account of the balance of payments closed and has restricted ownership in the financial sector to Ethiopian nationals, except in the case of investment in lease financing.

10.3 Gradual Financial Sector Reform Strategies and Policies

The Ethiopian government’s gradualist approach towards financial sector reform emanated from its beliefs that, first, in developing countries markets are subject to widespread failures because of underdevelopment and sometimes complete absence and, second, finance is only the means and not the end in economic development, so that government should do whatever it takes to make sure that the necessary finance is available for development projects or what are called priority sectors, such as public physical infrastructure, health, and education. The government’s thoughts about financial sector reform are clearly outlined in its industrial development strategy paper (Ethiopian Federal Democratic Republic 2001 ). The government has continued to resist mounting pressure from the International Monetary Fund and the World Bank to open up the financial sector to foreign competition. Even after more than twenty years of financial sector reform experience since 1995, and after a significant transformation in terms of assets, profitability, and prudence, 3 discussion about any form of financial sector liberalization 4 was still taboo in government circles, at least till mid-2018.

Although Ethiopia’s development strategy has unique features in terms of focus and details of implementation, which are designed to fit the country’s level of development and sophistication of the markets, it is clear that the strategy draws heavily on the East Asian developmental state experiences. For instance, the thought behind the gradual, managed, and limited liberalization of the capital account of the balance of payments and the resistance to opening up the financial sector to foreign investors draws on the East Asian countries’ development strategies and experiences, including those of China. First, these countries focused on industrial upgrading along with a pro-investment macroeconomic policy, which did not necessarily mean low inflation and which in many cases involved state interventions that ‘got prices wrong’ (Öniş 1991 ; Chang 2006 ; Rodrik 2004 ; Addison and Ndikumana 2001 ). Second, as Chang ( 2006 : 115) argues, the East Asian countries ‘were more open in the areas like trade, technology and debt, but less open to foreign direct investment, and almost completely closed in relation to the capital market’. They followed a gradual liberalization approach in opening the financial sector and the capital market (Chang 2006 ; Stiglitz 2008 ). In a contribution for the African Development Bank, Lee ( 2017 ) noted: ‘For an effective state activism or industrial policy, state ability for financial control was critical … In the Korean experience, the banking sector had always been expected to “serve” the real sectors by providing a stable supply of the so-called “growth money” at affordable rates, whereas manufacturing or production sectors had always been given priority.’ This was possible because of the establishment of development banks and because of the strong state control of commercial banks.

Moreover, rightly or wrongly, the aftermath of the 1997–8 East Asian crisis has also influenced Ethiopia’s very cautious approach.

10.4 Gradual Opening Up of the Financial Sector

There is also a rich history of theoretical and empirical debate on the role of finance in capitalism and in growth and development. The debates on whether finance leads economic growth or growth leads financial development are at least as old as the seminal papers of the two prominent economists Schumpeter ( 1911 ) and Robinson ( 1952 ). While Schumpeter argues for indiscriminate opening of the sector, Robinson ( 1952 ) argues for guided and gradual opening. Schumpeter ( 1911 ) claims that financial development is strongly associated with real per capita GDP growth, the rate and efficiency of physical capital accumulation. McKinnon and Shaw ( 1973 ) argue that repressing the monetary system by imposing restrictions on interest rates, heavy reserve requirements on bank deposits and compulsory credit allocations ‘fragments the domestic capital market with high adverse consequences for the quality and quantity of real capital accumulation’ (McKinnon 1989 : 206). A robust capital market requires an adequately liquid financial system and a stable monetary system (McKinnon 1989 ). Moreover, economists such as King and Levine ( 1993 ) argue that in a market economy, development of the financial sector determines the efficiency and proper functioning of the incentive system, 5 be it prices, interest rate, credit, or exchange rate. When the financial sector is stable and efficient, 6 economic actors gain confidence in government policies and the market, and investors are willing to take risks today trusting that the system is capable of rewarding their venture tomorrow, while, on the other hand, consumers are willing to postpone current consumption in favour of savings, fully relying on the system that they will be able to maximize consumption tomorrow. It is this coincidence of willingness of investors and consumers that enables an economy to achieve faster and sustainable economic growth, and the macro-economy to maintain a sustainable resource balance.

On the other hand, the Robinson camp argues that financial development follows economic growth. They argue that higher economic growth boosts the demand for financial services. Consequently, financial institutions and financial services expand in all dimensions, i.e. in type, quantity, and quality. Ang and McKibbin ( 2005 : 22) argue that ‘financial liberalization is unlikely to result in higher economic growth without an efficient and well-functioning financial system. To accelerate growth, the financial system must be properly shaped before undertaking any liberalization program.’ De Aghion ( 1999 ) and Öniş ( 1991 ) also contend that, in developing countries, markets are not ready to provide finance to long-term development projects, which calls for these countries’ governments to intervene in the market to ensure that there is adequate finance for industrial growth and that resources are directed to long-term projects by creating the necessary price distortion: the state has to ‘socialize’ the risk and high capital requirements of large-scale projects that may take years to generate returns, many of which are social rather than purely private returns. Therefore, unlike McKinnon and Shaw ( 1973 ), the Robinson camp favours a careful and phased approach towards financial liberalization. 7 According to the latter, the debate must not be whether to open or not to open. Rather, when to open and which necessary conditions must be fulfilled before resorting to full liberalization of the sector.

A further set of arguments have emphasized the inherent instability of financial markets and the tendency for financial innovation to outstrip regulatory efforts and to aggravate cyclical tendencies to instability. Economists working in this vein draw perhaps above all on Minksy ( 1986 ), and many have argued that their ideas were validated by the global financial crisis of 2007/8, whose effects rippled out beyond the United States and other advanced economies to affect many African and other low- and middle-income economies. Recent work—especially in the wake of the financial crisis—clearly reinforces the need for caution with respect to the size and rate of growth of finance and underlines the argument for ‘strong and counter-cyclical regulation of finance’ (Griffith-Jones, Karwowski, and Dafe 2016 ).

Empirical research on this area is also divided along the lines of the above two groups. Although a growing number of empirical researchers, including King and Levine ( 1993 ) and Calderon and Liu ( 2003 ), seem to support Schumpeter’s view, studies such as Atje and Jovanovic ( 1993 ), Demetriades and Hussein ( 1996 ), and Ang and McKibbin ( 2005 ), claim to disprove Schumpeter’s line of argument. Using data on eighty countries over the 1960–89 period, King and Levine ( 1993 : 717) claimed to prove Schumpeter’s view that ‘financial development is strongly (and causally) associated with real per capita GDP growth, the rate of physical accumulation, and improvements in the efficiency with which economies employ physical capital’. On the other hand, Ang and McKibbin ( 2005 ) challenge King and Levine’s finding by arguing that there is a bias in the cross-country analysis caused by the lack of adequate time series data and that this tilts the regression findings in favour of Schumpeter’s camp. Applying co-integration analysis on the Malaysian time series data between 1960 and 2001, Ang and McKibbin ( 2005 ) claim to find that, in the long run, output growth causes financial depth.

The Ethiopian government has tended to agree with the Robinson camp. The debate is not on whether to open the sector or not, rather on how and when to open it. Although markets may be relatively efficient in allocating resources, this is only the case under certain demanding conditions (Ang and McKibbin 2005 ). Perhaps particularly in developing countries, where markets are even more fragmented and less developed than in advanced capitalist economies, market failures are believed to be widespread. Thus, it is feared that letting ‘the market’ make resource allocation decisions completely freely might produce a sub-optimal allocation of very scarce resources.

In addition, as markets tend to direct resources to sectors whose benefits can be appropriated privately in full, critical sectors for long-run growth, i.e. sectors that help to expand the long-run capacity of the economy, such as public infrastructure, education, and health, will fall short of finance. In other words, if the economy does not redirect resources to development sectors, the economy will remain trapped in a vicious circle of poverty. Hence, to break the circle of poverty and turn it into a virtuous circle of growth, government must intervene to create the necessary conditions to increase the rate of domestic investment and savings and deposit mobilization. Plus, government should also make sure that mobilized resources are redirected to development projects by providing the necessary incentives and, when necessary, through direct allocation, for example, through the budget.

10.5 Gradual Liberalization of the Capital Account of the Balance of Payments

The financial sector, particularly the banking system, is one of the most sensitive sectors in developing countries, whose success or failure could have wider ramifications for the economy. Didier, Hevia, and Schmukler ( 2011 ) and Radelet and Sachs ( 1998 ) argue that financial crises can easily end up as full-blown domestic crises if they are not properly managed. 8 Countries that have been able to secure a stable and healthy financial sector, particularly the banking sector, for a relatively long period have enjoyed faster and more sustainable investment and economic growth. The East Asian experience was one of the most widely cited examples in this regard. Until the onset of the 1997–8 crises, East Asian countries enjoyed one of the fastest and most sustained growth episodes in the history of the modern world over more than three decades. Until the beginning of the 1990s, the capital accounts of many of the East Asian Tigers were well protected (Radelet and Sachs 1998 ).

Moreover, many of these countries continued to offer preferential treatment to their strategic sectors such as the export and infrastructure sectors, including using intentional undervaluation of their exchange rates and providing low-cost credit. The foreign exchange market was tightly regulated and effectively protected from domestic and external speculative attacks. This makes it possible for the government to intervene in the credit and foreign exchange market to redirect resources to the productive sectors, using either subsidized interest rate, undervalued exchange rate, or direct credit.

Some studies published after the 1997 crises argue that liberalization of the capital account was the main culprit for the onset of the most debilitating economic crisis in the region’s modern history. Stiglitz ( 2008 ) argues that immediately after the opening up of the capital account, East Asian countries experienced unprecedented inflows of short-term private capital, attracted by high returns and a booming economy. According to the estimates by Radelet and Sachs ( 1998 : 9), ‘total foreign bank lending to the five East Asian countries expanded from $210 billion at end-1995, to $261 billion at the end-1996, an increase of 24 per cent in a single year’. 9 Consequently, on the one hand, banks began to feel over-liquid, put strong downward pressure on domestic interest rates, and pushed real-estate prices artificially high while, on the other hand, central banks were unable to apply counter-cyclical policies due to unprecedented private capital inflow. 10 For instance, the sudden and unprecedented inflow of private portfolios led local currencies to appreciate against the US dollar, prices of goods and services to increase, return to capital of banks to surge, and prices of money to go down.

Then, when investors feel that there is a problem in the fundamentals of the economy, the pressure to withdraw their capital starts to mount to avoid sudden losses as a result of depreciation of the domestic currency or collapse of the economy. Sudden withdrawal of capital by foreign investors causes economies to fall into a liquidity crunch and a rise in interest rates, which, in turn, leaves many firms unable to repay loans. For instance, in 1996, the non-performing loans (NPLs) ratio surged to between 8 per cent in South Korea and 14 per cent in the Philippines. 11 In just a little more than three years of capital account liberalization, it became evident that the new system had significant shortcomings. Returns on investment began to falter, causing investors to worry about the stability of the macro-economy. Consequently, those worried domestic and foreign investors began to short-sell their asset holdings and withdraw, catching the East Asian economies, whose fundamentals had stayed sound for about three decades uninterrupted, off guard. For instance, more than US$100 billion were withdrawn from the ASEAN countries and Korea in the space of the eighteen months after the Thai baht devaluation. Finally, those proud East Asian countries found themselves suddenly forced to go cap in hand to the IMF for major bail-outs (Radelet and Sachs 1998 ). 12 The rationale for the restriction of the capital account in Ethiopia has, therefore, emanated from its interventionist approach to addressing market failure. Accordingly, foreign residents are neither allowed to invest in the financial sector nor to purchase domestic financial securities, such as treasury bills or bonds. Domestic residents, except banks, are also not allowed to buy foreign financial securities or to deposit their assets in foreign banks.

10.6 Financial Sector Performance and Implications for Economic Growth and Stability

10.6.1 financial sector performance.

Ethiopia has achieved significant progress in terms of financial sector growth, adopting a gradualist approach and government intervention in the credit and foreign exchange market. On the other hand, in terms of financial market development, Ethiopia still lags behind many of its African peers such as Kenya, Tanzania, Ghana, and Nigeria. The money market is underdeveloped, and there is neither a debt nor an equity market. It is highly likely that the absence of these markets might negatively affect the economy through lack of market-based price discovery or availability of alternative financing mechanisms. However, from the deposit mobilization and credit allocation perspectives, Ethiopia has achieved impressive results compared to its peers.

Figure 10.1 shows that, in the last seven years, between 2010 and 2017, total banking sector assets as a share of GDP registered significant growth only in Ethiopia and Ghana. Moreover, the increase in the ratio implies that the sector was growing faster than other sectors of the economy. On the other hand, Kenya and Nigeria experienced a marginal decline in total banking sector assets. Figure 10.2 indicates that Ethiopia lags behind Kenya in terms of financial deepening, as measured by broad money-to-GDP ratio.

Total banking sector assets

Broad money, per cent of GDP

Ethiopia’s financial sector growth has been uneven. Based on the government’s policy focus and the sector’s performance, the development process can be divided into three distinct phases since the initial year of the reform in 1992: Phase I (1992–2003), Phase II (2004–10), and Phase III (2011–17).

During the first phase, government policy focused on macroeconomic stabilization and restoring growth after seventeen years of negative annual average per capita growth of 1.9 per cent. Supported by the IMF and World Bank, in this period, the country adopted successive three-year structural adjustment and economic stabilization programmes. The main focus of macroeconomic policies was eliminating monetary overhang, which was believed to be one of the main reasons for the build-up of inflationary pressure (inflation rising to 22 per cent in 1992). Measures were taken to shrink the central bank balance sheet through a government domestic debt repayment programme and by raising the minimum deposit interest rate to 12 per cent. By contrast with the situation in the second and third phases, the average real interest rate for the period reached positive 5 per cent (see Figure 10.2 ). On the other hand, as the financial sector was now open to the private sector, new private banks joined the market. However, as shown in Figure 10.3 , lack of experience in project analysis and absence of information on the quality of customers led to a historically high non-performing loans ratio of 38.3 per cent. Another significant development in this period was that government secured IMF/World Bank-initiated external debt relief, which widened the fiscal space, further lowering the demand for central bank financing.

Selected macro indicators

In Phase II (2004–10), as the consolidation of the monetary and fiscal balance sheets had been completed, government began to reorient the economy towards growth. Monetary and fiscal policies were relaxed. Therefore, as depicted in Figure 10.2 , the base money bar, central bank’s balance sheet expanded significantly. On the other hand, claims on the private sector began to shrink as banks continued to shed non-performing loans from their balance sheet. While the central bank balance sheet saw rapid expansion, with a growth rate of 20.8 per cent, compared to the other two periods this was the only period when commercial banks’ balance sheet expansion fell below the central bank’s balance sheet growth. Consequently, NPL ratios fell significantly (Figures 10.3 and 10.4 ).

Banks’ soundness indicators (annual average)

Phase III (2011–17) was the period when government launched the first and second five-year Growth and Transformation Plans: GTP-I (2011–15) and GTP-II (2016–20). Unlike the first two phases, in Phase III the financial sector was assigned a special role in addressing the huge financing gap identified in the plan. In 2010, a year before the first five-year plan was launched, the domestic savings-to-GDP ratio was less than 10 per cent; but government planned to raise the investment-to-GDP ratio from 24 to 28 per cent, further widening the financing gap to 18 per cent. Hence, the financial sector needed to intensify its deposit mobilization efforts. Additionally, the government planned to undertake huge infrastructure projects and was determined to meet the Millennium Development Goals in health and education. As depicted in Figures 10.3 and 10.4 , this was the period when commercial banks registered a significant growth in deposit and loan expansion while, on the other hand, banks’ soundness indicators improved dramatically.

Moreover, the government has made substantial progresses in terms of bank branch expansion and financial inclusion. As depicted in Figure 10.5 , the number of commercial bank branches increased by more than five fold, between 2010 and 2017, from 681 to 4257. As a result, population per bank branch dropped from 115,712 to 21,940 in the same period. These were made possible through the following ways. First, the NBE advised the Commercial Bank of Ethiopia (CBE), the largest government owned bank, to take the lead in opening more branches outside Addis Ababa and pave the way for private banks to follow. Accordingly, in 2011, CBE managed to open more than 100 branches and the private banks immediately followed. Second, the NBE introduced a financial security called the ‘NBE Bill’, an instrument, which demands each private commercial bank to allocate every 27 per cent of its total loans disbursed a every month for the purchase of the Bill. 13 The outstanding amount of NBE-Bills held by private banks reached 68.9 billion birr in 2017. Practically, this left private banks in need of more liquidity to protect their share of loan disbursement to the rest of the economy and remain as profitable as before. Hence, in search of more deposits, they began to aggressively open new branches including in areas which had never seen any bank branch before.

Bank branch expansion

In terms of development banking, all was not so rosy. With the launching of GTP-I, the role of the Development Bank of Ethiopia in financing development projects intensified. The total assets increased by more than 470 per cent between 2010 and 2017 from 9.2 billion birr to 53.1 billion birr, and its branches numbered 110 in 2017 from just thirty-two in 2010. On the other hand, DBE’s non-performing loans ratio surged to 20.5 per cent in 2017 from 9.1 per cent in 2013. This suggests the government needs to think deeply and strategically about its current development banking model (De Aghion 1999 ; Di John 2016 ).

However, relative to Ethiopia’s regional peers, the domestic capital market is absent, the money market is less developed, and the foreign exchange market is less flexible. The current impressive growth is not sustainable as Ethiopia transitions from investment-led growth to productivity- and efficiency-led expansion. As the economy becomes more complex and the country’s integration into international markets intensifies, the importance of price discoveries and efficient use of resources will increase significantly if the country is to remain competitive in the international market.

10.6.2 Implications for Macroeconomic Stability and Growth

Ethiopia’s financial sector development is found to have a significant positive impact on macroeconomic stability and growth. In terms of efficiency and allocation of resources to economic sectors, banks continue to show strong improvement from one phase to the next, despite the shift in the government’s focus from stabilization to growth. As is clearly evident from Figure 10.6 , interest rate spreads continue to decline. On the other hand, the inflation rate experiences surges in both Phase II and Phase III, partly reflecting the effect of government policy reorientation towards growth and partly thanks to imported inflation resulting from international food price rises in 2006–7 and 2012 (Durevall, Loening, and Birru 2013 ).

Interest rate spread

The financial sector has also made an unprecedented contribution to domestic savings mobilization to finance the surge in investment demand as per the GTP. As depicted in Figure 10.7 , the bank deposit-to-GDP ratio climbed from 25.9 per cent in 2010 to 31.4 per cent in 2017.

Banks’ deposit and gross domestic savings

As shown in Figure 10.8 , the composition of loans has shifted in favour of public sector credit. The government’s increased demand for finance for infrastructure projects is reflected in the sharp rise of public sector outstanding credit since 2010, coinciding with the launch of GTP-I.

Bank credit

As the economy grows more complex while financial sector policy has remained more or less where it was in 2000, the challenges on the macroeconomic front have intensified. The balance-of-payments crisis that intensified after 2015 was a reflection partly of the less flexible foreign exchange market and partly of the collapse in international commodity prices. In terms of the foreign exchange market, the exchange rate remained overvalued for the last six years to 2017 despite the sharp decline in exports and the widening gap between the official and parallel market exchange rates. The wedge between the official and the parallel market exchange rates reached about 30 per cent in May 2018 from less than 5 per cent in May 2014.

10.7 Conclusion

The financial sector has played a key role in Ethiopia’s economic development, particularly since the launching of the first Growth and Transformation Plan. Although Ethiopia’s financial sector growth generally followed output growth in the first two phases, government has started to play a key role in accelerating the sector’s growth through active interventions. Consequently, the number of bank branches expanded from 681 to 4,257 in just seven years between 2010 and 2017 while the deposit-to-GDP ratio rose from 25.9 per cent to 31.4 per cent in the same period.

However, as the economy has been expanding very rapidly and shifting from volume (investment)-based growth to price- and market-led growth, price discovery and efficient allocation of financial resources have become increasingly important. In this context, there may be a case for rethinking policy. Whether a strategy could be developed that allowed for faster change in the finance sector and capital markets without exposing Ethiopia to the full force of liberalization and the very evident risks that accompany this remained, at the pivotal moment of 2018, to be seen. Clearly, there was by 2018 a case for financial sector reform, but the government needed still to heed the multiple warnings about the risks of unbridled financial liberalization.

There is growing evidence that inflexibility in the foreign exchange market has been negatively affecting the long-term growth prospects of the country. The country remains less competitive in international markets and the foreign exchange market imbalance loomed large. Again this signalled a need perhaps to inject some form of flexibility in the foreign exchange market or at least to push for a major export earnings drive of the kind the Korean government adopted in the late 1970s that effectively prevented its debt problem becoming a debt crisis.

Finally, development banking is one of the most important sectors for the government to realize its long-term growth vision. However, the mounting non-performing loans ratio sends a message to the government that the current model is unsustainable. So, there is a need to reconsider a more moderate development banking strategy that involves the participation of more diversified actors, including the private sector, and/or a more effective and selective approach to development banking.

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The Bill has a five-year maturity and the NBE pays 3 per cent interest per annum on it. Then, the NBE automatically transfers the fund to the Development Bank of Ethiopia at 3 per cent interest. The latter uses the fund to finance medium and long-term private-sector investment projects.

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Electronic banking adoption in Ethiopia: an empirical investigation

• Original Article
• Published: 09 August 2021
• Volume 1 , article number  112 , ( 2021 )

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• Pankaj Tiwari   ORCID: orcid.org/0000-0003-2401-184X 1  

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The bank has always been a very intense business, especially in the last few decades when information technology had a strong influence on the banking sector. This research followed almost the same pattern, particularly by examining the factors influencing information technology adoption. However, little work has been done to identify these factors in electronic banking services in developing African Countries. The purpose of this research was to analyze the variables that influence adoption in Commercial Bank of Ethiopia. The researcher has used factors perceived ease of use, infrastructure, security, trust, and e-banking adoption. The data were collected from 179 respondents of CBE. This study uses the structural equation model based on least partial square analysis. The results show that customer trust mediates between the perceived ease of use, infrastructure, security, and e-banking adoption. The practical result of this research is the provision of information and knowledge to the Ethiopian Commercial Bank, which is the financial backbone of this country. Further, combining Trust in technology will improve confidence in Ethiopian banking sector. Hence, the government should make more efforts to sustain and improve e-banking through technology-driven innovation in the banking sector.

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Source: Davis ( 1989 ), Lee and Turban ( 2001 ), Kolodinsky et al. ( 2004 )

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Ethiopia’s Banking Sector In Good Financial Health, But Vulnerabilities And Risks Present

Banking & Financial Services / Ethiopia / Fri 10 May, 2024

• Ethiopia’s banking sector is in good financial health, underpinned by a strong economic environment, which will support banks in the coming years.
• The findings from the latest stress tests suggest that the Ethiopian banking sector is generally stable, but there are vulnerabilities.
• The latest Financial Stability Report highlights a number of risks, including operational, market and liquidity risks. A technical issue at CBE in March underscores some of these risks.

Ethiopia’s banking sector is in good financial health, underpinned by a strong economic environment, which will support banks in the coming years.  The central bank's inaugural Financial Stability Report (FSR), released in April 2024, describes the banking sector as stable and resilient, boasting strong capital and liquidity buffers, solid profitability and good loan quality. The sector’s ratio of non-performing loans (NPLs) to total loans stood at 3.6% in June 2023 (latest available data, see chart below, left ), below the regulatory limit of 5.0% and down from a year before.  Despite a slight decline in the capital adequacy ratio (CAR) from pre-pandemic levels of 19.9% to 14.7% in June 2023, it comfortably exceeds the 8.0% regulatory mandate. Additionally, while the banking sector's total income surged by 20.4% y-o-y in June 2023, rising expenses, which increased by 26.0%, meant that net income before tax saw a marginal increase, reaching ETB62.9bn at the end of June 2023, up by ETB1.1bn from the year before.

We expect a further decrease in the aggregate NPL ratio. This anticipated decline will be primarily due to a strong economic backdrop , which will improve the debt repayment capacity of households and businesses. Concurrently, we expect that banks will strengthen their capital reserves while continuing to report robust and improving profitability metrics through 2024 and 2025. The sector's financial soundness indicators comfortably exceed (or in the case of the NPL ratio, remain below) the National Bank of Ethiopia's (NBE) benchmarks ( see chart below ), signalling a positive outlook for financial stability and the sector's growth potential in the medium to long term.

While the findings from the latest stress tests suggest that the Ethiopian banking sector is generally stable, there are vulnerabilities. The NBE conducted these tests using data from June 2023, examining credit and liquidity risks across three different scenarios: a baseline reflecting IMF economic growth projections, a moderately adverse scenario with a 10% increase in the NPL ratio, and a severe adverse scenario with a 30% NPL ratio. As detailed in the table below, the credit risk stress tests reveal that all banks are capitalised well enough to absorb a moderate shock. However, in the event of a severe shock, 12 out of the 31 banks would fall short of minimum requirements, necessitating an additional capital infusion amounting to 1.5% of risk-weighted assets. That being said, this requirement varies among banks—the Commercial Bank of Ethiopia (CBE), which is the largest and the only bank considered a domestic systemically important bank, along with most smaller banks, already possess adequate capital reserves.

The liquidity risk stress tests evaluated the potential impact on the banking sector's liquidity in the event that each bank's top ten depositors simultaneously withdrew all their funds. The results indicate a significant drop in the sector's liquidity ratio from 24.0% (as of end-June 2023) to 13.0%, narrowly missing the 15.0% regulatory minimum ( see table below ). The CBE would withstand this scenario, but 18 other banks would not meet the liquidity requirement—this includes four medium-sized banks and 14 small banks. This suggests a heightened sensitivity to liquidity risk among many domestic banks, particularly in the face of abrupt withdrawals by major depositors. The sector's vulnerability to such shocks has increased; only six banks would have fallen below the 15.0% threshold in a similar scenario at end-June 2022. In summary, while the sector is largely stable, these identified vulnerabilities highlight the need for enhanced capital and liquidity management strategies to safeguard its ongoing stability.

The FSR identifies several potential risks for the banking sector. First, the industry's credit risk is deemed moderate, but the NBE anticipates an uptick in 2024. This could stem from factors such as droughts, internal conflicts, and a weakening external sector, compounded by the concentration of credit, with the top ten borrowers accounting for 23.5% of total loans as of June 2023. Second, the stress tests underscore the sector's vulnerability to liquidity risk due to potential mass withdrawals by major depositors. The NBE foresees a slight escalation in liquidity risk in the near to medium term, attributed to mismatches in assets and liabilities, funding shortfalls, concentrated deposits, and lapses in meeting weekly liquidity norms. Third, operational risks are on the rise, with the FSR noting an increase in insider threats, social engineering, and bank fraud and forgeries, with fraud incidents doubling in one year to ETB1.0bn by end-June 2023. Fourth, the sector faces market risks in a high-interest-rate environment, where increased funding costs could impact profitability. This is particularly relevant in Ethiopia, where variable-rate deposit liabilities contrast with fixed-rate assets and treasury bonds. Additionally, banks’ overall open foreign currency position was 81.7% short at end-June 2023, well above the central bank’s limit of 15%. Lastly, economic and geopolitical risks continue to loom, with ongoing geopolitical tensions and domestic issues such as conflicts and droughts posing threats to financial stability.

A technical issue at CBE in March underscores some of the risks outlined in the FSR. On March 16 2024, CBE experienced a significant technical malfunction that led to a loss of ETB2.4bn (USD42mn). CBE is the largest state-owned bank, accounting for 49.5% of total industry assets in June 2023 (latest available data). During the glitch, customers, predominantly university students, were able to withdraw and transfer funds without any restrictions for several hours. While the bank has since recovered nearly three-quarters of the funds, as of end-March, following the publication of a list of those who took advantage of the glitch, this incident has broader implications for the Ethiopian banking sector. These include operational risks associated with system upgrades and maintenance, highlighting the necessity for robust risk management frameworks and advanced security protocols, which may be mandated by policymakers and regulators. Additionally, the event could pose liquidity risks; however, the stress tests indicate that the sector, and CBE in particular, possesses sufficient buffers to absorb such shocks. Moreover, the glitch raises concerns about customer trust and the reputation of not only CBE but the entire financial sector. 

On a positive note, the Ethiopian Securities Exchange (ESX) plans to start trading company shares, government-issued fixed income securities and money-market products as early as September 2024, which will bring a number of benefits to the banking and financial services sector. Announced in April 2024, the bourse aims to have 90 publicly listed companies on its exchange within the first seven to ten years and has cleared around ten state-owned firms for listing already, with investors able to buy stakes ranging from 10% to 100%. This development follows a successful initial capital raise, where the ESX exceeded its target of USD11.1mn for a 75% private ownership stake, securing USD26.6mn and witnessing an oversubscription rate of 240%. The group of investors includes FSD Africa, the Trade and Development Bank Group, Nigerian Exchange Group, 16 domestic private commercial banks, 12 private insurance companies, and other private domestic investors, with the government retaining a 25% share.

The benefits to the banking and financial services sector include facilitating financial institutions’ ability to raise capital, enhancing visibility and credibility owing to increased regulatory oversight and reporting standards and increasing the spectrum of possible investors into the industry. 

Key Banking Forecasts (Ethiopia 2021-2027)

Structural Characteristics Of The Banking Sector

Asset Quality:  The ratio of NPLs to total loans improved from 3.9% at end-June 2022 to 3.6% at end-June 2023 (latest available data), which is well below the regulatory maximum of 5.0%. Provisioning to NPLs also increased from 122.9% to 132.5% over the same period. 

Funding Structure:  The country's loan-to-deposit ratio will remain low as increasing financial sector penetration sees deposit growth outpace loan growth. Whilst this means that banks should not suffer from domestic liquidity issues, as a result of sudden withdrawal in funds, it means that banks are not utilising all available deposits to benefit the economy. 

Capital Adequacy:  Capital adequacy ratios remain robust. The sector’s capital adequacy ratio fell from 16.3% in Q2 2022 to 14.7% in Q2 2023 (latest available data), although this is above the minimum requirement of 8.0%.

Sovereign Support Capacity:  The government's persistent fiscal deficits, due to large-scale public investment, will weigh on the country's sovereign support capacity. The budget will remain in deficit over the next decade. That said, the government will likely support state-owned banks, Commercial Bank of Ethiopia and the Development Bank of Ethiopia, in the event of a financial crisis.

Ownership Structure:  Ethiopia's two large public banks hold a significant share of deposits and new loans. The split in ownership share between private and public banks are relatively equal. In the long term, we expect private banks will continue to increase their share of loans and deposits as they continue to expand in the country. This has been limited by the government's policy of locking out foreign investment in the sector. However, parliament in July 2019 approved legislation allowing foreign nationals of Ethiopian origin to buy shares in local banks, and in Q4 2022 legislation was tabled enabling foreign financial institutions to invest in the sector.

Regulatory Body Assessment:  The commercial banking sector is regulated by the NBE, which is mandated to provide licences and supervise the sector. Foreign banks have traditionally not been permitted to operate in the country, although this has been changing in recent years with the sector opening to foreign investment from Q4 2022. Since changing regulations detailing that private sector banks had to invest 27.0% of their portfolio in government bonds were removed in 2015, the environment for private sector banks has improved.

This commentary is published by BMI, a Fitch Solutions company, and is not a comment on Fitch Ratings Credit Ratings. Any comments or data included in the report are solely derived from BMI and independent sources. Fitch Ratings analysts do not share data or information with BMI. Copyright © 2023 Fitch Solutions Group Limited. All rights reserved. 30 North Colonnade, London E14 5GN, UK.

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Financial Stability Report—2024

A stable and efficient financial system is essential for sustaining economic growth and raising standards of living. In the Financial Stability Report , the Bank of Canada assesses the resilience of the Canadian financial system and identifies key risks that could undermine its stability.

This year, the Bank renamed its annual assessment of the stability of the Canadian financial system to the Financial Stability Report from the Financial System Review . This reflects a continuing evolution in how the Bank assesses risks to Canadian financial stability. In particular, the Report:

• takes more of a cross-sectoral perspective when assessing overall financial stability in Canada by accounting for interconnections among sectors in the financial system
• considers how financial system participants are building resilience against the risks to their sector and to the broader financial system

Analysis about the structure and efficiency of the financial system will continue to be covered on the Bank’s Financial System Hub .

Overall assessment

Key takeaways.

• Canada’s financial system remains resilient. Over the past year, financial system participants—including households, businesses, banks and non-bank financial institutions—have continued to proactively adjust to higher interest rates.
• Debt serviceability —Businesses and households continue to adjust to higher interest rates. Indicators of financial stress in both sectors were below historical averages through the COVID-19 pandemic but have been normalizing. Some indicators look to be increasing more sharply and warrant monitoring. Higher debt-servicing costs reduce financial flexibility for households and businesses and make them more vulnerable in the event of an economic downturn.
• Asset valuations —The valuations of some financial assets appear to have become stretched, which increases the risk of a sharp correction that can generate system-wide stress. The recent rise in leverage in the non-bank financial intermediation sector could amplify the effects of such a correction.
• The financial system is highly interconnected. Stress in one sector can spread to others.
• Participants should continue to be proactive, including planning for more adverse conditions or outcomes.

The global backdrop has generally improved over the past year, and investors’ appetite for risk has increased

Over the past 12 months, the global economic and financial environment has been marked by a further decline in inflation in advanced economies and a reduction in the risk of a major recession. However, geopolitical tensions have increased.

Financial system participants—including households, businesses, banks and non-bank financial institutions—have become increasingly focused on when and by how much central banks will reduce their policy interest rates. This has driven a renewed appetite for risk, which has pushed up the prices of a range of financial assets and driven down risk premiums and credit spreads in both Canada and the United States. Benchmark US and Canadian equity indexes reached all-time highs in 2024, and corporate credit spreads in both countries are now at or below levels seen on average since the 2008–09 global financial crisis.

Volatility and liquidity in bond markets have improved over the past 12 months, but volatility remains higher and liquidity remains lower than before central banks began increasing their policy rates. Markets have continued to function well. Trading volumes have remained relatively stable and the private sector has continued to absorb government debt, even as governments increased their issuance of debt and central banks continued their quantitative tightening programs. 1 The issuance of corporate bonds has also been robust.

Despite some improvements in the global backdrop, uncertainty remains elevated. For example, inflationary pressures globally could be higher than expected, causing markets to further reassess the timing and the pace of the expected declines in policy interest rates by some central banks, as seen recently in the United States. Geopolitical tensions—in particular, the wars in the Middle East and Ukraine—persist and could escalate. These sources of uncertainty could reduce the global appetite for risk, leading to an abrupt repricing of assets and to stress in core funding markets.

Canada’s financial system has remained resilient

Over the past 12 months, financial system participants have taken steps to enhance their resilience in the face of higher interest rates.

• Households and businesses have reduced their demand for credit, and most have maintained higher levels of liquid assets built up during the pandemic.
• A growing number of borrowers with variable-rate, fixed-payment mortgages are making lump-sum payments or increasing the value of their regular payments ahead of renewal.
• Banks have increased their provisions for loan losses and maintained their large capital buffers.
• Some asset managers have strengthened their processes for managing liquidity risks.
• Some pension funds and insurance companies have reduced their exposure to commercial real estate or written down the value of assets in the office subsector, where vacancies are high.

These actions are reducing the risks to individual borrowers and lenders as well as to overall financial stability. In addition, financial sector authorities have enhanced their regulatory and supervisory activities around risky exposures. For instance, the Office of the Superintendent of Financial Institutions has provided stricter regulatory guidance for lenders with negatively amortizing mortgages as well as commercial real estate lending. 2 It has also raised the level of the domestic stability buffer, a capital reserve that large banks can use in times of stress. 3 Market participants believe that the likelihood of a shock occurring that could impair the Canadian financial system has declined. Participants also report having a high degree of confidence in the Canadian financial system’s resilience to a severe shock, should one occur. 4

In sum, the financial system appears well positioned to manage the ongoing adjustments to elevated interest rates and the ongoing volatility in financial markets. Nevertheless, risks remain.

Risks to debt serviceability could affect the performance of lenders’ credit portfolios

Although most households are adapting to higher interest rates, some are showing increasing signs of financial stress. After hitting historical lows during the COVID‑19 pandemic, the share of borrowers without a mortgage who are behind on credit card and auto loan payments has come back up to more normal levels or has surpassed them.

The increasing stress that borrowers face has not significantly impacted large banks, but some smaller mortgage lenders have seen a sharp uptick in credit arrears. Over the coming years, more borrowers will face pressure as they refinance existing mortgages at higher interest rates. Higher debt-servicing costs reduce financial flexibility for households and businesses and make them more vulnerable in the event of an economic downturn.

Valuation risks could lead to corrections in asset prices and to market strains

Price corrections could be large and abrupt if expectations around the path for interest rates change significantly or if the economic outlook deteriorates significantly. Valuation risks could also materialize if ongoing large increases in the issuance of government debt cause term premiums and bond yields to rise.

Stretched asset valuations may not properly reflect risks to the economic outlook and therefore increase the likelihood of a disorderly price correction. Asset managers could face losses, a sharp increase in liquidity needs from redemptions or margin calls, and forced deleveraging if investors abruptly reprice risky assets. A repricing could reverse recent investor flows into corporate bonds, prompting further redemptions. The recent increase in leverage through repurchase agreements (repos) by hedge funds and pension funds could amplify the liquidity needs of these funds arising from margin calls.

In this scenario, asset managers may contribute to strains on market liquidity if they unwind fixed-income positions to meet their liquidity needs. This could cause prices for these securities to decline further, reducing market liquidity and, in extreme cases, leading to fire sales and price spirals. 5

Valuations remain under pressure in parts of the commercial real estate sector, particularly the office subsector where vacancies are high. Not all asset managers have fully reflected these reduced valuations on their balance sheets, meaning that further adjustments may be necessary in the future.

Interconnections in the financial system could transmit stress

The risks to the financial system related to debt serviceability and asset valuations are important to monitor because they could have a large impact on individual borrowers and lenders if they materialize. Links between participants could spread and amplify the impact of any shock, leading to system-wide stress.

Banks are well capitalized and have sufficient liquidity buffers, making them well positioned to continue supporting the economy, even through a period of stress.

However, stress in the global banking sector, like that seen in March 2023, could impact depositor and investor confidence. This could spark deposit outflows, even at healthy banks. Large Canadian banks could also be impacted by a disruption in global wholesale markets given their reliance on this source of funding. Funding pressures could lead banks to reduce lending and the provision of liquidity to markets.

A large-scale liquidity event could cause many financial system participants to simultaneously take actions to enhance their own resilience to stress. Such a situation could cause secondary effects, such as a fire sale of assets, that amplify and transmit stress through the system.

Participants need to continue planning for more adverse outcomes

The Bank works closely with federal and provincial financial authorities to monitor the health of Canada’s financial system. This collaboration is particularly important in areas where data gaps at an individual authority limit its ability to fully assess risks to the financial system.

While public authorities can intervene to preserve financial stability in periods of severe stress, banks and market participants should anticipate and plan for periods of stress and build adequate loss-absorption and liquidity buffers to ensure they remain resilient. In particular, market participants planning to raise cash through the sale of financial assets should consider that other market participants may also intend to sell the same type of assets to meet their liquidity needs during periods of stress.

Households and businesses should also continue to be proactive, planning for higher payments when mortgages and other debt renew at higher interest rates.

Banks can continue to support borrowers by reaching out well ahead of renewal dates and helping them plan for higher payments.

A stable and resilient financial system benefits all Canadians. Preserving financial stability requires the prudence and diligence of all financial system participants.

Households are adjusting to the rise in debt-servicing costs.

Following sharp declines during the COVID‑19 pandemic, many indicators of financial stress have now returned to more normal levels. 6 Signs of stress are concentrated primarily among households without a mortgage and survey data suggest that, of these households, renters are most affected. In contrast, indicators of stress among mortgage holders are largely unchanged, remaining at levels lower than their historical averages. Factors such as income growth, accumulated savings and reduced discretionary spending are supporting households’ ability to deal with higher debt payments.

Over the coming years, more mortgage holders will be renewing at higher interest rates. Based on market expectations for interest rates, payment increases will generally be larger for these mortgage holders than for borrowers who renewed over the past two years. Higher debt-servicing costs reduce financial flexibility for households and businesses and make them more vulnerable in the event of an economic downturn.

Signs of financial stress have risen primarily among households without a mortgage

The combination of higher inflation and higher interest rates continues to put pressure on household finances. Many indicators of financial stress, which had declined during the pandemic, are now close to pre-pandemic levels. Signs of increased financial stress appear mainly concentrated among renters. 7 , 8

The rates of arrears on credit cards and auto loans for households without a mortgage—which includes renters and outright homeowners—are back to pre-pandemic levels and continue to grow ( Chart 1 ). 9 In contrast, arrears on these products for households with a mortgage have remained low and stable.

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Households have also increased their reliance on credit card debt. Research by Bank staff finds that households relying on credit cards to finance spending are more likely to experience financial stress in the future. 10 In particular, borrowers without a mortgage who carry a credit card balance of at least 80% of their credit limit are significantly more likely to miss a future debt payment. Over the past 12 months, the share of these borrowers has continued to trend up ( Chart 2 , yellow line).

More mortgage holders will be facing higher payments in the coming years

About half of all outstanding mortgages are held by borrowers who have yet to face higher rates because their payments were fixed for five years (with either a fixed or variable mortgage rate). 11 Households that hold these mortgages will generally see a larger payment increase than those that have already renewed ( Chart 3 ). The impact of the rise in debt-servicing costs will be partially offset for households whose income has grown over the intervening period.

As mentioned in previous Reports, the financial pressure will increase most for households that took out a mortgage in 2021 and early 2022 when house prices were close to their peak and mortgage rates were very low. These borrowers generally:

• have taken on large mortgages relative to their income
• have seen little increase (and potentially a decrease) in home equity
• will see larger increases in payments at renewal

Debt-servicing costs for new mortgages remain elevated

The share of income dedicated to mortgage payments—also called the mortgage debt service ratio— has been much larger for households that took on a mortgage after interest rates started rising in 2022 relative to households that took on a mortgage in prior years ( Chart 4 ). As a result, at the end of 2023, over one-third of new mortgages had a mortgage debt service ratio greater than 25%, double the share of new mortgages with the same ratio in 2019. This growth has occurred despite households opting for smaller mortgages relative to their income and for longer amortization periods. 12

Higher debt-servicing costs reduce a household’s financial flexibility, making them more financially vulnerable if their income declines or they face an unexpected material expense.

Most households retain some financial flexibility

The rise in house prices since the beginning of the pandemic has increased equity for most homeowners. In cases where mortgage holders run into financial stress, higher levels of home equity can act as a financial buffer, leaving room for borrowers to reduce their payments.

Similarly, access to liquid assets gives households some capacity to adjust to unexpected budget pressures. Survey data show that households—regardless of homeownership status—generally have more liquid assets as a share of their income than before the pandemic ( Chart 5 ). That said, mortgage holders and renters hold fewer liquid assets as a share of their income compared with homeowners without a mortgage. In addition, the value of some of these assets could decline significantly during periods of stress when the funds are needed. 13

Non-financial businesses

Higher interest rates can affect non-financial businesses both directly—by increasing financing costs—and indirectly—by slowing the economy. So far, the financial health of large non-financial businesses has remained broadly solid, thanks in part to their diversified sources of funding and their long-term financing. However, the number of insolvency filings—which are typically submitted by small businesses—has surged recently, suggesting that small businesses are facing more financial pressure.

Overall, non-financial businesses remain in good financial health

Demand for credit by non-financial businesses has softened considerably over the past 12 months, reflecting lower economic growth and higher interest rates. More generally, the ratio of total debt to assets among non-financial businesses picked up over 2023, primarily due to lower asset valuations, but remains below pre-pandemic levels ( Chart 6 ). The liquidity position of non-financial businesses—measured by the ratio of total cash to debt—has deteriorated somewhat over the past 12 months but is still robust by historical standards.

Financial pressure is increasing for some businesses

The rise in financing costs over the past two years—either through bank or market sources of funding—and slowing economic growth have been challenging for many businesses. Since 2022, the debt-servicing costs of publicly listed businesses headquartered in Canada have risen sharply after having declined in the years before ( Chart 7 ). While interest costs as a share of earnings remain below pre-pandemic levels, this share will likely keep rising in the coming years as existing debt is refinanced at higher interest rates.

An important factor temporarily protecting large businesses from the effects of higher interest rates is the financing structure of their existing debt. In Canada, most publicly listed businesses rely on issuing bonds as their primary source of debt financing, rather than relying on bank loans. Currently, about two-thirds of the bonds on their balance sheets have a remaining maturity of five years or more. For many firms, this means the cost to finance their existing debt will not increase for some time. Over the past 12 months, spreads between corporate and government bond yields have declined below their average level since the 2008–09 global financial crisis, which is also mitigating the increase in refinancing costs for large businesses.

Smaller businesses appear to be under more financial pressure than their larger counterparts. The number of businesses in Canada filing for insolvency, which had been unusually low during the pandemic, has surpassed pre-pandemic levels by a large margin ( Box 1 ). A key reason for this rebound could be that the temporary government support programs put in place during the pandemic delayed the impacts of underlying financial pressures for some businesses and reduced the number of insolvency filings relative to pre-pandemic levels. The Bank will continue to closely monitor the level of business insolvencies and the risk they may pose for financial stability.

Box 1: A closer look at the sharp increase in the number of business insolvencies

Business insolvencies have increased steadily since early 2022 and more sharply since the middle of 2023 ( Chart 1‑A ). 14 As of March 2024, the number of businesses filing for insolvency was up significantly from a year earlier and was about double its average from before the COVID‑19 pandemic. The surge in insolvencies over the past 12 months has generally been:

• concentrated among small businesses 15
• broad-based across industries
• driven by bankruptcy filings rather than insolvency proposals 16

The run-up in business insolvencies since early 2022 likely reflects a combination of factors, including:

• higher borrowing costs
• slower economic activity
• phasing out of federal and provincial pandemic support programs

A rebound in business insolvencies from pandemic lows was to be expected. Some businesses may have been sustained throughout the pandemic by government support programs, and successive pandemic lockdowns disrupted the process for insolvency filing, particularly the use of bankruptcy courts, leading to a backlog of cases.

To better understand the rise in business insolvencies in relation to pandemic lows, we examine 19 industries in Canada (each represented by a bubble in Chart 1‑B ). We compare the cumulative deviations of insolvency filings from their pre-pandemic average (from 2016 to 2019) over two periods: 17

• from early 2020 to the end of 2022 (period of below-average number of insolvencies)­­—shown on the horizontal axis in Chart 1‑B
• from the end of 2022 onward (period of above-average number of business insolvencies)—shown on the vertical axis in Chart 1‑B

The size of each bubble in Chart 1‑B is proportional to the size of the industry. The concentration of bubbles around the diagonal 45-degree line suggests that, for many industries, the cumulative rise since the end of 2022 is similar in size to the cumulative decline from 2020 to 2022. In addition, some of the industries that saw the largest initial declines, such as retail trade and accommodation and food services, have also experienced the largest rebounds. This reinforces the idea that government support programs likely played a role in limiting insolvencies from 2020 to 2022. While higher interest rates and slowing demand have contributed to stress among businesses, the rebound in the number of insolvencies above its pre-pandemic average appears to be mainly the result of a catch-up effect in the overall number of insolvencies since 2020.

Canadian banks remain resilient. Overall, credit performance remains strong, and capital and liquidity buffers remain above regulatory minimums. Increased provisions for loan losses are impacting profitability but also enhancing banks’ resilience. Funding costs have increased, but deposit retention has remained strong and access to wholesale markets continues to be robust. The Bank will continue to monitor indicators of borrower stress and how that stress may impact the credit quality of banks’ assets.

Funding for banks remains accessible, but costs have increased

Ongoing access to stable sources of funding affects the stability of individual banks, the banking sector as a whole and the ability of banks to support the economy.

Banks rely on two main sources of funding:

• deposits of households and businesses
• funds obtained through wholesale capital markets, both domestically and internationally

While bank deposits in the United States have declined over the past 12 months, those in Canada have continued to grow, but at a higher cost for banks. As interest rates have risen, depositors have migrated to higher-yielding products such as term deposits. This translates to higher funding costs for banks. Banks generally pass these higher costs on to customers in the form of higher interest rates on loans, maintaining interest rate margins.

Large banks also rely on domestic and international wholesale markets for additional funding. This exposes large banks to strains in global fixed-income markets that could impact their access to funding during periods of stress. Large Canadian banks continue to maintain access to wholesale markets, although at a high cost. The total cost of wholesale funding for large banks has remained high, driven by yields for Government of Canada bonds.

However, bank credit spreads have declined sharply over the past year and are back to pre-pandemic levels ( Chart 8 ). This reduction has occurred against the backdrop of diminishing concerns from investors about the health of the global banking sector following the stress episode seen in March 2023. Since late 2023, investors have increased their appetite for corporate debt, suggesting greater ease of access to markets for banks.

Loan impairments at large banks remain low

Overall, the credit performance of bank assets generally remains strong. Among large banks, impairments on loans to households (including mortgages and consumer loans) are low by historical standards, despite a recent increase ( Chart 9 ).

The share of mortgages in arrears has risen more for small and medium-sized banks ( Chart 10 ). The difference in mortgage arrears at smaller lenders likely reflects differences in the borrower profiles and in the timing of mortgage renewals. Some small and medium-sized banks specialize in mortgage lending to higher-risk borrowers and typically issue more mortgages at shorter terms than other lenders. 18 As a result of these shorter terms, nearly all borrowers who took out mortgages at small lenders have already renewed at higher rates. In contrast, about half of the mortgages at large banks have yet to be renewed.

The recent rise in business insolvencies discussed in Box 1 does not represent a significant source of concern for the credit performance of banks. Businesses filing for insolvency have typically been small and represent a small share of the total business loan portfolio of banks. 19

The credit performance of loans to the commercial real estate sector—particularly the office subsector—continues to face pressure. For most Canadian banks, exposures to the office subsector are generally minimal. The Bank is closely watching developments in this area ( Box 2 ).

Banks are managing their balance sheets more cautiously

Banks have increased loan-loss provisions, which serve as an early line of defence to absorb credit losses. Allowances for loan losses at large banks—the cumulated stock of provisions expressed as a percentage of loan balances—were 20% higher in the first quarter of 2024 than before the pandemic. Smaller lenders are also improving their resilience by increasing loan-loss provisions.

Large banks continue to maintain ample buffers to meet unexpected liquidity needs and absorb unexpected losses. As of the first quarter of 2024, the average common equity Tier 1 capital ratio of large banks was 13.4%, about 2 percentage points higher than just before the start of the pandemic. 20 The average liquidity coverage ratio of large banks was 135% in the first quarter of 2024, up from 132% prior to the pandemic. 21

Box 2: Exposures to commercial real estate in the Canadian financial system

Parts of the commercial real estate (CRE) sector, particularly the office subsector, are under pressure. This reflects both cyclical and structural factors, such as higher borrowing costs and weaker demand for office space. Weaker demand has pushed the national vacancy rate up to about 20% for offices located in the downtown areas of major cities. 22 The industrial and retail subsectors have been performing relatively better, as illustrated by how market pricing of real estate investment trusts has evolved since 2020 ( Chart 2‑A ).

Various financial entities—both banks and non-banks—are active in the CRE sector, either providing lending or taking ownership stakes in real estate properties ( Table 2‑A ). Given ongoing pressures in the CRE sector, these entities face risks linked to credit or valuation losses, particularly in cases where this sector accounts for a large share of their overall assets.

Note: CRE is commercial real estate. The share of loans for large insurance companies is not available and the share of loans for large pension funds is not applicable. Sources: Financial statements of Canadian banks, large insurance companies and pension funds; regulatory filings of Canadian banks; and Bank of Canada calculations Last observations: large banks, 2024Q1; small and medium-sized banks, December 2023; large insurance companies and pension funds, respective year-end dates

For banks, exposures to the CRE sector come largely in the form of loans, including commercial mortgages and loans to real estate developers, builders and real estate investment trusts. In Canada, the CRE sector accounts for 10% of the total loan book of large banks and 20% of that of small and medium-sized banks, although with significant variation among smaller lenders.

In the United States, the loan exposure of small and medium-sized banks to the CRE sector (36%) is, on average, more than twice as large as that of their Canadian counterparts (16%). For most Canadian banks, exposures to the office subsector are generally minimal—in the range of 1% to 2% of loans—with only a few small lenders having exposure above 5% of total loans.

Among non-bank financial intermediaries, substantial data gaps limit the ability to fully assess CRE exposures. However, Statistics Canada reports that roughly half of non-residential mortgages in Canada are held by institutions other than banks and credit unions.

Canada's largest life insurance companies hold about 12% of their total invested assets in the global CRE sector, and 70% of that is held in commercial mortgages. Large public pension funds hold a slightly higher fraction of their assets in the CRE sector (15%), but their exposure is more heavily weighted toward ownership stakes than loans. About 90% of pension funds’ exposure to CRE reflects ownership stakes compared with 30% for insurance companies. Both types of entities hold only about 3% of their total invested assets in the office subsector. The ownership stakes of pension funds are mostly high-quality office properties in large city centres, which have seen more modest declines in value than office properties of lower quality.

Canadian pension funds and insurance companies are generally well equipped to absorb losses:

• They have both the diversity of holdings required to help offset impacts on their earnings and the long investment horizons necessary to absorb losses.
• They are structurally less exposed to funding and redemption risks.
• There is typically less leverage in Canadian CRE relative to CRE in the United States.

In recent months, some asset managers, including pension funds and insurance companies, have written down their exposures to the CRE sector as part of periodic asset revaluations. The extent of these revaluations has likely lagged behind the declines in market valuations shown in Chart 2‑A . This could reflect long-term valuation assumptions that investors such as pension funds and insurance companies make or a higher-quality asset base. It could also suggest that further adjustments may be necessary in the future, particularly in the office subsector.

There are two key takeaways about risks to the Canadian financial sector from commercial real estate:

• First, because many Canadian financial entities participate in the CRE sector, the risk is not concentrated in any one area of the financial system.
• Second, given their diversified loan and asset portfolios, the largest entities in the system appear to have generally limited exposures to CRE.

Risks in this area are expected to continue to evolve, and the Bank of Canada will continue to monitor this area closely.

Non-bank financial intermediaries

In Canada, a significant amount of bank-like activity occurs outside the traditional banking sector and involves non-bank financial intermediaries (NBFIs), such as non-bank lenders and asset managers (e.g., pension funds, insurance companies and fund managers). NBFIs—in particular asset managers—face liquidity risks resulting from portfolio rebalancing needs, investor redemptions and increases in margin requirements for derivative positions. They rely on core funding markets to manage these risks. 23

Asset managers’ leverage has grown over the past 12 months, led by an increase in hedge fund repo borrowings. Asset managers often take on leverage, through both repos and derivatives, to increase their return to investors and to manage risks. 24 This leverage can increase the vulnerability of asset managers in periods of volatility to liquidity needs arising from, for example, a withdrawal of funding or margin calls. Asset managers, particularly those who rely on short-term loans like repos, face the risk that they will not be able to replace maturing debt with new debt. This is known as refinancing (or rollover) risk. A rapid unwinding of repo borrowings can also have negative spillover effects on the broader repo and fixed-income markets.

In contrast, risk associated with liquidity mismatch faced by bond and money market mutual funds is broadly unchanged over 2023. Mutual funds face liquidity risks when they offer daily redemptions to investors but invest in assets, such as corporate bonds, that are relatively less liquid than other mutual fund assets. If a fund faces redemptions that exceed its available liquidity—the cash and safe assets it sets aside to meet regular and unanticipated liquidity needs—the fund may have to sell assets from its portfolio. If many asset managers try to sell similar assets over a short period of time to raise liquidity, it can amplify price movements.

Hedge funds and pension funds have significantly increased their use of repo leverage

Leverage obtained by asset managers through borrowing in the repo market increased by around 30% in the past 12 months. 25 This increase was driven largely by hedge funds and pension funds increasing their repo leverage by approximately 75% and 14%, respectively. 26 Pension funds are the largest non-bank participants in Canadian repo markets, with over $90 billion in total borrowing outstanding. These pension funds face relatively less refinancing risk than hedge funds. About half of pension fund repo leverage has a maturity greater than one month, while about 70% of hedge fund repo exposure is under one week because hedge funds tend to rely more heavily on overnight and short-term repos. Some individual repo positions held by hedge funds are also very large and highly concentrated—for example, in a single Government of Canada bond.

The largest pension funds and insurance companies are typically sophisticated users of leverage that manage their liquidity risk and use liquidity coverage ratios to monitor planned and potential outflows. 27 Nonetheless, even sophisticated users can run into difficulties during periods of market stress, as seen in the October 2022 UK pension fund experience and during the March 2020 “dash for cash.” 28

Discussions with market participants and analysis of trading data indicate that one of the drivers behind the increase in hedge fund leverage is relative-value strategies. An example is the increasingly popular cash-futures basis trade in the Government of Canada bond market (see Box 3 ). These trades can provide market liquidity in both futures and bond markets. However, the large degree of leverage employed can leave hedge funds vulnerable to changes in the price difference between the underlying securities as well as to sudden changes in the availability and cost of repo financing.

Liquidity mismatch in the mutual fund sector is broadly unchanged

The liquidity mismatch in the mutual fund sector remained roughly the same over the past 12 months. Bond fund assets grew 4.3% in 2023, while liquid holdings, composed of cash and government treasury bills and bonds, grew from 9.2% to 10.2%, as these funds reduced their share of assets in corporate bonds. Money market funds grew significantly in 2023, with assets increasing 51% to $78 billion, primarily as a result of investor inflows. Despite this growth, money market funds remain a relatively small segment of the mutual fund sector. 29 The liquidity of these funds has improved over time as the share of their assets held in cash or Government of Canada treasury bills has grown from 30.0% to 37.6%.

Many non-bank financial intermediaries are holding more liquidity

In discussions with Bank of Canada staff, asset managers report putting a greater focus on monitoring and managing liquidity risk, including increasing liquidity buffers. In the Bank’s 2024 Financial System Survey (FSS), more than half of asset managers reported that they have shifted more of their investments toward cash equivalents and government bonds since the start of monetary policy tightening in 2022 ( Chart 11 ). 30

These increased liquidity buffers should improve the ability of asset managers to absorb liquidity shocks. Asset managers should bear in mind, however, that other market participants may have liquidity buffers made up of similar assets that they also intend to sell during periods of stress. The aggregate impact of these sales during periods of stress may lead to fire-sale dynamics, transmitting stress through the financial system.

Box 3: Cash-futures basis trade

The basis trade, a relative-value strategy that has been a feature of the US Treasury market in recent years, is becoming more popular in Canada. This type of trading strategy uses a mix of long and short positions to capitalize on price differences between bonds and bond futures.

Market participants typically use a high degree of leverage—or borrowed funds—to increase profits for these trades. For example, when bond futures contracts are relatively more expensive than the underlying bond, an entity could profit from a cash-futures basis trade by selling bond futures, buying the underlying bond, and borrowing cash in repurchase agreement (repo) markets using the bond as collateral to finance the position.

Basis trades can improve market efficiency by reducing the cost of buying bond futures and supplying futures market liquidity to those who prefer holding long futures instead of bonds. 31 These trades can also pose risk in times of stress—both to those making the trades and to financial markets more generally—due to many factors.

• The pricing discrepancies tend to be quite small, so to increase the profitability of the trades, financial firms (usually large, foreign-domiciled hedge funds) often use a large degree of leverage, which they typically obtain in the repo market. Indeed, the increase in the basis trade has been cited as one of the contributing factors for the surge in demand for repo funding seen earlier this year in Canada. 32 High repo leverage, particularly when it is obtained through overnight or short-term repo maturities, can amplify sudden price movements in the underlying bond market.
• Maintaining these trades could become costly if repo rates were to spike suddenly, or if higher bond market volatility were to result in larger margin calls. The unwinding of these trades as a result of these shocks could lead to abrupt sales of fixed-income assets and, possibly, to strains on market liquidity. The more leveraged a hedge fund is, the more vulnerable it is to such shocks, and the greater the risk it poses to the overall system. This was evident in the US Treasury bond market in March 2020, when pandemic-related market stress caused many hedge funds to unwind their sizable cash-futures basis trade positions. This unwinding resulted in a large volume of US Treasury bonds being sold and contributed to the severe hampering of what is normally considered the most liquid bond market in the world. The one-way selling negatively affected market participants around the world that rely on the liquidity and stability of US Treasuries. 33 As the International Monetary Fund recently noted, the aggressive use of repo leverage can also leave these trades vulnerable to other shocks, including upside inflationary surprises that could lower the value of bonds. 34

The cash-futures basis trade is estimated to have grown steadily in Canada ( Chart 3‑A ), with exchange-for-physical transactions reaching $51 billion by the end of April 2024. 35 This represents about 8% of the total trading volume of Government of Canada bonds ( Chart 3‑B ). 36 , 37 Of the total volume, 45% is in 2-year futures contracts, and the remainder is split somewhat evenly between the 5- and 10-year futures contracts.

The growth of the basis trade in Canada has mirrored the growth of the Government of Canada bond futures market, including the reintroduction of 2- and 5-year futures contracts a few years ago. This has resulted in relatively steady shares of total futures trading volumes.

• 1. The upward pressure seen periodically in Canadian repo markets over the past 12 months is largely due to an increase in borrowing to finance investment positions rather than due to quantitative tightening. See B. Plong and N. Maru, “ What has been putting upward pressure on CORRA? ” Bank of Canada Staff Analytical Note No. 2024-4 (March 2024).[ ← ]
• 2. See Office of the Superintendent of Financial Institutions, “ 2024 Capital Adequacy Requirements (CAR) – Letter (2023) ” (letter to banks and trust and loan companies, October 20, 2023), and Office of the Superintendent of Financial Institutions, “ Commercial Real Estate Risk Management ” (regulatory notice, September 29, 2023).[ ← ]
• 3. For more information, see Office of the Superintendent of Financial Institutions, “ OSFI Reinforces Resilience of Canada’s Financial System: Sets Domestic Stability Buffer at 3.5% ” (press release, June 20, 2023).[ ← ]
• 4. For more details, please see the results of the 2024 Financial System Survey .[ ← ]
• 5. For instance, many asset managers responding to the Bank’s Financial System Survey indicated that they would rebalance their portfolios toward safer assets if interest rates were to be higher than expected. Such behaviour could contribute to unusually large price movements and, in extreme cases, fire-sale dynamics.[ ← ]
• 6. For more information, see the “ Indicators of financial vulnerabilities ” page on the Bank’s website.[ ← ]
• 7. Separating out renters from outright homeowners in the TransUnion data is not possible. Both groups are categorized as households without a mortgage .[ ← ]
• 8. The survey results show that renters were more likely than homeowners to report having their financial situation worsen in 2023 and being at risk of missing a debt payment in the next three months. See N. Bédard and P. Sabourin, “ Measuring household financial stress in Canada using consumer surveys ,” Bank of Canada Staff Analytical Note No. 2024-5 (April 2024).[ ← ]
• 9. To protect the privacy of Canadians, TransUnion did not provide any personal information to the Bank. The TransUnion dataset was anonymized, meaning it does not include information that identifies individual Canadians, such as names, social insurance numbers or addresses.[ ← ]
• 10. See J. Xiao, “The reliance of Canadians on credit card debt as a predictor of financial stress,” Bank of Canada Staff Analytical Note (forthcoming).[ ← ]
• 11. See M. teNyenhuis and A. Su, “ The impact of higher interest rates on mortgage payments ,” Bank of Canada Staff Analytical Note No. 2023-19 (December 2023).[ ← ]
• 12. For instance, 12% of new mortgages had a loan-to-income ratio above 450% at the end of 2023, a historical low. Also, 47% of new mortgages had an amortization period longer than 25 years , up from 34% in 2019.[ ← ]
• 13. This definition of liquid assets includes some financial instruments that can be converted to cash, such as equities and mutual funds, and whose value may fluctuate. This definition also includes guaranteed investment certificates, which could be subject to early withdrawal penalties.[ ← ]
• 14. The data behind this analysis are published by the Office of the Superintendent of Bankruptcy under the Bankruptcy and Insolvency Act. See Office of the Superintendent of Bankruptcy, “ Insolvency and CCAA Statistics in Canada ” (modified May 3, 2024).[ ← ]
• 15. Businesses filing for insolvency are typically small. Insolvency data reveal that the median liabilities held by businesses at the time of filing were close to $210,000 in 2023. Note that summary statistics calculated using the publicly available dataset from the Office of the Superintendent of Bankruptcy must be interpreted with some caution. This is because data on liabilities reflect what is reported as part of the filing by insolvency trustees, which need to report only $1,000 in liabilities to start the insolvency process. Since 2013, submissions that reported the minimum liabilities represented under 4% of all business insolvency filings. Also, data on liabilities are totalled by the first three digits of postal codes in the dataset.[ ← ]
• 16. Insolvency proposals allow businesses to continue operating while restructuring their debt. In contrast, under bankruptcy filings, businesses stop operating and their assets are liquidated.[ ← ]
• 17. The construction industry is somewhat of an outlier to this analysis and is excluded from Chart 1‑B for ease of illustration. Business insolvencies in construction during the pandemic were significantly below the industry’s 2016–19 average. A rebound above the construction industry’s pre-pandemic average has occurred, but only from mid-2023 onward. Because of this, the cumulative rebound is small compared with the cumulative deviations below average that were registered during the pandemic.[ ← ]
• 18. The shorter terms of mortgages issued by smaller and alternative lenders reflect the fact that high-risk borrowers usually aim to improve their credit score and transition to a prime lender at a lower mortgage rate.[ ← ]
• 19. For large banks in Canada, business lending comprises about 40% of total lending, of which loans to small businesses tend to make up a relatively small share. Among the two large banks that publish information on their business loan portfolio by firm size, loans to small and medium-sized businesses account for about 8.5% of total business loans. The liabilities of insolvent businesses (as declared at the time of filing) totaled about $11.4 billion in 2023. On the extreme assumption that all of these liabilities were owed in the form of bank loans, this would have represented only about 0.7% of all outstanding bank loans to incorporated businesses.[ ← ]
• 20. The common equity Tier 1 ratio is a measure of a bank’s capacity to absorb losses. It measures a bank’s equity, including certain regulatory adjustments, to its overall risk-weighted assets. This measure weights the value of assets for their perceived riskiness.[ ← ]
• 21. The liquidity coverage ratio measures a bank’s ability to continue to meet its obligations during a short period of acute funding stress. It is defined as the total amount of liquid assets to its net cash outflows, adjusted for assumed stressed flow rates.[ ← ]
• 22. See CBRE, “ Canada Office Figures Q4 2023 ,” Executive summary (January 9, 2024).[ ← ]
• 23. An asset is considered to be liquid if it can be traded at low cost in large quantities in a short period of time without a significant impact on its price. For more details, see S. Gungor and J. Yang, “ Has Liquidity in Canadian Government Bond Markets Deteriorated? ” Bank of Canada Staff Analytical Note No. 2017-10 (August 2017).[ ← ]
• 24. For example, pension funds and life insurance companies make use of derivatives to hedge risk related to foreign exchange and interest rates.[ ← ]
• 25. Data are as at May 1, 2023.[ ← ]
• 26. Estimates are based on transaction data reported to the Canadian Investment Regulatory Organization (CIRO) through the Market Trade Reporting System 2.0. Therefore, the estimates reflect only transactions where at least one counterparty is a CIRO-registered dealer. Only Canadian-dollar repo transactions with known maturity dates are included. These data may not fully reflect the positions of firms. For example, firms may also transact with non-CIRO-registered dealers.[ ← ]
• 27. For details on pension funds, see G. Bédard-Pagé, D. Bolduc-Zuluaga, A. Demers, J.-P. Dion, M. Pandey, L. Berger-Soucy and A. Walton, “ COVID‑19 crisis: Liquidity management at Canada’s largest public pension funds ,” Bank of Canada Staff Analytical Note No. 2021-11 (May 2021). For life insurance companies, see P. Aldridge, S. Gignac, R. Vala and A. Walton, “ Liquidity risks at Canadian life insurance companies ,” Bank of Canada Staff Analytical Note No. 2024-7 (April 2024).[ ← ]
• 28. See J.-S. Fontaine, C. Garriott, J. Johal, J. Lee and A. Uthemann, “ COVID‑19 Crisis: Lessons Learned for Future Policy Research ,” Bank of Canada Staff Discussion Paper No. 2021-2 (February 2021).[ ← ]
• 29. Money market funds comprised 2.6% of total Canadian mutual fund assets at the end of 2023.[ ← ]
• 30. The FSS also showed that a large number of firms had not significantly changed their asset composition, while some had increased their exposure to less liquid assets. For more details, see Bank of Canada, Financial System Survey highlights—2024 (May 2024).[ ← ]
• 31. See J. Sandhu and R. Vala, “ Do hedge funds support liquidity in the Government of Canada bond market? ” Bank of Canada Staff Analytical Note No. 2023-11 (August 2023).[ ← ]
• 32. See B. Plong and N. Maru, “ What has been putting upward pressure on CORRA ?” Bank of Canada Staff Analytical Note No. 2024-4 (March 2024).[ ← ]
• 33. The US Securities and Exchange Commission has subsequently required firms providing significant liquidity in the US Treasury market to register as dealers.[ ← ]
• 34. See International Monetary Fund, “ Global Financial Stability Report – The Last Mile: Financial Vulnerabilities and Risks ” (April 2024).[ ← ]
• 35. The Montréal Exchange offers market participants the ability to simultaneously take offsetting positions in fixed-income instruments and bond futures through exchange-for-physical transactions. Fixed-income instruments must have a risk profile similar to Government of Canada bonds that underly bond futures. For more details, see Montréal Exchange, “Exchange for Physical (EFPs) .”[ ← ]
• 36. See A. Uthemann and R. Vala, “How big is cash-futures basis trading in Canada’s government bond market?” Bank of Canada Staff Analytical Note (forthcoming).[ ← ]
• 37. See J. Glicoes, B. Iorio, P. Monin and L. Petrasek, “ Quantifying Treasury Cash-Futures Basis Trades ,” FEDS Notes , Board of Governors of the Federal Reserve System (March 8, 2024). Glicoes et al. estimate, using a different methodology than presented in this Report, that in the United States, positions in the basis trade ranged from US$317 billion to US$991 billion at the end of January 2024.[ ← ]
• 38. See Sandhu and Vala (2023).[ ← ]

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