The big Canadian banks have about half their balance sheets in foreign assets and liabilities, but the sort of business they do overseas is much different than their domestic operations, potentially exposing them to added risks, according to a working paper from the Bank of Canada.
The paper, published by the central bank’s financial stability department, reported that the Big Six banks have increased the foreign share of their balance sheets over the past 10 years — to the point that foreign exposures represent about half of their overall balance sheets, and more than half for certain balance sheet items.
“Having fared relatively well through the 2008–2009 global financial crisis, the Big Six have expanded their international activities extensively over the past decade,” the paper said, adding that their foreign assets and liabilities have roughly doubled in the past 10 years.
While there are benefits to this increased diversification, the paper suggested that it carries risks too, as “international expansion inevitably exposes Canadian banks — and consequently the Canadian banking system — to foreign economic and financial developments.”
For instance, the banks’ foreign businesses are much different than their traditional, domestic businesses.
According to the paper, while the banks primarily deal with households and businesses in their domestic operations, their primary counterparties in their foreign arms are non-bank financial institutions (NBFIs) — a category that includes investment banks, hedge funds, insurers and private equity funds — which tend to be riskier and more opaque than the banks’ domestic counterparties.
“Evidence from the literature suggests that the NBFI sector is less regulated, more complex, and riskier than the traditional banking sector,” the paper said.
And, given that non-bank financials tend to be “complex entities that are potentially difficult to assess and fully understand,” having large exposures to these kinds of entities “could constitute a potential vulnerability,” the paper said.
The central bank stressed that it’s “important that all market participants significantly exposed to NBFI counterparties —particularly to foreign NBFI counterparties — improve their understanding of the NBFI sector as a whole and manage their exposures prudently.”
In addition to this increased exposure to potentially complex, opaque counterparties, the big banks’ increased foreign exposure also carries an array of added currency, country, credit and market risks, the paper noted.