Canada is known for many things: a polite general public, a high standard of living and corrupt government officials. However, there is another attribute to add to the image of the Great White North: a world leader when it comes to debt.
A new report published by the McKinsey Global Institute outlined that Canada is susceptible to an economic crisis because of its enormous levels of household debt unless something is done by the consumers and banks.
In fact, Canada is just second to Greece in the spike in household debt-to-income ratios between 2007 and 2014.
Studying the debt levels of 22 developed and 25 developing countries, it concluded that Canada’s “unsustainable” household debt levels are higher than those in the United Kingdom and the United States prior to the financial collapse in 2007. According to the report, the debt-to-income ratio in Canada stands at 155 percent as of 2013, and this has increased by 22 points since 2007.
The report authors note that Canada faces similar risks as Australia, Malaysia, the Netherlands, South Korea, Sweden and Thailand. The difference with Canada is that the central bank is reducing interest rates – last month it slashed interest rates by 0.25 percent – as other countries are mulling over raising rates.
Whether or not Canada dips into a fiscal crisis depends upon several factors, including the national economy and lenders’ abilities to evaluate credit risk. For instance, if those who are borrowing immense sums and already maintain exorbitant amounts of debt but are high-income earners then there is a diminished risk.
“Compared with other households, highly leveraged ones are more sensitive to income shocks as a result of job losses, costly health problems, or increases in debt servicing costs,” the report stated. “To safely manage high levels of household debt, more flexible mortgage contracts, clearer personal bankruptcy rules, and stricter lending standards are needed.”
In addition, the low-rate environment helps servicing debt payments easier. But what happens if the Bank of Canada (BoC) does boost rates in the coming years? The study ignored that, but it did allude to rising housing prices in contributing to vast consumer debt loads, something that can be found in places like Holland.
“What the financial crisis showed us is that when you have rising real-estate prices and rising household debt, it can be a deadly mix. You have to manage each carefully,” said Susan Lund, a partner at McKinsey, in an interview with the Business News Network (BNN).
The BoC has previously warned on various occasions that household debt poses a risk to the long-term growth of the country.
In the past month, there have been a wide spectrum of reports highlights consumer debts. The Bank of Montreal (BMO) released its 2015 Credit Card Report on Tuesday, which found that nearly half of Canadian consumers carry some form of credit card debt, and one-third don’t pay off their balance each month.
More than half (56 percent) use their credit card for a majority of their purchases, but then about one-quarter (26 percent) pay off their credit card with all of their funds and attain more debt by paying for other expenses. It has been called a vicious cycle.
“Credit cards are a popular payment tool for Canadians; however, unchecked spending habits can result in getting stuck in continuous monthly debt cycles that can hamper near and long-term financial goals,” said Nick Mastromarco, managing director of North American retail payments at BMO, in a statement.
Perhaps the only solution for Canada is to follow in the footsteps of Croatia since consumers aren’t making the tough decisions to spend within their means. The Croatian government announced a new program called “fresh start” that effectively wipes out the debts held by the country’s 317,000 poorest citizens, who have been denied bank accounts because of outstanding debts.
In order to be considered for the program, a person’s debt must be smaller than $5,000, monthly incomes cannot be higher than $138 and a person cannot own any property or maintain savings. The Croatian government says this $300 million short-term investment will lead to long-term prosperity.
