Bank of Canada warns pension funds of risky buys
By Allan Dowd
VANCOUVER (Reuters) - The Bank of Canada warned on Thursday that Canadian pension funds and insurance companies could be tempted to invest in risky assets in order to fulfill expectations of obtaining decent returns.
Timothy Lane, deputy governor at the central bank, said institutional investors are often expected or required to deliver a target rate of return.
In an environment where interest rates are still at extraordinarily low levels following the global financial crisis, the only way to achieve certain targets is by taking on extra risk, which can be rewarded by higher yields, Lane said in a speech in Vancouver, British Columbia, to an audience of professionals in the pension industry.
"This is a particular instance of the 'search for yield' that often accompanies a long period of very low interest rates," he said.
"It may be associated with excessive credit creation and undue risk-taking as investors seek higher returns, leading to the underpricing of risk and unsustainable increases in asset prices," he said.
Lane said new risks to the financial system were emerging as a result of a two-speed global economic recovery in which emerging markets are growing robustly and starting to raise interest rates to cool their economies while growth in advanced economies remains sluggish and rates still very low.
In addition, sovereign debt problems could indirectly threaten Canadian banks even though direct exposure to peripheral European countries is small. Debt problems elsewhere could hit Canada through higher funding costs and a decline in asset price valuations.
Canadian banks emerged from the global crisis unscathed and without need of bailouts. But policymakers say it's too early to declare victory. Continued...