Financial Indicators

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Recently, there has been a great deal of discussion surrounding the financial positions of Canadian individuals, businesses and governments. The global financial and economic turmoil has sparked interest and debate about the impact of the “international financial crisis” on the Canadian economy.

The quarterly Financial and Wealth Accounts contain detailed information on the financial situation of the Canadian economy. The Financial and Wealth Accounts are comprised of the National Balance Sheet Accounts and the Financial Flow Accounts. The Financial Flow Accounts are accumulation accounts that articulate sector transactions in capital items and financial assets during a quarter; while the National Balance Sheet Accounts present the stock of assets, liabilities and the resulting net worth for the sectors of the Canadian economy at the end of each period.

One of the more powerful features of the Financial and Wealth Accounts is its ability to construct financial and wealth indicators which succinctly capture the evolution of the financial position of the sectors of the economy, in a timely fashion. The rich time series, based on internationally accepted conventions, provide users with both a historical perspective and the ability to make international comparisons.

This note explains the construction and relevance of some of these indicators, and highlights recent trends in indebtedness. International comparisons can be made using data available from the Organisation for Economic Co-operation and Development (OECD) or from statistical data presented by various agencies (e.g., U.S. Federal Reserve Board).

Leverage indicators

Individuals, corporations and governments take on debt for a number of reasons. For example, borrowing can be used to finance current consumption, to invest in machinery and equipment, to purchase real estate or to make financial investments. Debt and the ability to take on debt is an important element that is tied to economic growth; equally important is the ability to manage this debt. Looking at the values of debt in Chart 1 or the growth in debt on its own does not paint a complete or clear picture of financial soundness. Analyzing debt in relation to key macro-economic variables such as income and assets adds perspective to the analysis of financial positions.

Chart 1 Total debt: domestic non-financial sectors

Persons and unincorporated businesses sector – debt to income

The ratio of debt to personal disposable income is one leverage indicator. The major components of debt are the consumer credit and the mortgage debt of the personal sector. However, the debt measure includes other borrowings of households, such as loans for investment as well as the borrowings of the unincorporated businesses and the non-profit institutions serving households sector. Personal disposable income is defined as the income that individuals, unincorporated businesses, and institutions of the non-profit sector serving households (PUIB) receive, including transfer payments, minus the income taxes and fees that they pay to governments.

The debt to income ratio is a measure of the amount of current after-tax income (on a National Accounts basis) required to eliminate one's debt—providing a broad indication of the sector's ability or inability to pay down its debt. This ratio is also a rough indicator of the sector's ability to take on additional debt and/or lenders' willingness to extend the sector additional funds. An upward trending debt to income ratio can be indicative of a number of changes in demand for, or supply of, funds, such as an increased willingness of individuals to consume today and pay later or relaxed credit conditions on the part of lenders.

Over the last 20 years, the PUIB sector's debt to income ratio has been steadily increasing, reflecting increased demand for goods and services and evolving attitudes towards taking on debt. This increase intensified at the start of the decade as lending practices at financial institutions became more open. The debt to income ratio in Canada and the United States (Chart 2) has grown in excess of 50% since the 1990s. The Canadian debt to income ratio increased faster than the American's in the 1990s, while the opposite has been true since the start of this decade.

Chart 2 Houshold debt a share of personal disposal income, Canada, United States

The debt service ratio (Chart 3) helps to explain the increase in the PUIB debt to income ratio. The debt service ratio measures the claim on personal disposable income required to make interest payments on total liabilities.

While Canadians have increased their overall debt load relative to their income, interest rates have been declining. This has translated into a slowing of the growth in costs to service debt relative to income. This, in turn, may have been a demand-side factor, increasing Canadian's willingness to incur debt. The debt service ratio has declined from a high of 10% in the early 1990s to a low of 6.5% in 2004, and currently sits at 7.9%. Simply put, one of the reasons Canadians were willing to let their debt grow dramatically was that the relative decline in the cost of servicing the debt was equally dramatic for most of the period.

Chart 3 Persons and unincorporated businesses sector debt service ratio and debt-to-income ratio

Persons and unincorporated businesses sector – debt to net worth

Income is only one factor that economic agents take into account when borrowing or providing credit. Assets and net worth are also important factors. If a sector's total assets exceed their liabilities, or if asset growth exceeds liability growth, borrowers and lenders may judge that additional debt may be reasonable, given the assets which are available for liquidation, if required.

Comparing the PUIB sector's debt to its net worth (total assets minus total liabilities) provides another measure of the sector's capacity to carry debt (Chart 4).

Chart 4 Debt to net worth

The PUIB sector's debt to net worth ratio has varied from around 22% in 1990 to 19% in 2000 to the current high of around 25%. Overall, the ratio has remained relatively stable, meaning that asset growth has largely kept pace with liability growth. This suggests that since 1990 there may have been a significant wealth effect in the spending and saving patterns of individuals, with saving out of income being replaced with the accumulation of wealth through an appreciation of assets. Financial assets became increasingly concentrated in equities over time, in both direct and indirect holdings, through investments in mutual funds and pension funds. The appreciation of both financial assets and non-financial assets, combined with declining debt-service costs, likely had a stimulative effect on borrowing. The increased borrowing spurred consumption, which supported economic growth. This demand for products, housing and financial instruments, in turn, contributed to driving up the value of financial and non-financial assets. The wealth effect leads economic agents to feel as though the increasing value of their assets can support increases in their debt (see Trends in Saving and Net Lending in the National Accounts).

Corporate sector – debt to equity

Debt ratios can also be calculated for the corporate non-financial sector. One such indicator, the debt to equity ratio, is the ratio of credit market debt of non-financial private corporations to the book value of their equity (Chart 4).The value of the equity of non-financial corporations increased much faster than their debt, driving the ratio down from 90% in 1990 to around 50% in 2008. In many ways non-financial corporations are in better financial condition today than at any point in the last 20 years, having spent most of the last two decades investing part of their earnings in strengthening their balance sheets (see Recent Trends in Corporate Finance from the Canadian System of National Accounts).

Debt to gross domestic product ratios

Debt to gross domestic product (GDP) ratios provide a convenient way of making comparisons across sectors or economies with respect to relative indebtedness (Chart 5). These are calculated by scaling debt by nominal gross domestic product. Debt to GDP ratios are ratios at the national or sector level, which provide a very general indication of a country's or sector's ability to meet its financial obligations. By comparing what a country owes and what income arises from productive activity, the debt-to-GDP ratio is an indication of a country's ability to make future debt payments.

Statistics Canada provides measures of debt to GDP for the persons and unincorporated businesses, non-financial private corporations, federal government, other levels of government and the consolidated government sectors.

Chart 5 Debt to gross domestic product

The overall debt to GDP ratio (summing debt across all non-financial sectors) currently sits at roughly the same level as in 1990. In the early 1990s debt of all sectors was increasing at a faster rate than GDP. In the late 1990s as economic growth accelerated, debt to GDP began to trend downward. At the same time, there were significant sectoral shifts in the debt ratio. The personal sector continued to accumulate debt at a faster pace than the growth in GDP, while the government sector and non-financial private corporation sector appreciably reduced their demand for borrowed funds, such that debt slowed relative to growth in GDP.

At the same time as the PUIB sector was accumulating debt, both the government and non-financial corporate sectors were strengthening their balance sheets. Strong earnings, lower interest costs and sustained demand for corporate shares have all contributed to an overall strengthening of financial positions of corporations.

The global financial uncertainty makes timely financial indicators a critical source of information. The ratios in this note represent a sub-set of financial indicators that will be released with the first quarter of 2009. The complete set of indicators will include indicators pertaining to financial corporations. This note has focused on indicators related to debt. Given the differences in the use of debt by financial corporations, this note does not include a framework through which financial corporations could easily be compared to other sectors.

Statistical tables

• Table I.1 Financial indicators