UPDATE 2-Bank of Canada aims to develop stress test framework

(Adds comments on government role)
By Leah Schnurr
OTTAWA, May 6 (Reuters) - The Bank of Canada plans to
develop a framework for stress tests that will incorporate
different sectors of the financial system to enhance its
contribution to macroprudential oversight in Canada, Deputy
Governor Lawrence Schembri said on Friday.
In a speech focused on what central banks can do to
contribute to financial stability, Schembri said the system-wide
framework would cover banking, insurance and investment funds,
as well as financial markets and financial infrastructures.
Central banks must rethink their role in financial stability
in light of the severity of the global financial crisis, he
said.
Although the best contribution central banks can make to
financial stability is stability in inflation and the economy,
Schembri noted, "this is a necessary, but not sufficient,
condition for financial stability."
While Canada emerged relatively unscathed from the credit
crisis, the subsequent housing boom has raised concerns that
overly hot prices and heavily indebted homeowners pose a risk to
the system.
Asked about how much responsibility the Bank of Canada
bears, Schembri said the Canadian government is ultimately
responsible for financial system stability, though the central
bank plays an important role through the advisory committees it
sits on.
"The level of cooperation is relatively high and we're able
to respond fairly nimbly to situations where vulnerabilities are
cropping up," Schembri said, pointing to last year's mortgage
changes by the government to cool the housing sector.
Among measures Schembri suggested central banks can take to
aid financial stability are encouraging prudence among borrowers
and lenders, and increasing transparency to create market
awareness of potential vulnerabilities.
Central banks can improve their contribution to financial
stability by using their two key strengths, which are their
broad system-wide perspective and their analytical capacity, he
said.
"Although central banks don't themselves have a broad set of
instruments to mitigate financial vulnerabilities, they do have
that system-wide view, which they can and do use to promote
financial stability by making public their analyses of financial
vulnerabilities and risks and making recommendations for
preventive policy actions," Schembri said.
Schembri also said the Bank of Canada aims to improve its
models to better understand the interactions between monetary
and macroprudential policy. He described the bank's plans as
"aspirations", and did not suggest a timeline.