While the four economies it dubbed the "CANNS" (Canada, Australia, New Zealand, Norway and Sweden) represented a modest portion of the global economy, the size of their banking sectors, which have benefited from low rates and exposure to China, had grown dangerously out of proportion.

These economies, it said, would be "highly important for global investors to monitor in 2018".

ASR was founded in 2006 by Ian Harnett, the former chief ­European investment strategist at UBS, and David ­Bowers, the former global investment strategist at Merrill Lynch. It consults to several large Australian institutions.

A banking sector, they said, that accounted for 20 per cent of total market capitalisation was a "danger signal" in developed markets as major economies have not been able to "sustain" such a large financial sector.

The big four Australian banks account for over 25 per cent of the S&P/ASX 200 Index. Karl Hilzinger

ASR cited Japan in the 1990s, the United Kingdom in 2003-04 and the eurozone in 2007 as instances when banks had reached one fifth of their respective equity markets only to fall sharply in value. Australia, it noted, has been "the only major counter-example".

"The problem is that to keep sustaining 20 per cent of total market cap, the banks need to keep generating increased income.

"In a world of low rates, this entails an expansion of their assets. However, there are only so many financial assets that the home economy can generate before saturation kicks in, or the asset quality deteriorates."


The big four Australian banks account for over 25 per cent of the S&P/ASX 200 Index.

However, it's a lesser-known fact that Australia's big four banks are among the top 11 weightings in the MSCI Asia Pacific index along with the likes of Japanese industrial giants Toyota, Sony and Softbank. That is despite the entire Australian market accounting for just 18 per cent of the index.

The potential for issues in the banking sector to spread to the broader economy should not be underestimated, ASR said.

"The key lesson for us from [the global financial crisis] was that systemic risk is multiplicative, rather than additive. It was the collapse of relatively small, but important, institutions that triggered the market meltdown".

Coining CANN

The firm said it coined the CANN acronym in November after it was struck by how "global house price inflation had been focused in a small group of economies in the post-GFC recovery".

These economies had experienced annualised house price growth of around 5 per cent to 6 per cent since 2009, compared to 1.6 per cent for other developed economies.


While overall debt levels of these economies were in line with peers, they were notable because a higher proportion of the debt resided with the household sector.

ASR said this led to "a toxic mix of high debt and high house prices" and there was a "a clear reason to be concerned about the outlook for the CANNS as standalone economies in the year ahead".

"Higher rates, or slowing growth, especially if it is triggered by a China slowdown, will expose their fragility," the strategists said.

The threats posed to financial stability have not gone unnoticed by regulators, which have taken measures to reduce the vulnerabilities to their respective economies.

But the report notes while the Bank of Canada and the Reserve Bank believe their policies have helped manage risks, the Swedish Riksbank is under no illusions as its systemic vulnerability index has increased to a multi-decade high.

Another risk that ASR identified is a reliance on foreign capital to finance mortgage lending, which if cut off could lead to a funding crisis.

Australian banks' reliance on offshore wholesale funding has long been identified as a structural weakness that they have sought to manage.

However, it appears that regulators in Sweden and Canada are beginning to be worried about the prevalence of "covered bonds".


"Covered bonds" allow banks to pledge mortgages as additional security and have been used in Europe for hundreds of years without default.

But ASR says Sweden's banks now all own each other's covered bonds while Canada's banks have used this form of debt to raise billions of foreign-denominated debt, making them vulnerable to a fall in the currency.

There was some "irony", ASR wrote, that a funding tool promoted by policymakers in the aftermath of the financial crisis as an alternative to sub-prime mortgage securitisations "might themselves become a potential source of instability".

Pressure on house prices

ASR said "the cracks are beginning to appear" and any factor that "impacts debt sustainability could challenge the CANNS".

"Slower Chinese growth is a key risk, both because of reduced demand for the exports of these countries but also, potentially, through reduced liquidity," it said.

"Rising global rates would also challenge stretched CANNS households to sustain repayments.

"A sharp rise in the US dollar might also limit access to foreign currency funding for the CANNS banks.

"Any of these factors could, potentially, intensify the negative pressure on house prices in key CANNS cities, damaging collateral values and triggering retrenchment."