Bank of Canada Warns of Financial Risks Amid Stability Assessment

The Bank of Canada has issued a cautionary statement regarding the stability of the Canadian financial system, citing lingering risks attributed to debt servicing costs and stretched valuations of financial assets. In its Financial Stability Report released on Thursday, the central bank evaluates the risks and stability within the Canadian financial landscape.

Bank of Canada Governor Tiff Macklem emphasized that while households, businesses, banks, and other financial institutions have taken proactive measures to adapt to higher interest rates and economic shocks, there are still risks that need to be addressed. Stretched asset valuations, particularly among non-bank participants such as pension funds and hedge funds, pose a significant concern, with leverage increasing by 30 percent over the past year.

Macklem expressed apprehension about the potential for a sharp correction in asset prices, which could precipitate system-wide stress, particularly in the non-bank financial sector. The report underscores the increased liquidity among asset managers, who have shifted investments towards government bonds since 2022. However, the concentration of cash equivalent assets among market participants could lead to a fire sale scenario during market downturns, exacerbating financial stress.

Furthermore, the report highlights the financial distress experienced by non-mortgage holders, particularly renters, who are facing rising arrears on credit cards and car loans. Macklem attributed this stress to lower incomes, inflationary pressures, and high-interest rates. Among mortgage holders, the bank notes that half of borrowers with 5-year fixed mortgages are yet to renew, potentially facing significant increases in monthly payments.

Bank of Canada Senior Deputy Governor Carolyn Rogers emphasized the importance of monitoring the labor market, as stable income is crucial for debt servicing. Insolvencies among businesses have surged, surpassing pre-pandemic levels, mainly affecting the small business sector due to higher borrowing costs and reduced government support programs.

The central bank’s assessment underscores the need for continued vigilance and proactive measures to mitigate financial risks and ensure the stability of the Canadian financial system amidst ongoing economic challenges.