Canada's OSFI identifies housing market and interest rates as main risks to financial system

According to Canada’s financial regulator, the Office of the Superintendent of Financial Institutions (OSFI), the main threats to the country’s financial system this fiscal year are the possibility of a decline in the housing market and the challenge of adapting to sudden rises in interest rates. In its inaugural annual risk outlook report for the period until March 31, 2024, OSFI stated that it is taking measures to ensure that federally regulated financial institutions remain attentive to shifting market circumstances.

Peter Routledge, the superintendent at OSFI, stated that OSFI is getting ready for the possibility, but not making a prediction, that the housing market could go through a period of sustained weakness throughout 2023. The regulator also mentioned that the transition to higher interest rates might not be entirely smooth and that it was increasing its monitoring of market liquidity.

Over the past year, the Bank of Canada has raised rates at an unprecedented pace to control inflation, which hit a four-decade high in June. In its last two policy meetings, the bank has left its key policy rate at the 15-year high of 4.50% to allow the effects of policy tightening to take hold.

According to OSFI’s report, the significant surge in interest rates has resulted in a decrease in debt affordability. This could lead to mortgage holders being unable to manage their monthly payments if interest rates continue to rise or experience a significant payment shock when it comes time to renew their mortgage, which may increase the likelihood of defaults.

As a result, OSFI is planning to issue draft guidance on debt management measures to help mitigate the risk associated with high levels of consumer indebtedness. The regulator is also exploring ways to enhance credit quality and mortgage underwriting at federally regulated financial institutions. Additionally, OSFI is examining the risks associated with variable rate fixed mortgages.

According to the regulator, OSFI, there are additional risks to the financial system that include the growth and unpredictability of unregulated non-bank financial institutions. In circumstances where markets are volatile or declining, such entities could pose a threat to the broader financial system. These non-bank financial institutions, such as investment funds, insurance companies, and pension funds, operate using different business models, balance sheets, and governance structures.

Apart from non-bank entities, OSFI also highlighted climate-related risks, such as weather events, as a potential threat to the financial system. Additionally, the regulator warned of the indirect effects of transitioning toward a low-emitting economy. OSFI has announced its intentions to gather, scrutinize and divulge new data pertaining to climate-related risks. The regulator has also identified other risks to the financial system, including cyber-attacks and hazards that arise from the advent of emerging technologies.

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Canada's OSFI identifies housing market and interest rates as main risks to financial system

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