Financial System Review Summary—2021

The Financial System Review explains how financial vulnerabilities in Canada have evolved over the past year.

Household vulnerabilities have intensified

Many households have built up savings and paid down debt over the past year. Signs of financial stress, like personal bankruptcies, are low. This is mainly thanks to exceptional government support.

Despite this support, we remain concerned about household indebtedness and the rapid rise in house prices:

  • Many households have taken on large mortgages compared with their income, so have less flexibility to deal with unexpected events like the loss of a job.
  • Overall, the increase in mortgage debt has more than offset declines in consumer debt, such as credit card debt.
  • Many Canadians are spending more of their work and leisure hours at home and they are looking for larger places to live. But the number of houses available to buy is limited, and prices in several housing markets are rising quickly. What’s more, some people may be buying homes now because they expect prices to keep climbing, and this is a concern.
  • If house prices and household incomes were to fall in the future because of a shock to the economy, some households could need to cut back on spending. This would slow the economy and possibly put stress on the financial system.

Heightened vulnerabilities: Market liquidity and climate change

The potential demand for liquidity in the bond market is growing faster than what banks can supply in times of high stress.

The asset-management sector relies on liquidity to manage its risk. This sector is growing faster than banks’ capacity to supply liquidity. So, the financial system could be vulnerable to a sudden spike in demand for cash. This is not a new vulnerability. But the risk it poses for the stability of the financial system was highlighted by the market stress seen in spring 2020—which some called the “dash for cash.”

Assets that are exposed to climate risks are generally mispriced. This can leave investors and financial institutions exposed to sudden losses due to severe weather events and the transition to a low-carbon economy.

Other challenges on the horizon

Canada’s financial system faces other vulnerabilities that will need to be watched closely:

  • the viability of some businesses when government supports end
  • the continued reliance of some firms on high-yield debt—a form of financing subject to sudden changes in investor sentiment
  • the growing threat of cyber attacks
  • the rapid evolution of cryptoasset markets

Another challenge is that financial conditions could tighten considerably if a trigger event were to lead to a global repricing of risk. Such an event could include:

  • a more severe and persistent pandemic
  • an earlier-than-expected withdrawal of global policy support
  • geopolitical tensions
  • a reassessment of global inflation risks

News – Bank of Canada