The Office of the Superintendent of Financial Institutions (OSFI) has released a fall update to its Annual Risk Outlook, first published in April. While the risk outlook is published once a year, if risks in the financial system substantially evolve, the fall update may be required.
In this update, nine financial system risks are identified, all previously discussed in the annual report, including housing market downturn risk, liquidity and funding risks, commercial real estate risk, the risk that stress will be transferred from non-bank financial intermediaries, corporate and commercial credit risk, digital innovation risk, climate risk, cyber risk and third-party risk. The update to the annual report focuses on the impact of inflation and signs of weakening credit quality, particularly in commercial real estate.
“The financial system is adjusting to a higher interest rate environment. Given the rapidity at which interest rates globally have increased, the risk has grown that such an adjustment may not be completely smooth,” they write. “Other risks also present themselves on OSFI’s horizon. Growth and uncertainty in unregulated, non-bank financial intermediation may increase the likelihood of risk transmission to the broader financial system during periods of volatility and market decline.”
They say the non-bank financial intermediaries sector, dubbed the NBFI sector, is comprised of insurers, pension funds, financing companies, independent broker-dealers and regulated and unregulated investment funds.
“The NBFI sector has taken on significant amounts of credit and liquidity transformation, which are traditional bank-like activities, while being subject to limited or no prudential regulations,” they proclaim. “The growth and associated direct and indirect interconnectedness with the banking system has created a potential structural vulnerability. NBFIs could amplify and transmit risk back to the financial system during market downturns.”
The report further states that OSFI will be intensifying its focus on supervisory assessments of federally regulated financial institutions (FRFIs) capital, liquidity and risk profiles to ensure they remain “prudentially sound.”
“The Government of Canada intends to introduce legislative amendments to modernize the federal framework to address emerging risks to Canada’s financial sector and to protect the integrity and security of FRFIs. OSFI will be working with the Department of Finance.”
