The Biggest Financial Risks For The Next Two Years

Today your hosts Daniel Foch and Nick hill look at OSFI's report on the biggest financial risk for 2024-2025 as they identify the current risk environment with elevated interest rates and market uncertainty. They cover topics such as real estate secured lending and mortgage risks, rising household debt costs, credit stress and changing depositor behaviour.

Key Takeaways:

1. Consumer sentiment, or how consumers feel about the economy, affects their spending and saving behaviours. High consumer confidence typically leads to increased spending, benefiting businesses and the overall economy. Conversely, low confidence can reduce spending and trigger economic contraction.

2. Canada's financial regulatory framework evolved significantly over time. Notable milestones include the formation of the Office of the Superintendent of Insurance in the late 1800s, the establishment of the first formal bank (BMO) in 1817, and the creation of the Canada Deposit Insurance Corporation (CDIC) in 1967 to protect small deposits.

3. The Office of the Superintendent of Financial Institutions (OSFI) was established in 1987 to supervise federally regulated financial institutions. OSFI develops rules, interprets legislation, and ensures financial stability by analyzing trends and assessing risks. It oversees around 400 financial institutions and 1,200 pension plans in Canada.

4. Canada has the highest household debt-to-income ratio among G7 countries, with debt levels reaching 180% of disposable income. This high level of debt, largely due to home ownership, poses significant risks, especially if labor markets weaken and borrowers struggle to make payments on their loans.

5. The construction and development sectors, particularly commercial real estate, face significant stress and uncertainty. This is compounded by changing depositor behaviours and increased competition for deposits, which could draw funds away from traditional savings accounts.

6. A substantial portion of Canadian mortgages will come up for renewal by the end of 2026, which could lead to significant payment shocks for homeowners who initially borrowed at lower interest rates. This situation is particularly concerning for those with variable rate mortgages with fixed payments.

7. OSFI is continuously monitoring the risk profiles of residential mortgage lending activities and conducting examinations to ensure sound underwriting standards. They are also considering institution-specific loan-to-income limits to prevent the buildup of highly leveraged borrowers.

8. The pre-construction real estate market in Canada is seen as a significant risk. High leverage loans and negative equity situations could lead to widespread financial distress among borrowers and developers, potentially triggering bankruptcies and negatively impacting the broader economy.

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