Regretful Readiness

By Regitze Ladekarl, FRM

The Canadian Office of the Superintendent of Financial Institutions (OSFI) just released its Annual Risk Outlook.

The outlook lists the top risks faced by the Canadian financial system and the actions OSFI is taking in response. Words like geopolitical turbulence and trade protectionism are used a lot, and there is a general sense of regretful readiness for what comes next.

In order of priority, these are beeping loudest on the radar:

Integrity and security—OSFI sees financial institutions being exposed to more risks from using AI and digitalization and relying on third-party service providers. Since there is an element of moving tasks from old-school banking to newer realms, all of these can cause red flags to go up and/or unnoticed. Oddly specific, though without naming names, OSFI points to Canadian banks being penalized in foreign jurisdictions for insufficient monitoring of illegal and otherwise unacceptable activities. And with third-party service providers, the concern is that these providers are less or not regulated and therefore can pose an uncovered systemic risk. These risks will be given high priority when approving new banks and supervising existing ones.

Wholesale credit—this sector, and the institutions that finance it, continue to struggle. The current direction of the world won’t make it better. Negative credit migration might be sticky, delinquencies and defaults are trending higher. An already precarious situation will be worsened by the overall economy that was supposed to be the engine out but now could be stalled in its tracks. In addition to calling for more data on the banks’ exposures to wholesale, OSFI will be focused on, well, focus. This is the time to stay up on credit risk management, loan loss provisioning, borrower and portfolio vulnerability, and be prepared for a downturn. ??

Funding and liquidity—uncertainty is contagious and self-amplifying. It makes for erratic moves and high volatility, and financial institutions need to ensure that their balance sheets can make it safely through choppy waters. While Canadian consumers have confidence in banks, deposit flows are stable, and funding within the national and global financial system hums along, the weather forecast holds no guarantee that will continue. OSFI will zoom in on stresses from interest rate, currency, and credit access fluctuations and how they impact funding and hedging costs.

Real estate secured lending and mortgage—last but not least there is the risk that interest rates will not come down as fast or to a level that was hoped. Inflation is still very much a thing and trade tantrums aggravate that. That means that the mortgages that are up for renewal before the end of 2026 (about a third of all outstanding) more than likely will renew at a higher rate than they originated at, resulting in higher payments. That is going to hurt, especially for borrowers who are already vulnerable to inflation and unemployment. Again, OSFI will supervise that the banks stay on top of this with active account management, early intervention to prevent and alleviate payment shocks, prudent underwriting practices, and adequate loan loss provisions.

Canadian seatbelts are fastened.

Regitze Ladekarl, FRM, is FRG’s Director of Company Intelligence. She has 25-plus years of experience where finance meets technology.

This article is part of the FRG Risk Report, published weekly on the FRG blog. To read other entries of the Risk Report, visit frgrisk.com/category/risk-report/.