Good morning everyone. Welcome to the Bank of Canada in this morning's press conference about today's financial stability report. Senior Deputy Governor Carolyn Rogers and Deputy Governor Toni Gravelle will have some opening remarks, after which they will be happy to take your questions. So, Senior Deputy Governor Rogers, the floor is yours.
Thanks, Paul. Welcome, everyone. The Governor couldn't be with us today. He's in Montreal with his mother, who is seriously ill. Deputy Governor Toni Gravelle and I are pleased to be here to discuss the Bank's Financial Stability Report, or the FSR. A stable and efficient financial system is essential to our economy. It supports growth, and it helps households and businesses to save, invest, and manage risk. We monitor the financial system closely, and every year we publish this report to share our assessment with Canadians. The FSR is very different from our Monetary Policy Report. It's not a forecast, and it doesn't guide our interest rate decisions. Instead, it gauges the resilience of the Canadian financial system, and it explores key risks and vulnerabilities that could undermine that resilience. I'll start today with our overall assessment, and then I'll highlight a few areas that we're keeping a close eye on. Then, Deputy Governor Gravelle will delve into the conditions across financial markets, households and businesses, banks, and non-bank financial intermediaries.
Overall, Canada's financial system has functioned well through a challenging year. Households and businesses remain in stable financial condition and banks have strengthened their capacity to absorb shocks. However, vulnerabilities in some parts of the system have increased. Stock and corporate debt valuations have risen and are high relative to historical norms. This makes markets more vulnerable to a sharp correction. The issuance of global sovereign debt is also rising and hedge funds are playing a bigger role in that debt, often using borrowed money. In normal times, hedge fund activity helps keep markets running smoothly, but if conditions become strained, this activity could amplify stress and disrupt core funding markets. Individually, these vulnerabilities look manageable. However, the economic and geopolitical environment has become more volatile. And this has made it more likely that a new shock or a combination of shocks could cause several vulnerabilities to crystallize at once. If this were to happen, these vulnerabilities could interact and reinforce each other. A cascading series of events could cause a sharp loss in investor confidence and lead to a spike in demand for liquidity or to rapid asset sales. Funding markets could come under pressure and stress could spread more broadly. To be clear, the FSR is not about what we expect will happen. It's an assessment of how existing vulnerabilities or pockets of stress could amplify shocks and ultimately spread across the financial system. At the time of the 2025 report, we were concerned that tariffs and trade uncertainty could lead to market volatility, strains on liquidity, or even market dysfunction. So far, the impacts have been less widespread than we originally feared. But of course, the risk hasn't gone away, and the future of Canada's trade relationship with the United States remains uncertain. New risks are also emerging, particularly from artificial intelligence. AI is expected to boost productivity and economic growth over time, but it's sparking concerns about disruptions in some sectors and about overinvestment. AI may also increase the speed, scale, and sophistication of cyberattacks. Now, let me turn to Deputy Governor Gravelle to talk about the conditions in each of the five sectors that we monitor.
Thank you, Senior Deputy Governor. I'll start with households, where the overall picture is similar to last year. Canadians continue to carry high levels of debt relative to their income, but overall household wealth has risen. And the share of borrowers who are behind on debt payments has stabilized. In recent years, we've highlighted the risk of payment shocks when households renew pandemic-era mortgages. Today, most borrowers have managed this risk well. With the final wave of these renewals set to happen over the next 12 months, we expect this risk to have fully passed by the second half of 2027. I'd like to stress that this overall picture masks important differences. Some households face far greater strain than others. And those with the highest debt burden have very little financial flexibility to cope with a job loss or an unexpected expense.
The main concern for both households and businesses is a geopolitical or economic shock that leads to a deep recession and a sharp rise in unemployment. Canada's large banks have become more resilient over the past year with higher profitability and healthy capital buffers. They have also set aside additional funds to absorb potential loan losses. This positions them to support the economy and financial system even in a severe downturn.
Non-bank financing has continued to increase. Hedge funds have made greater use of financial leverage, partly to finance their purchases of government bonds. This practice supports market liquidity but can also be a source of fragility. I'll finish with financial markets. Recent geopolitical events have caused volatility, but markets have been generally resilient.
Overall, we assess that the Canadian financial system remains well positioned to withstand shocks. Over the past year, it has often been put to the test. It has faced challenges, but these have not caused widespread financial tensions. Our overall view is that the Canadian financial system remains well positioned to weather shocks. Over the past year, it has faced repeated tests. While there have been some strains, these episodes did not lead to broader-based financial stress. Still, we must stay vigilant. We will continue to monitor vulnerabilities closely and remain in regular contact with financial system participants and with domestic and international partners. A stable and resilient financial system absorbs shocks rather than amplifying them. And that benefits every Canadian. With that, the Senior Deputy Governor and I would be happy to take your questions.
Thank you, Senior Deputy Governor and Deputy Governor. We will go to questions now. We'll start with the reporters here in Ottawa at the bank, and then we will go to those at our regional offices. As a reminder everybody, today's topic is the Financial Stability Report. We will be back here in a couple weeks' time for an interest rate announcement, at which point we will be happy to talk about monetary policy. We have time to get to everybody. If we can just limit ourselves to one question each so that everybody has a chance to participate, and if I forget to do so, please state your name and affiliation. For those in the room, just press that button on the microphone in front of you to activate it so everyone can hear your question, then press it again to turn it off once you are done. So, we'll go to our first question here in Ottawa and I'm going to call on Greg Quinn from Market News, please.
Good morning. I'm sorry for the present circumstances. The report touches on the rising bond yields and the higher premium that investors are demanding to cover fiscal policy risks and how that could create a financial stability problem. I was just wondering if that rise in bond yields and the potential volatility makes monetary policy more complicated in the current moment.
Well, maybe let me talk about how we view sovereign bond risk from a financial stability perspective, Greg. Really, we think about the reason the sovereign bond market is really important to financial stability really comes down to two things. One is it's a reference market. Sovereign bonds provide a risk-free rate and all other debt is priced off that market. So, any instability in that market is going to feed through to other markets. The other reason we really focus on the sovereign bond market is it's core to our funding markets. It's the primary source of collateral in the repo markets. It's the primary source of regulatory liquidity for the banks. So, it's really critical to the markets that fund other markets. So, any disruption in the sovereign bond market, whatever the source of that disruption, has the potential to feed through to other parts of the financial system. So, that's really the lens through which we look at the sovereign bond market in the context of the financial stability report.
Okay, next I'm going to go to Prabhat Mukherjee from Thomson Reuters, please.
Governors, among the risks highlighted in the financial stability report, which ones do you think are a matter of when they will happen than if they will happen? For example, stock market valuations, perhaps.
I mean, I think there's potential for any of them to happen. Really, what the financial stability report focuses on is the potential for more than one of them to crystallize at once. So, you know, valuations have been high for quite a long time. Some of that is fundamentals, some of that is exuberance. So, whether or not those are going to crystallize at any given time is really less what we spend our time thinking about than what would happen if it did, and particularly what would happen if it did in concurrence with other risks crystallizing at the same time, and what are the transmission mechanisms for those risks to spread more broadly and into things like the core funding market that have the potential to manifest into more financial instability.
All right, next I'm going to go to Craig Lord from The Canadian Press, please.
Good morning, Governors. Thank you for taking our questions. Why is the mortgage renewal wave that we spent a few years worrying about cresting and hitting household finances? Why has that not appeared to put that feared level of stress on households?
Well, I think there's a number of reasons, Craig. I mean, I would start with households have been prudent. I mean, I think we saw this wave coming. They saw it coming, too. They saved. They also, some households have seen wage increases that helped absorb the payment shock. Rates did come down, too. So, at one point we were forecasting what the maximum payment shock would look like, but as rates came down, that shock got smaller. At the same time, we saw wage gains and savings offset that shock. Mortgage holders were also able to take advantage of some flexibility, so they could re-amortize their mortgage, particularly if the value of their home has gone up and they had a little bit more equity. So, there was a whole bunch of factors, I think, that fed into that risk sort of gradually declining over time, rather than increasing or playing out the way we were concerned it would.
Okay, I'll go to Nijat Al Malees from Bloomberg, please.
Good morning. I was wondering if you could talk a little bit about how risks to financial stability have evolved compared to last year. Are they worse? Not worse?
