Investor confidence and lead to a spike in demand for liquidity or too 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. More recently, the war in the Middle East has added to global uncertainty, leading to volatility in some markets and also a short period of reduced liquidity. Markets have continued to function well. But it remains unclear how long the war will last or how it might be resolved. 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 over-investment. AI may also increase the speed, scale, and sophistication of cyber attacks. 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. To date, 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 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. Business financial health is generally stable, but in the sectors most exposed to U.S. trade policy, a slowdown in the economy could put pressure on margins and make it more difficult to borrow. 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.
Vulnerabilities associated with loan growth continue to grow. Hedge funds and we actually have to finance their purchases of government securities, but source of fragility. I'll leave it with financial markets. Recent have been resilient. Our financial markets have generally proven. The Canadian financial system remains well positioned to weather shocks. 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 our 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 to 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. Please identify yourself before you ask your question. And of course, you are free to ask your question in either language. 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 rise in bond yields, and the high premium that investors are demanding to cover kind of 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.
Governor, 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 Almalis from Bloomberg, please.
