The Bank of Canada released its Financial Stability Report (FSR) for 2024 on Thursday, May 9th, stating that the Canadian financial system remains stable, but risks remain due to high debt costs for households and businesses, as well as overvalued financial assets.
Over the past year, households, businesses, banks, and other financial institutions have taken proactive measures to adapt to higher interest rates and mitigate economic impacts, according to Bank of Canada Governor Tiff Macklem.
The report conveys several key messages, with the first being that the Canadian financial system still possesses resilience, and the second highlighting that adjustments are not yet complete, posing ongoing risks to financial stability.
The Bank of Canada identifies risks primarily in debt repayment capacity and asset valuation.
The report notes that risks in debt repayment capacity could affect the performance of lenders’ credit portfolios, with some households and businesses facing challenging times.
While most households are adapting to higher interest rates, there are signs that financial pressures on some households are increasing.
The Bank states that Canadian households’ financial stress, which sharply decreased during the COVID-19 pandemic, is now returning to normal or even surpassing pre-pandemic levels.
It is noteworthy that Canadians without mortgages are faring worse in repaying credit card and auto loans.
Compared to homeowners facing higher mortgage rates, the delinquency rates for credit cards and auto loans of tenants are on the rise.
Data from March this year showed that delinquency rates for auto loans and credit cards (delinquent for 60 days or longer) increased by 0.5% and 1.5%, respectively, for mortgage holders, while tenants and non-mortgage holders saw increases of 1.31% and 2.22%, respectively.
While the increasing debt pressures on households have not significantly impacted major banks, smaller mortgage institutions are experiencing a surge in non-repayment issues.
In the coming years, more Canadian homeowners will face greater debt pressures and refinance existing mortgages at higher rates.
Higher debt costs are reducing the financial flexibility of households and businesses, and in the event of an economic downturn, all parties will face even greater challenges.
The report warns that overvalued assets could pose risks to financial stability. The Bank of Canada states that this could lead to asset price corrections and market pressures.
Leverage ratios for non-bank participants such as pension funds and hedge funds have increased by a significant 30% in the past 12 months.
Higher leverage ratios mean that companies rely heavily on debt to cover operational costs. In times of economic recession or rising interest rates, the risks are greater, potentially leading to financial distress or bankruptcy.
The report also mentions that valuations in certain areas of Canadian commercial real estate continue to face pressure, particularly in office spaces with high vacancy rates.
It is pointed out in the report that not all asset managers have fully reflected the lowered valuations on their balance sheets, indicating that further adjustments may be necessary in the future.