Bank of Canada Warns of Stability Risks Amidst Record High Interest Rates, Asset Valuation Concerns

By John Lopez

May 09, 2024 03:22 PM EDT

The Bank of Canada recently warned about stability risks in the financial system, citing the impact of record-high interest rates and concerns over stretched asset valuations. 

In its annual Financial Stability Report, released Thursday, the central bank stressed several key areas of concern and emphasized vigilance in managing these risks.

Bank of Canada Warns of Stability Risks Amidst Record High Interest Rates

Bank of Canada governor Tiff Macklem noted that while many households are coping with increased debt servicing costs, there are significant concerns about mortgage holders facing substantial payment hikes upon renewal. 

Senior Deputy Governor Carolyn Rogers also expressed concern for renters and households without mortgages. Rogers pointed out that data shows increased stress in these households, with a rise in credit card and auto loan arrears. 

"Higher debt-servicing costs reduce financial flexibility for households and businesses and make them more vulnerable in the event of an economic downturn," the report said.

The report revealed that payments have risen for approximately half of all outstanding mortgages since March 2022, with further increases expected as more mortgages renew over the next two and a half years.

The median increase in monthly mortgage payments is expected to go above 20% at renewal in 2025 and more than 30% in 2026 when compared to origination.

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The Bank of Canada in Ottawa, Ontario, Canada, on July 12, 2023. Canada's central bank on July 12, 2023, raised its key interest rate by 25 basis points to five percent, its highest level since 2001. While the Bank of Canada acknowledged that global inflation was easing, it explained its decision -- which was in line with analyst expectations -- by saying: "Robust demand and tight labor markets are causing persistent inflationary pressures in services."
(Photo : Photo by DAVE CHAN/AFP via Getty Images)

Asset Valuation Concerns Highlighted in Bank of Canada Report

Concerns were also raised about stretched valuations of financial assets and the sharp rise in leverage by the non-bank financial sector. Additionally, risks associated with exposure to commercial real estate, particularly in the office subsector, were highlighted due to weaker demand.

Despite the challenges, the report noted that large banks with healthy capital cushions have managed stresses in the mortgage market well. However, smaller lenders have seen a notable uptick in credit arrears. 

The report suggested that most borrowers should be able to manage with conservative wage increases but emphasized the potential impact of a significant shock to the financial system.

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