Regulator sets out some of the key risks for Canadian financial institutions
Canada’s financial institutions regulator is seeking feedback on the regulatory framework of cryptocurrencies held by FIs and has published its final guideline on operational risk and resilience.
The Office of the Superintendent of Financial Institutions wants feedback from stakeholders on guidelines for federally regulated financial institutions to publicly disclose their exposures to crypto assets “to protect Canadians’ savings and the security of our financial system.”
It follows a consultation in November 2023 in parallel with the Basel Committee on Banking Supervision and new draft amendments to the Pillar 3 Disclosure Guidelines for domestic systemically important banks and small and medium-sized deposit-taking institutions for public consultation to incorporate the new BCBS disclosures standard.
OSFI has also published its final guidance E-21 on operation risk and resilience, revised with simplified language to make it clearer and better streamlined.
It follows on from OSFI’s annual report highlighting the risks to FIs in May which noted that the inflation target has not yet been reached and with current interest rates and market volatility continued higher borrowing costs, increased mortgage renewal/refinancing risk, decreased consumer spending and business investment can be expected.
OSFI states that today's financial institutions operate in a complex risk environment, with increasing risks to their operations from:
- internal control failures
- third-party disruptions
- infrastructure outages
- technology failures
- cyber and geopolitical incidents
- pandemics
- natural disasters
This requires robust risk management and resilience, the regulator states.
The new guideline:
- Enhances expectations for operational risk management.
- Sets new expectations for operational resilience, a vital component of OSFI’s supervisory framework.
- Sets new expectations for business continuity risk management, crisis management, change management, and data risk management, which strengthen operational resilience.
While its annual report acknowledged opportunities ahead, such as the higher rate benefits for pension fund investment income and decreasing future liabilities, it also highlighted that “changing institution and consumer behaviour could have unexpected effects on actuarial experience, policy design, risk modelling, and other institutional decisions.”
Household debt
Rising Canadian household debt was also noted in the annual report as a risk with mortgage payments taking a larger chunk of household income and if the labour market weakens “the effects on credit quality could be material, and the landscape could change dramatically.”
With 76% of mortgages outstanding as of February 2024 due for renewal by the end of 2026, OSFI says Canadian homeowners could be in for a payment shock, especially if they took out their home loan when interest rates were lower between 2020 and 2022.
“We expect payment increases to lead to a higher incidence of residential mortgage loans falling into arrears or defaults,” the report states.
FIs are also significantly exposed to wholesale credit risk especially from commercial real estate lending, but also from corporate and commercial debt. “Current interest rate levels have produced challenging refinancing conditions for some commercial and corporate borrowers and the conditions could negatively affect wholesale credit markets in the coming year,” OSFI warns.
Also, liquidity and funding conditions “remain sensitive to an uncertain financial market landscape. The expected and actual path of global interest rates will influence the risk appetite of market participants.”
Among other risks identified by the regulator are “threats to institutions’ integrity and security ranging from fraud and money laundering to cyber security and foreign interference.” This is exacerbated by technology, OSFI says, allowing for more sophisticated attacks on FIs.
The regulator will be closely monitoring how these risks and others could impact Canadian financial institutions in the months ahead.
