Bank of Canada financial system review: Canada’s financial system remains resilient

Over the past year, financial system participants - including households, businesses, banks and non-bank financial institutions - have continued to proactively adjust to higher interest rates.

Households and businesses have reduced their demand for credit, and most have maintained higher levels of liquid assets built up during the pandemic.

Banks have increased their provisions for loan losses and maintained their large capital buffers.

Some asset managers have strengthened their processes for managing liquidity risks.

The financial system is highly interconnected. Stress in one sector can spread to others.

Over the past 12 months, the global economic and financial environment has been marked by a further decline in inflation in advanced economies and a reduction in the risk of a major recession. However, geopolitical tensions have increased.

Financial system participants have become increasingly focused on when and by how much central banks will reduce their policy interest rates. This has driven a renewed appetite for risk, which has pushed up the prices of a range of financial assets and driven down risk premiums and credit spreads in both Canada and the United States.

Volatility and liquidity in bond markets have improved over the past 12 months, but volatility remains higher and liquidity remains lower than before central banks began increasing their policy rates.

Despite some improvements in the global backdrop, uncertainty remains elevated. 

Inflationary pressures globally could be higher than expected, causing markets to further reassess the timing and the pace of the expected declines in policy interest rates by some central banks

Geopolitical tensions—in particular, the wars in the Middle East and Ukraine—persist and could escalate. These sources of uncertainty could reduce the global appetite for risk, leading to an abrupt repricing of assets and to stress in core funding markets.