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Housing downturn and cyber attacks top risks to Canada’s financial system, says OSFI

Issues highlighted in banking watchdog’s first-ever risk outlook

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The threat of cyber-attacks and a housing market downturn are among the biggest risks to the financial system, according to the Office of the Superintendent of Financial Institutions’ first ever annual risk outlook.

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The report, which aims to promote transparency by providing a yearly snapshot of the most pressing systemic threats and how regulators are responding to them, noted that cyber security threats have become more sophisticated and severe. This concern was heightened following Russia’s invasion into Ukraine, leading OSFI to stress to federally regulated financial institutions the importance of putting security measures in place to ward off such attacks.

There has been a rise in disruptive ransomware attacks, such as the Colonial Pipeline hack in the U.S. in May last year which crippled the computer equipment needed to manage the oil pipeline infrastructure. OSFI said such attacks could lead to lost data, lost finances and a hit to public confidence that would erode the institution’s reputation.

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To combat the problem, OSFI is piloting its own cyber-resilience testing to scope out weaknesses in financial institutions’ cyber security defences, which the office said have already yielded valuable insights. The firm also drafted a guideline of expectations for sound cyber risk management.

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OSFI also raised the alarm on an overheated housing market and over-leveraged borrowers, which have heightened the financial system’s sensitivity to a price correction.

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“While lending institutions are currently well-capitalized and appear to be financially resilient, such a sequence of events could lead to borrower defaults, a disorderly market reaction and broader economic uncertainty and volatility,” the report cautioned.

The report added that recent supervisory reviews were identifying underwriting problems, most notably faulty income verification.

OSFI is also considering extending the mortgage underwriting practices from the B-20 guidelines to other products such as reverse mortgages as they swiftly gain in popularity. Reviewing the minimum qualifying rate stress test and examining other measures in the B-20 guidelines is part of OSFI’s strategy to keep an eye on real estate risks.

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The organization also identified a number of other risks to be monitored closely, including: rapidly evolving digital innovations such as cryptocurrencies and open banking, which could pose a threat to financial institutions’ business models, should they fail to keep pace; risks related to climate change; disruptions stemming from financial services’ arrangements with third-party service providers; the potential for a commercial real estate market downturn; and a fragile corporate debt picture.

OSFI said it plans to keep track of ongoing risks to the financial system with annual reports as the risk landscape shifts from year to year.

“With our inaugural Annual Risk Outlook, we are providing transparency to Canadians about the financial system risks facing our country and our supervisory and regulatory responses to those risks,” said Peter Routledge, the Superintendent of Financial Institutions. “In so doing, we commit ourselves to strengthening the prudential oversight framework for Canada’s federally regulated financial institutions and pension plans which, in turn, will add to financial system resilience.”

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