Bank of Canada says risk to financial system is slightly higher than last June

OTTAWA (Reuters) - The Bank of Canada said on Thursday the overall risk to the Canadian financial system was slightly higher than in June 2018 and expressed concern about the increasing threat posed by fragile corporate debt funding.

A sign is pictured outside the Bank of Canada building in Ottawa, Ontario, Canada, May 23, 2017. REUTERS/Chris Wattie

“Overall, the financial system remains resilient, and confidence among market participants continues to be high,” it said in its annual review of financial systems.

The central bank cited a slowdown in economic growth, last year’s oil price slump, continuing problems in the energy sector and expanded risk-taking in global financial markets as reasons for the increased risk.

The Bank of Canada raised interest rates five times from July 2017 to October 2018 but has been on hold since then as the economy slowed.

It said in the review that the main risks to the system remained a severe nationwide recession, a deep house price correction and a sharp repricing of risk in financial markets. Canadian banks were well-positioned to handle such challenges, it added.

For the first time, it specifically highlighted the risks posed in Canada and other nations by fragile corporate debt funding, especially among lower-rated companies.

“Investor appetite for high-yield bonds and leveraged loans has driven this increase in borrowing, thus making future activity susceptible to shifts in investor sentiment. We will be monitoring this closely,” it said.

The challenge for Canada is that many of the companies involved are raising money on U.S. markets.

“Persistent problems in these markets could have broader implications for financial stability in Canada through the macroeconomic effects of a decline in corporate funding availability in the United States,” it said.

Market participants continue to see cyber incidents as the greatest risk to the Canadian financial system, in particular problems at third-party service providers.

Vulnerabilities associated with high household debt and imbalances in the housing market - factors the bank has been fretting about for several years - have declined modestly but remain significant.

“Despite this progress, we need to remain vigilant as the overall level of indebtedness continues to be high, with a large portion of that debt held by highly indebted households,” the review noted.

Bank of Canada Governor Stephen Poloz said the total amount of debt would “be with us for a long time.”

He also told a news conference that household borrowing was set to pick up, given a decline in global bond yields since the start of 2019 had lowered mortgage rates.

Reporting by David Ljunggren; Editing by Jeffrey Benkoe and Dan Grebler