A combination of economic and geopolitical upheaval is raising risks in the financial system and will likely claim some victims around the world, Canada’s top banking regulator told a conference in Montreal on Tuesday.

“We are in uncharted waters. Our geopolitical environment (has) changed on us pretty dramatically, and I don’t think we’re done with that,” said

Peter Routledge

, head of the

Office of the Superintendent of Financial Institutions

. “There will be costs associated with that and I don’t know how the costs are going to fall. I think they’re going to fall unevenly, and there will be unfortunate victims that don’t survive.”

Despite that backdrop, Canada’s banks are in good shape compared to international peers, Routledge said during a fireside chat with bank analyst Gabriel Dechaine at National Bank of Canada’s annual financial services conference.

Over the past 30 years, there have been hundreds of

bank failures

in the United States and none in Canada, Routledge said. That won’t stop the regulator from continuing to press Canadian banks on whether they are properly managing risks and whether capital held against those risks is adequate.

OSFI is loosening capital requirements for banks on certain types of commercial lending to encourage loans that fuel economic growth in Canada, but Routledge said the regulator may push back on internal models that appear “bold,” given potential risks on the horizon.

 

“I think it’s reasonable to ask, looking at what we’re facing, ‘Is that a prudent allocation of risk?’” he said, using the example of a standard uninsured mortgage risk weighting of between 10 and 12 per cent.

 

“Our models might say it is, but our models are based on analysis done over the last 20 years, not what’s going to happen over the next 20 years.”

Canada’s banks have weathered recent credit challenges against a backdrop of global

trade

tensions fairly well, but face about 2.1 million mortgage renewals over the next two years. Many households will see monthly payments rise and there will be pain for some, Routledge said, but he does not expect the financial system here to be shaken.

“I think the financial system is going to absorb that toughness, not without pain, but without real threat to financial sector resilience,” he said.

Many of those mortgages were originated in 2021 and early 2022, when interest rates were much lower.

Routledge said OSFI estimates that somewhere between 30,000 to 150,000 of those are in the most vulnerable position where, depending on how much house prices have fallen, the loan-to-value at renewal time will be greater than 80 per cent and the total debt service ratio will be greater than 44 per cent.

“Those folks are going to struggle,” he said. “I believe they’ll be renewed by their lender, but they might not be able to refinance. And we worry about that cohort.”

Private credit is another area of the financial sector that is likely to face a shakeout, Routledge said. However, he doesn’t expect the trends that led to a recent spate of redemptions in private credit funds to lead to a deep or widespread financial crisis.

“Private credit firms are going to have to cycle that through their investor group, and that will be painful,” he said. “But to me, it doesn’t feel like a 2007-2008 credit crunch. It feels like some of the aggressiveness in the private credit industry is going to result in higher-than-expected credit losses.”

The banking sector does provide loans to private credit and therefore has exposure to that market, he said, but while some of their loans may sour, the regulated financial institutions should be able to withstand the fallout.

“Here again, I’m reasonably confident that that risk concentration is isolated enough that it won’t be a significant threat to overall resilience,” he said.

The relative strength of Canada’s financial system is among the reasons OSFI is pushing ahead with plans to encourage new financial services players to enter the market by dramatically shortening the time it takes to get approval from the regulator, Routledge said.

 

The aim is to reduce the path to licensing to 12 months from 36, and the regulator is anticipating that applications will begin flowing in later this year.

There are sure to be some “bumps and bruises” in the rollout of challengers to the

big banks

and increased competition may not be welcomed by incumbents. At the same time, Routledge said, there will be guardrails for new entrants and not all of them are expected to survive.

“Our thesis is our system is strong and resilient enough to accept a greater risk of institutional failure in order to get the benefits of competition and efficiency,” he said, adding that competition and innovation within the regulated system is easier to track and should reduce overall risk.

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• Email: bshecter@nationalpost.com