Bank of Canada Warns Trade War Risks Financial Stability

The Bank of Canada has stated that while the country's financial system remains robust, the ongoing trade war poses significant risks to its stability. In its annual Financial Stability Report, the central bank highlighted that the trade tensions, particularly those between the United States and Canada, could have detrimental effects on the financial sector if they persist. The bank warned that prolonged trade disputes could make it harder for households and businesses to repay debts, thereby increasing the risk of financial instability.

The Bank of Canada emphasized that the unpredictability of U.S. trade policies could exacerbate market volatility and lead to liquidity tightness in the short term. In extreme cases, this volatility could result in market dysfunction. Over the medium to long term, a protracted global trade war could have severe economic consequences. The bank's governor, Tiff Macklem, noted that the level of uncertainty is high, stating that the bank's analysis is not a prediction but an assessment of vulnerabilities.

If the trade war continues, some households, especially those with high debt levels, may struggle to meet their repayment obligations. This risk is primarily concentrated among households without mortgage loans. The bank also pointed out that this could potentially harm the strong banking system, which has established a solid liquidity base and access to funding. If there are significant credit losses, banks may reduce lending, making it even harder for struggling households and businesses to obtain loans to weather the storm. This cycle could exacerbate an economic downturn.

The Bank of Canada also highlighted the increasing risk from hedge funds, which have been increasing their investments in Canadian government bonds. In some bond auctions, nearly half of the bonds are purchased by hedge funds. However, these funds often borrow money to buy bonds, making them more likely to exit the market during times of stress, thereby threatening the bond market's stability.

Since the beginning of last year, the overall level of household debt has decreased due to interest rate cuts, and the corporate bankruptcy rate has also declined. This has strengthened the ability of banks and non-bank financial institutions to absorb shocks. With interest rates falling, households that will renew their mortgages this year or next are generally more resilient in terms of repayment. However, some households may be impacted if they face unemployment or reduced income. This situation could also affect businesses, particularly those with high leverage, weak profitability, and low cash reserves, which may struggle to repay their debts.