Canada’s banking watchdog says mortgage risk is the number one threat to the financial system as more borrowers are expected to struggle to repay loans in a challenging economic environment.
On Tuesday, the Office of the Superintendent of Financial Institutions (OSFI) released its 2026-2027 annual risk outlook report, identifying the main potential pain points facing Canadian banks.
The regulator had ranked mortgage risk as the fourth biggest threat last year.
Now, with uncertainty stemming from the conflict in Iran and U.S. President Donald Trump’s trade war, OSFI predicts residential mortgage loan arrears or defaults will rise over the next two years.
“A month ago, I think I would have said that the Canadian economy did a lot better than we had feared,” Peter Routledge, head of OSFI, said during a virtual fireside chat hosted by Bank of America on March 30.
“The war in the Middle East is the wrench,” he added.
“The market is certainly predicting higher interest rates, which will translate into higher borrowing rates, particularly for households. And we’re entering a period of a pretty sizable amount of renewals. So that’ll add more stress in the near term.”
As of January, 3.1 million, or 52 per cent of all mortgages will be renewing by the end of 2027, according to OSFI.
Of these renewals, 1.3 million are fixed rate mortgages or variable rate mortgages with fixed payments that will be renewing for the first time since 2021 and 2022, when interest rates were lower.
This group of borrowers will experience “material” monthly payment increases, OSFI warned in the Tuesday report.
At the same time, economic uncertainty has led to more home listings and a decline in sales and prices, particularly in Toronto and Vancouver where there are a lot of condominiums.
“The near standstill in new condo activity and condo construction builds,” OSFI wrote, “is straining builders and has negative implications for the labour force they employ.”
Another concern is that many presale buyers will struggle to close as borrowers may need a larger down payment to qualify for their mortgage.
The number two risk to banks is what OSFI calls “nonbank financial institution risk,” coming, in part, from hedge funds, according to the report.
The regulator is concerned that funds, such as private equity, and other nonbank entities, have taken risky positions in the market.
If many of them fail, that could harm the financial system as a whole, given that the big banks lend money to those institutions.
OSFI said it will continue to monitor the banks’ risk management practices.
“They’re looking at how the bank portfolios continue to perform as more and more of these mortgages mature and more of these headwinds amplify,” said Carl De Souza, an analyst at credit rating service Morningstar DBRS.
The mortgage stress test and institution-specific loan-to-income ratios, added De Souza, are examples of measures OSFI has implemented over the years to manage mortgage risk.
