Canadian Financial Stability Reportâ2025
Navigating Trade War Uncertainties
Executive Summary
The Bank of Canada's Financial Stability Report 2025 indicates that while Canada's financial system remains resilient, the recent trade war initiated by the United States poses significant risks to financial stability. Canadian households, businesses, banks, and non-bank financial intermediaries have weathered the pandemic, inflation, and interest rate increases, but US trade policy uncertainty threatens to test this resilience.
Key Risk #1
Market volatility leading to liquidity challenges
Key Risk #2
Export-dependent business defaults
Key Risk #3
Job losses leading to household debt serviceability issues
Market Reaction to Trade Policy
Since January 2025, the unpredictability of US trade policy has caused a sharp increase in uncertainty and market volatility. The new tariffs announced by the United States in early April were significantly larger than market participants had anticipated, leading to sharp repricing in equity, bond, and currency markets as investors revised their economic outlooks.
Benchmark equity indexes fell sharply before recovering almost entirely, while stock market volatility rose to its highest level since the COVID-19 crisis. Sovereign bond yields in Canada and the United States saw large swings. Many investors appeared to diversify away from US assets.
Market Volatility Indicators
Financial System Risk Assessment
Risk Distribution
Risk Assessment Comparison
Banking System Resilience
Canadian banks remain well positioned to support the financial system and the broader economy, even through a period of financial stress. They have good access to funding through deposits and wholesale markets, and credit performance has been strong.
Banks have increased their accumulated provisionsâfunds set aside for anticipated loan lossesâand they maintain elevated levels of capital to absorb unexpected losses. They also continue to hold sufficient liquidity to meet their short-term obligations.
Bank Capital Ratios Under Stress Testing
International Financial Contagion
The global financial system is highly interconnected, with shocks in one region often spreading rapidly to others. Canada's economy is particularly sensitive to developments in the United States due to deep trade and financial linkages.
The current trade war increases the risk of financial contagion from international markets to Canada. A deterioration in the US financial system would have significant implications for Canadian financial institutions and markets, potentially amplifying the direct economic effects of trade restrictions.
While European and Asian markets also present contagion risk, the US remains the dominant channel through which external financial shocks could impact Canada's financial stability.
International Financial Contagion Risk
Key Vulnerabilities by Sector
Household Vulnerabilities
Many households continue to adjust to higher debt-servicing costs. While interest rates have come down significantly over the past year, previous increases are still affecting mortgage renewals. A large share of mortgages being renewed this year or next were taken out during the pandemic at historically low interest rates.
However, the trade war threatens jobs and incomes, particularly in trade-dependent industries. Some affected households may become unable to continue making debt payments, potentially leading to a significant rise in mortgage arrears under a severe scenario.
Mortgage Arrears Projection
Housing Market Vulnerability Index
Housing Market Vulnerabilities
The Canadian housing market faces several vulnerabilities that could amplify the impact of economic shocks from the trade war. The Housing Market Vulnerability Index highlights four key areas of concern.
Debt service vulnerabilities are particularly elevated as many homeowners face higher mortgage payments during renewals. Market overvaluation also remains a concern in major urban centers, creating the risk of price corrections if economic conditions deteriorate significantly due to trade tensions.
These vulnerabilities could interact with macroeconomic shocks from trade disputes, potentially amplifying downside risks to the financial system.
Business Sector Vulnerabilities
Non-financial businesses have adjusted well to past interest-rate increases and have generally remained in solid financial health over the past 12 months. The ratio of total debt to assets has remained broadly stable since mid-2023 at relatively low levels. However, the trade war will test the financial resilience of businesses in industries tied to trade.
Business Sector Vulnerabilities
Businesses that export a large share of their production to the United States and have high leverage, low profitability, and low cash reserves are particularly vulnerable to a long-lasting trade war. This applies mostly to firms in manufacturing subsectors, as shown in the chart above.
Emerging Risk: Climate Change Financial Impact
While the trade war dominates near-term financial stability concerns, climate change remains a significant medium to long-term risk to the Canadian financial system. The transition to a low-carbon economy could have substantial implications for certain sectors of the Canadian economy.
Transition risks arise from policy changes, technological disruption, and shifting market preferences as the economy adapts to climate change mitigation efforts. Physical risks include direct damage to assets and disruption to supply chains from extreme weather events and long-term climate shifts.
The Bank of Canada continues to develop its approach to assessing climate-related financial risks, including through scenario analysis and stress testing methodologies.
Climate-Related Financial Risk
Risk Monitoring Focus
Near-Term Monitoring
- Financial stress indicators: Delinquency rates for businesses and households, especially for consumer credit products
- Precautionary behavior: Unusually high line of credit draws, risk-off investor moves, bank provision changes
- Credit availability: Access to new credit or refinancing, especially in trade-exposed sectors
- Market liquidity: Evidence of deterioration in core funding markets like government bond and repo markets
Medium-Term Concerns
- Unemployment growth: Particularly in trade-dependent sectors and regions
- Business adaptation: Ability of firms to pivot to new markets or business models
- Bank lending behavior: Changes in credit standards or willingness to extend credit
- Government policy response: Effectiveness of measures to support affected businesses and households
Conclusion
The Bank of Canada's analysis shows that Canada's financial system entered 2025 with increased resilience. This resilience provides a buffer against the risks posed by the current trade war and associated economic uncertainties. While markets have experienced increased volatility, they continue to function well.
The Bank will work closely with federal and provincial financial authorities to monitor and assess the health of Canada's financial system and to address potential emerging issues. The objective is to foster a stable and resilient financial system that absorbs shocks and can support the economy through periods of turbulence.
"A stable and resilient financial systemâone that absorbs shocks and does not amplify themâcan help the economy through periods of turbulence."
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Sources
- Bank of Canada. (2025, May 8). Financial Stability Reportâ2025. Bank of Canada.
- Bank of Canada. (2025, April). Monetary Policy Report, April 2025.
- International Monetary Fund. (2025). Financial Sector Assessment Program: Canada.
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This analysis was produced by the Governing Council of the Bank of Canada: Tiff Macklem, Carolyn Rogers, Toni Gravelle, Sharon Kozicki, Nicolas Vincent, Rhys Mendes and Michelle Alexopoulos.
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