Amid rising global inflationary pressures, major central banks have entered a phase of monetary policy tightening. As the global economy emerges from the COVID‑19 pandemic, several factors have combined to increase volatility in financial markets and reduce investors’ appetites for risky assets.This exposes investors to risks such as large and sudden financial losses due to fraud, price declines or a run on stablecoins. While they do not yet pose a systemic risk to the Canadian financial system, the lack of a regulatory framework means they operate without many of the safeguards that exist in the traditional financial system. Cryptoasset markets continue to evolve and grow rapidly, and price volatility remains high.Overall, the risk of a quick repricing of assets exposed to climate change has increased. In the short term, concerns around global energy security are likely to delay the transition, while the long-term impact is highly uncertain. The war in Europe has further complicated the transition to a low-carbon economy.Such an attack could have far-reaching effects on the broader financial system. With the ongoing war in Ukraine, state-sponsored cyber attacks are occurring with greater frequency and sophistication, increasing the risk of a successful attack on a Canadian financial institution or financial market infrastructure. Cyber threats represent a continued vulnerability given the interconnected nature of the financial system.The recent tightening in financial conditions and increased market volatility have reduced liquidity. A sudden spike in demand for liquidity from asset managers could exceed the willingness of banks to supply such liquidity, causing large price movements and a potential freeze in some markets. Fragile liquidity in fixed-income markets is an ongoing structural vulnerability.The vulnerability associated with the reliance of some businesses on high-yield debt markets has also diminished. Previously, concerns were that the pandemic would cause unsustainably high levels of debt across the non-financial sector. Publicly traded non-financial businesses are generally in good financial shape and appear well-positioned to handle higher interest rates.Significant drops in prices would reduce household wealth and access to credit. A moderation of housing markets could reverse these forces and amplify the decline in prices. Expectations of future price increases and increased investor demand likely contributed to this rise. House prices rose more than 50%, on average, during the pandemic.Those with high debt are more vulnerable to a decline in income and will face more financial strain when they renew their mortgages at higher rates. At the same time, the share of highly indebted households has risen. Many households have seen an improvement of their net worth and liquid asset holdings over the course of the pandemic. In Canada, elevated levels of household debt and high house prices remain two key interconnected vulnerabilities.The tightening of monetary policy globally will test the resilience of the financial system and could worsen existing financial vulnerabilities. The lasting effects of the pandemic on supply chains in the context of strong demand for goods and the ongoing Russian invasion of Ukraine are complicating these efforts. Central banks around the world have shifted their focus from providing pandemic-related stimulus to responding to the significant increase in inflation.The vulnerabilities highlighted in this report suggest the effects for the real economy could be significant if a trigger event occurs, even as systemically important financial institutions remain resilient. While the sharp increase in house prices over the past year has resulted in significant equity gains for many households, those who entered the housing market in the last year or so would be more exposed in the event of a significant price correction. These households are more vulnerable to declines in income and rising interest rates. The Bank is paying particular attention to the fact that a greater number of Canadian households are carrying high levels of mortgage debt. However, in an environment of tightening financial conditions, high global inflation and increased geopolitical tensions, financial system vulnerabilities have become more complex, and risks have become more elevated. The Canadian financial system has proved resilient throughout the COVID‑19 pandemic, and the balance sheets of businesses and households are generally in good shape.
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