Regulator highlights rising concerns in annual report
Canada’s banking regulator has identified risks posed by non-bank financial institutions (NBFIs) as the second-highest threat to the country’s financial system, warning that the growing role of hedge funds and private capital firms could destabilize federally regulated lenders in a stress event.
The Office of the Superintendent of Financial Institutions (OSFI) released its 2026–2027 Annual Risk Outlook (ARO) on Tuesday, outlining the top risks facing Canada’s financial institutions and the supervisory and regulatory actions it is taking in response.
The ARO ranked NBFI risk second, behind real estate secured lending concerns and ahead of funding and liquidity risks.
Leverage and spillover
According to the ARO, hedge funds use significant leverage obtained through repurchase agreement funding and derivatives to amplify risk and return in their trading strategies. OSFI warned that if funding costs rise or large margin calls occur suddenly, positions could unwind abruptly, destabilizing sovereign bond markets where these strategies are deployed.
The regulator noted that Canadian financial institutions provide leverage to funds and other NBFI firms engaged in leveraged trading strategies. When market stress triggers rapid unwinds, federally regulated institutions could face increased counterparty risk, margin disputes, and potential liquidity strains – and in extreme cases, losses on collateralized positions.
Private capital exposure
OSFI also highlighted growing concern over private capital firms, which provide debt and equity to businesses. Canadian institutions’ exposures to private capital firms and their portfolio companies have grown considerably in recent years, the ARO noted, representing a material component of the balance sheet.
The regulator warned that the opaque nature of private capital markets can mask structural weaknesses and that the highly leveraged nature of these firms can intensify losses in a stress event.
Regulatory response
OSFI said it will conduct supervisory reviews on exposure to NBFIs, risk-rating approaches, and governance processes, and will strengthen its research and analytics to better understand complex relationships between NBFIs and the institutions it regulates.
OSFI also said it is developing a comprehensive Credit Risk Management Guideline to strengthen how institutions manage credit risk, with input sought on the initial consultation document by July 29, 2026.
Superintendent of Financial Institutions Peter Routledge offered assurance in the ARO’s accompanying news release. “Canadians can be confident that OSFI acts early, transparently, and decisively to strengthen financial system resilience in an uncertain economic and geopolitical environment,” Routledge said.
