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A housing market downturn in Canada is among the biggest risks facing the financial system this year, the country’s financial regulator said on Thursday, adding it plans to review the existing home loan stress test and expand its application to other loan products.

The “unprecedented run-up” in home prices has led to increasingly leveraged borrowers, which in turn increases financial institutions’ exposure to a market correction, the Office of the Superintendent of Financial Institutions (OSFI) said in its first annual risk outlook report for the year ending March 31, 2023.

While lenders are “well-capitalized and appear to be financially resilient, such a sequence of events could lead to borrower defaults, a disorderly market reaction and broader economic uncertainty and volatility,” the regulator said.

OSFI has identified issues around income verification in some “problematic” areas and is considering expanding the application of the stress test to products including reverse mortgages, mortgages with shared equity and combined loan plans, which have become more common, it said.

The stress test sets the qualifying rate for mortgages at the higher of 5.25% or 200 basis points above the rate the borrower pays.

Other financial system risks include cyber attacks, digitalization of money, climate change, a downturn in the commercial property market, riskier corporate debt funding and third-party arrangements, the regulator said.

OSFI is running a pilot to help financial institutions identify technology weaknesses and plans to consult on a draft guideline on operational risk management this fall, it said.

It will also issue guidance on expectations of institutions’ climate risk management and financial disclosures and, along with the central bank, conduct exercises to assess the impact on mortgage and securities portfolios and balance sheets, it said.

Pandemic-related changes to workplaces and shopping habits have introduced uncertainty for office and retail properties, and a protracted sharp increase in unemployment and work-from-home policies could pose further risks, the regulator said.

Noting some deficiencies in assessment and management of COVID-related risks, OSFI said it will consider developing supervisory expectations for commercial real estate.

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