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Peter Routledge, superintendent of Office of the Superintendent of Financial Institutions, says Canadian banks are well-equipped to weather any fallout from rising interest rates or liquidity shocks, thanks to capital buffers built up after the global financial crisis.Fred Lum/the Globe and Mail

Canada’s top banking regulator said financial institutions can expect heightened oversight as the country heads into a period of increasing risks to financial stability.

Speaking at an event on Monday, Peter Routledge, superintendent of Office of the Superintendent of Financial Institutions, said Canadian banks are well-equipped to weather any fallout from rising interest rates or liquidity shocks, thanks to capital buffers built up after the global financial crisis.

But he said that regulators need to be more pro-active in assessing pockets of risk.

“As we go into more difficult times with higher debt service costs, as well as higher inflation, does my team have a will to act early, and accept the risks that come from acting early?” Mr. Routledge asked at an event hosted by Toronto Centre. He said the answer was yes.

“What does that mean for the institutions we regulate? It means if we’re worried, we’ll be knocking on your door and you’ll be spending more time than you might have anticipated with us.”

Financial stability risks have been on prominent display in Britain in recent weeks, after the announcement by its government of a package of tax cuts caused a sharp sell-off in government bonds.

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This rapid move of bond prices and yields ended up squeezing pension funds, and prompted the Bank of England to step in to prevent a fire sale of government bonds.

Canada has so far avoided any significant market disruptions as the Bank of Canada has raised interest rates by three percentage points since March, one of the sharpest monetary-policy tightening episodes on record. But regulators need to be vigilant, Bank of Canada senior deputy governor Carolyn Rogers said at the same event.

“A shock like the one that we saw in the U.K., the response you’d probably get out of industry participants is that was a pretty extreme tail-risk event. To see sovereign spreads move that much in that short of a time is pretty extreme,” Ms. Rogers said.

“But if there’s one thing that we’ve learned over the past two years, it is that those tail events, those one-in-a-thousand-year events, seem to be happening every three years. So we have to take a bit more of a pro-active and defensive stance in this environment to be a little bit more alive to these issues.”

Ms. Rogers said the vulnerabilities in the financial system today are fairly similar to those before the COVID-19 pandemic: namely, high levels of household, corporate and government debt. Many household balance sheets actually improved over the course of the pandemic, as people paid down debts and saved money, she said. But people who stretched and took on large amounts of variable-rate debt to get into the overheated housing market may be at risk.

“High levels of debt are easier to sustain at lower interest rates. So as interest rates go up to combat inflation, certainly those levels of debt can manifest into financial instability,” she said.

When it comes to financial oversight, Mr. Routledge said that financial institutions can expect a “cultural shift” at OSFI. “That means their supervisors will be more inquisitive, more forward-looking, and more likely to collaborate in understanding the risks to the institutions.”

Not everyone, however, will have to spend more time responding to regulators, he said.

“As we build on our supervisory framework, or how we classify or rate the relative safety of the institutions we oversee, those institutions that are on the safer end of the scale are going to see a lot less of us, and those on the less safe end of that scale are going to see a lot more of us,” he said.