The Bank of Canada’s latest financial system review says that risks to the stability of the Canadian financial system are modest.

“The likelihood that a shock would have a significant adverse impact on the Canadian financial system remains small,” it says. “The Canadian financial, non-financial corporate, and household sectors are healthy and in a good position to withstand shocks.”

Although, it notes, “The possibility of a significant price reversal in riskier assets remains, although markets have so far been resilient in the face of negative shocks.”

The review also indicates that a small risk in the adjustment of global imbalances persists, specifically that it “could slow the growth of the global economy appreciably and increase volatility in financial markets significantly”. However, it adds this risk may be lower than previously thought.

The Bank says that the Canadian economy has adjusted remarkably well to large relative price changes, including a significant appreciation of the Canadian dollar, although it allows that the higher dollar and heightened global competition “continue to pose challenges for a number of firms”.

It notes that market volatility has increased recently, adding, “There is thus a possibility that a more pronounced increase in market volatility could still trigger a significant repricing of risk. An important question is how resilient world markets would be to such repricing.”

Canadian financial institutions are currently in a good position to withstand shocks, the Bank says. “Major banks have been profitable, are well capitalized, and are using sophisticated risk-management models.”

Also, non-financial corporations have been prudent, the Bank adds, “at a point in the cycle when risk taking can often lead to vulnerabilities that can cause problems when the macroeconomic environment becomes less favourable.”

The Bank also says that the funded ratio of pension plans has improved in recent months. “While the risks to the financial system related to the funding status of pension plans have declined since December, defined-benefit pension plans in Canada remain underfunded on balance.”