OSFI flags spillover risks from non-bank lending while cyber risks remains on the list
Canada’s federal banking regulator is flagging exposure to non-bank lenders such as hedge funds as one of the top three risks to the financial sector.
In its annual risk outlook, released Tuesday, the Office of the Superintendent of Financial Institutions zeroed in on the expansion of risks outside the traditional banking system, including in areas where non-bank lenders and investment funds are taking on more borrowing.
Federally regulated financial institutions have become active lenders to private capital firms, their portfolio companies and clients, OSFI said, adding that the opaque nature of this leveraged market can mask problems and intensify losses in times of stress.
“Canadian institutions’ exposures to private capital firms and their portfolio companies have grown considerably in recent years, representing a material component of the balance sheet,” the report said.
In addition to lending to and investing in private capital firms, Canadian institutions are also competing with the private lenders.
“Competition with less-regulated firms can lead to riskier lending terms and the opaque nature of the market can mask weaknesses,” OSFI said.
The regulator’s two other top concerns are real estate secured lending and liquidity and funding risk.
“Housing and mortgage pressures have increased in some parts of the country,” OSFI said, pointing to strains in the Toronto and Vancouver housing markets in particular and the potential for unfavourable economic impacts from trade negotiations and escalating global conflicts and commodity prices.
Despite high-level meetings in Ottawa this week about cyber risks posed by a new artificial intelligence model on the cusp of being released by U.S. tech company Anthropic, cybersecurity is further down on the list of risks highlighted by the regulator.
Outside the top three concerns for 2026, OSFI said regulators remain vigilant over a longer list of key risks, including wholesale credit risk, AI, cyber and technology, integrity and security, and third-party risk on that list.
Once again looking to spillover risks from areas of the financial market it does not regulate, OSFI flagged banks’ increasing use of unregulated and lightly regulated financial players such as hedge funds to provide credit protection on their lending portfolios. This is done using arrangements such as synthetic risk transfers, where banks pool loans and sell tranches of the credit risk to non-bank investors while retaining the loans on their balance sheets .
The regulator is concerned that these non-bank financial institutions would have reduced capacity to provide credit protection to banks during times of stress, which could increase credit risk for the banks, ding their capital levels, and crimp their ability to lend to core clients.
The regulator is also concerned about potential impact on federally regulated financial institutions from increasing hedge fund involvement in sovereign bond markets, which underpin bank liquidity and capital frameworks.
“Any material dislocation in the sovereign markets… could cause spillover—straining funding conditions and reducing liquidity coverage,” OSFI said.
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