Financial System Survey highlights—2025

The Bank of Canada conducts the Financial System Survey (FSS) annually to solicit the opinions of senior experts in risk management.1 These experts provide their views on the risks to, and the resilience of, the Canadian financial system as well as on new developments they are monitoring. The survey results are a useful benchmark for comparing Bank views and analytical work with outside opinions. Bank staff also use these results to identify new topics for research and analysis.

The 2025 FSS, completed by 62 respondents, took place between February 10 and 28, 2025 (Chart 1). On April 2, the United States administration announced that it would impose broad-based tariffs on imports on goods from several countries. Following this announcement, financial markets experienced increased volatility, which was not captured in this survey.

In addition to the set of recurring questions, this survey included a set of questions on scenarios that could lead to a severe repricing in financial markets in the near term. Insights gained from FSS respondents on this special topic can help support the Bank’s ongoing assessments of the stability of the Canadian financial system. The questions revolved around learning about:

• the types of scenarios that could potentially result in a severe repricing in financial markets over the next six months
• whether investors are adequately compensated for their risk exposures in different asset classes given the potential for scenarios that could trigger a repricing in financial markets
• whether and how organizations are preparing for such risk scenarios, including through any changes to asset allocation, geographical diversification or other changes to risk management approaches or strategies

Highlights

• Respondents believe the likelihood that a shock could impair the Canadian financial system has increased since the 2024 survey. Those who think that the likelihood of a shock is high cited concerns about the impact of potential changes to trade and tariff policies. While respondents believe the likelihood of a shock has increased, their confidence in the resilience of the Canadian financial system remains high. The reasons cited for this include:
  • the well-regulated financial system, including the well-capitalized banking sector
  • the resilience of the Canadian financial system to past episodes of turmoil
• Respondents ranked changes to trade and tariff policies as the top risk to organizations. Cyber incidents ranked second, declining in relative significance from the top risk in the 2024 survey.
• In terms of scenarios that could trigger a severe repricing in financial markets in the next six months, most respondents cited concerns about changes to trade and tariff policy. Respondents believed that the repricing expected in this scenario could result in:
  • increased liquidity risks, such as margin calls on derivatives or increased requests for redemptions from clients)
  • potential funding challenges
In the longer-term, respondents also expressed concern about higher inflation and slower economic growth in such a scenario.
• Overall, respondents believe that valuations in financial markets do not adequately compensate investors for their risk exposures given the near-term risk scenarios on the horizon, citing that the lowest levels of risk compensation are offered by high-yield credit, public equity and commercial real estate.
• In total, respondents changed their asset allocations only slightly over the past year. Around one-third of respondents reduced risk exposures by increasing allocation to liquid assets such as cash and government bonds and reducing allocation to riskier assets such as investment-grade and high-yield credit and commercial real estate. Notably, the survey results reveal significant variation among respondents, with some respondents increasing their risk exposures.
• Despite heightened concerns about geopolitical tensions, respondents made minimal changes overall to their exposures across geographical regions. Nonetheless, some reported increasing exposures to the United States, and some reported decreasing exposure to China.
• Although respondents reported minimal changes to their exposures across asset classes and regions, they cited other changes they made to their risk management practices, such as:
  • increasing their liquidity stress testing
  • improving their access to liquidity, including by diversifying liquidity sources
  • increasing their hedging of downside risks
  • reducing their risk exposures within an asset class or geographical region by focusing on higher-quality assets
• Respondents consider the cost of mitigating risks to be their main risk management challenge, citing higher costs to increase or even maintain hedging and potential forgone returns from reducing risk exposures.

Risks to the financial system

Overall perceptions of risk and confidence

Respondents believe that the likelihood of a shock that could impair the financial system has increased in both the short term (less than one year) and medium term (one to three years) since the 2024 survey (Chart 2). This increase was larger in the short term, with the share of respondents who believe that a shock was moderately or extremely likely over this horizon increasing from 2% to 21%. Respondents who believe that a shock was more likely mentioned similar concerns in both the short and medium terms:

• changes to trade and tariff policies
• geopolitical tensions
• the potential for higher fiscal deficits in both Canada and the United States
• macroeconomic concerns, including slow growth and higher inflation
• elevated property prices and high household debt
• the potential for a cyber attack, particularly in the context of broader use of artificial intelligence (AI)

Respondents’ perceptions of an increase in the likelihood of a shock were accompanied by continued confidence in the resilience of the Canadian financial system. Confidence decreased very slightly, but it remains high and in line with the results from previous surveys (Chart 3). The main reasons cited for this ongoing confidence were similar to those cited in past surveys:

• the well-regulated financial system, including the well-capitalized banking sector
• the resilience of the Canadian financial system to past episodes of turmoil

Some respondents continue to expect that regulators, central banks and governments would intervene if a large shock were to occur. Those with lower levels of confidence raised concerns about the government’s ability to respond to shocks given existing high levels of fiscal deficits and debt.

Most important risks

Respondents ranked the three risks that would have the most severe impact on their organization if they were to occur over the next three years. They also assigned each of these risks to a broader category. Chart 4 shows the top risk categories in the order of their risk index, calculated by combining the ranking of each risk category weighted by its frequency among responses.

The following are details on the top three risks:

1. International economic and political risks. These predominantly involve the risk of changes to trade and tariff policies, which was the top risk to organizations overall. The risk index would have increased by even more if we had considered cases where tariff-related risks were also reported in other risk categories, including domestic macroeconomic, strategic and real estate sector risks. Respondents mentioned concerns about how an extended and significant trade war could result in persistent inflation, slow growth and a sharp repricing in financial markets. Some respondents also raised concerns around the risk of rising geopolitical tensions. Respondents are managing these risks by:
   • adjusting hedging strategies to adapt to changing market conditions
   • employing scenario analysis and stress testing
   • maintaining diversified exposures across regions, sectors and asset classes
   • maintaining sufficient levels of liquidity
2. External risks. These mainly consist of the risk of a cyber incident that affects operations or data security. This risk fell from the top risk in the 2024 survey to second overall in this survey. Respondents are managing the risk of cyber incidents by:
   • regularly monitoring cyber security risks, including reviewing risk exposures of third-party vendors
   • investing in cyber security initiatives
   • raising employee awareness
3. Domestic macroeconomic risks. The potential for persistently high inflation and for a recession that could lead to a severe repricing in financial markets were frequently cited risks in this category. Many respondents mentioned that such macroeconomic risks could be triggered by changes to trade and tariff policies. They highlighted the negative impacts of these risks could have on unemployment, housing affordability and their financial asset exposures. Respondents’ risk management approaches to these risks were similar to those reported for the international economic and political risk category.

New developments

Respondents also reported new developments that their organization started monitoring within the past 12 months and shared how these may affect risks to their organization. The most frequently reported new developments relate to changes to trade and tariff policy and geopolitical tensions. Other new developments included:

• artificial intelligence and other technology risks
  • Some respondents shared concerns that advances in AI could lead to increased risks of fraud and cyber attacks and other threats.
  • Others mentioned looking for use cases for AI to drive efficiency and growth.
• banking sector policies and developments
  • Some respondents expressed concerns that the increased adoption of online banking could expose their organizations to increased risks of fraud and reputational damage.
  • Some respondents raised concerns that the possible deregulation of financial institutions in the United States could reduce the competitiveness of Canadian financial institutions.
• margin requirements on derivatives
  • A few respondents mentioned potential changes to margining practices for non-centrally cleared derivatives and suggested that higher margin requirements would increase the cost of obtaining leverage.2

Scenarios that could lead to a severe repricing in financial markets in the near term

We used a special section of the 2025 FSS to better understand the types of scenarios that could result in severe repricing in financial markets over the next six months. We asked how market participants adjusted their strategies over the past year to prepare for these scenarios.

Specifically, we asked market participants to tell us:

• the types of scenarios that could trigger the most severe repricing in financial markets where respondents have exposure over the next six months
• whether investors are adequately compensated for risks in different asset classes, based on current market valuations, given the potential for risks that could result in a severe repricing in financial markets
• how respondents’ organizations may have been changing or planning to change their asset allocation or geographical diversification or other risk management strategies

Risk scenarios

Among the risk scenarios that could trigger a severe repricing in financial markets within the next six months, respondents were most concerned about changes to trade and tariff policies. Rising geopolitical tensions was the second most frequently mentioned scenario (Chart 5).

• Changes to trade and tariff policies: All types of respondents reported this was the top risk. The primary concern cited was the possibility of a prolonged US-led global trade war resulting from the US imposing higher tariffs on imports of goods from other countries followed by cycles of counter-tariffs. Respondents believe this scenario could result in a worsened macroeconomic outlook and lead to strains in market liquidity and funding challenges.
• Rising geopolitical tensions: These predominantly included concerns about China invading Taiwan, a Russian expansion in Europe and threats to Canada’s national sovereignty. Respondents also cited concerns about inflationary pressures from potential disruptions in global supply chains and higher fiscal deficits.

In addition to losses on their assets, respondents indicated other ways their organizations could be negatively affected by these types of risk scenarios. In particular, 39% expected higher needs for liquidity and anticipated funding challenges. More specifically:

• Many investment fund managers raised concerns about higher redemptions from their clients and losing access to funding, including that obtained through the repurchase agreement (repo) market.
• Some pension funds and insurers anticipate needing greater liquidity to meet margin calls on their derivatives and mentioned higher costs for issuing debt in public markets.
• Some banks and credit unions raised concerns about large withdrawals of deposits from their clients and significant draws on their committed lines of credit.

Of respondents, 26% expect that a risk scenario will have minimal impacts on, or even potential benefits for, their organization. If a repricing occurs, some pension funds and investment fund managers plan to invest opportunistically to capitalize on the market movements. These respondents highlighted that a long-lasting recession or stagflation would be of greater concern to them than a short-term repricing.

Perceptions of risk compensation in different asset classes

Respondents generally believe that most asset classes do not adequately compensate investors given the potential for the risk scenarios identified above (Chart 6). Overall, respondents believe that risk compensation was lowest for high-yield credit, public equities and commercial real estate. Nevertheless, 11% of respondents consider valuations in these categories to fully compensate investors for their exposure to risk.

Responses also varied depending on the type of respondents:

• Investment fund managers, pension funds and insurers reported lower perceptions of risk compensation for investment-grade and high-yield credit and public equities than those reported by other types of respondents.
• Compared with other respondents, pension funds and banks believe that private debt and private equity offer higher risk compensation levels.
• For most asset classes other than commercial real estate, the level of risk compensation reported by banks, broker-dealers and credit unions was higher than that reported by other respondents.

Changes to asset allocation, geographical diversification and other risk management strategies

Despite concerns about risk scenarios previously identified and low perceived risk compensation across many asset classes, respondents have made only minimal changes to the allocation of assets over the past year (Chart 7).

Reasons for minimal asset allocation changes varied:

• For respondents with a long-term or strategic asset allocation mix target, 80% reported that their current asset allocations were in line with their long-term targets.3 Many of these respondents reported that their target mix was already well-diversified and suitable for an environment of increased risk.
• Respondents whose current asset allocation deviated from their target mix or who do not have a long-term target mix mentioned that they had already adjusted their asset allocation to favour more liquid assets given long-term concerns of stretched asset valuations.4
• Many respondents also mentioned that they had increased their hedging of downside risks rather than changing their asset allocation.
• Other respondents were waiting for more signs of risks occurring before changing their asset allocation further.

Nevertheless, there were some notable changes in asset allocation:

• Of respondents, 36% appeared to reduce overall risk exposures. This was done by:
  • increasing exposure to more liquid assets, such as cash and government bonds
  • reducing exposure to some riskier asset classes, such as high-yield credit, public equity and commercial real estate
  This trend was most pronounced for investment fund managers, who also reported reducing their leverage. Pension funds and insurers made similar changes to their asset allocations but increased their exposures to less-liquid assets such as private equity and private debt to improve diversification and to better align with their long-term asset allocation targets.5
• Of respondents, 16% appeared to increase risk exposure, with higher allocation to assets such as high-yield credit or public equities. Some of these respondents mentioned that they believed potential deregulatory policies and tax cuts in the United States could support risky asset valuations despite concerns around trade policy and tariffs. Some also mentioned that they were still underweighting these assets relative to their long-term asset allocation target mix even though they were increasing allocation to riskier assets.

Respondents also reported making minimal changes to their exposures to different geographical regions over the past year (Chart 8). However, some trends observed in responses include the following:

• Over the past year, 41% of respondents reported increasing their US allocation. Some of this trend may be related to the rise in market valuations, rather than new exposures. Reasons for increased US exposure included higher yields on US fixed-income assets relative to Canada as well as expectations that the US dollar would appreciate in a risk scenario. As mentioned earlier, some respondents also expected policy changes aimed at deregulation as well as possible tax cuts in the US to support financial markets.
• Of respondents, 25% reported reducing their allocation to China. These mostly included pension funds and investment fund managers. These trends are in line with concerns raised in this and past surveys about rising geopolitical tensions involving China.

Respondents reported making other changes to their risk management strategies and practices:

• Many respondents reported adding more stress-test scenarios, especially related to tariffs, and improving their risk models.
• Some mentioned improving their access to liquidity by diversifying liquidity sources and increasing their monitoring of exposures to liquidity risk.
• Some respondents reported more hedging of risks in foreign exchange, equity and credit markets by, for example, using options to protect against large declines in asset valuations.
• Some respondents changed asset allocation within a given asset class to reduce risks by focusing on higher-rated issuers within their credit portfolios or on assets in certain areas within a geographical region.

Challenges in managing near-term risks to financial markets

Of respondents, 60% indicated that costs of risk mitigation affected their ability to manage risk scenarios.

Asset managers noted:

• the opportunity cost of holding more cash and liquid assets, which could lead to lower returns
• the higher cost of hedging products such as put options on public equities and foreign exchange hedges

Banks, broker-dealers and credit unions mentioned:

• operational costs
• increased investments required for more risk controls

Of respondents, 39% indicated that a lack of hedging products constrained their risk management strategies. Specifically, respondents cited the lack of:

• alternative products for real-return bonds to hedge against inflation risk
• a market for credit default swaps in Canada

Of respondents, 34% mentioned their risk management could be constrained by:

• lack of depth in some Canadian markets
• wider bid-ask spreads across different assets
• strains in the repo market during periods of higher volatility

Finally, some respondents also cited uncertainty in how a risk scenario would play out as a challenge in managing risks.

Endnotes