Bank of Canada Report Flags AI Concentration and Basis Trades as Market Risks

The Bank of Canada released its 2026 financial stability report on Thursday. The report states that financial asset valuations have continued to rise and that stock market concentration in a small number of large technology companies heavily invested in artificial intelligence has increased.

A negative shock to AI sectors would therefore have an outsized impact on broader stock indexes, the report said. The central bank also highlighted risks tied to basis trades. It warned that the increased role of hedge funds in overnight funding markets poses a vulnerability to the overall financial system.

A sharp pullback in hedge fund activity in government debt markets could negatively affect liquidity and functioning in those markets and other fixed-income markets, the report said.

For households and businesses, the main financial health vulnerability relates to a geopolitical or economic shock that leads to a deep recession and a spike in unemployment, the report said. The bank noted that most borrowers have managed mortgage renewal risks well and that the final wave of renewals is expected to pass by the second half of 2027.

The report states that Canada’s big banks have become more resilient over the past year amid higher profitability and healthy capital buffers. They have also set aside additional funds to absorb potential loan losses, positioning them to support the economy and financial system even in a severe downturn, the report said.

Repo activity has risen in part because more Government of Canada bonds are being issued and traded. More than $130 billion in repo transactions now take place in Canada each day, about double the amount from five years ago. The report cautioned that a disruption in repo markets could lead to sudden deleveraging by asset managers, wider bid-ask spreads, and sharp movements in the Canadian Overnight Repo Rate Average.