Canada’s bank regulator urges lenders to tackle risks from mortgage extensions at the “earliest opportunity.” This is as many borrowers try to navigate higher mortgage costs after the Bank of Canada’s surprise rate hike last week. CIBC and RBC raised their mortgage rates this month, raising the cost of existing variable and fixed-term mortgages for tens of thousands of Canadian homeowners. At the same time, many mortgages will be up for renewal this year. They will face the higher payment with a more extended amortization period or reverting to the original rate.
The Office of the Superintendent of Financial Institutions (OSFI) has spelled out “enhanced expectations for residential mortgage underwriting,” requiring that lenders verify borrowers’ income and conduct more thorough due diligence in areas where home prices are rising rapidly. OSFI’s letter also warned lenders that relying on collateral value as an indication of a borrower’s ability to service debt is risky.
A four-page document lays out new requirements for banks and federally regulated mortgage companies to ensure that they’re evaluating the risks of borrowers who take on more debt than their ability to manage repayments, especially if interest rates start climbing. The move marks an escalation in OSFI’s approach to managing systemic risks as it balances the interests of lenders, borrowers, and the public.
It’s a stark shift from the relaxed approach to risk that has characterized the past few years of booming housing markets and low-interest rates. In a speech to the RBC Canadian Bank CEO Conference Monday, OSFI Governor Mark Carney said that although it is difficult to predict when Canada’s housing market will cool down or how much the resulting slowdown would affect mortgage demand, “it is clear that current conditions are creating significant challenges for financial institutions.”
Banks have already started to take steps to deal with the new realities. CIBC, for example, has set aside more money to cover bad loans as mortgages come up for renewal. RBC also wants to change its amortization terms for some borrowers to avoid higher payments. However, OSFI’s new guidelines suggest that the bank regulator may have plans to go further.
While OSFI’s new requirements are aimed at the big banks, it also signals that the federal government will not weaken its stress test for uninsured mortgages. Bucking pressure to weaken the rules, the Bank of Canada in December maintained a critical threshold for interest-rate affordability stress tests and is seeking input on whether to beef up other related debt servicing controls such as loan-to-value and debt-service coverage ratios.
But, while OSFI is raising its game, it’s important to remember that the problem hasn’t been a lack of competition among banks and that banning mergers won’t solve the problem. Instead, the focus should be ensuring that small and medium-sized businesses can get credit to keep their operations running.
