Weak spot found in Canada’s financial stability

The Bank of Canada is expecting new mortgage rules to help ease a continued rise

OTTAWA — The Bank of Canada is expecting new mortgage rules to help ease a continued rise in household indebtedness that it says has left the country increasingly exposed to an economic shock.

The central bank warned Thursday that the still-climbing levels of debt and the growing proportion of highly indebted households in many cities amid low interest rates have opened up a larger weak spot in Canada’s financial stability.

In its latest financial system review, the bank says at a national level the proportion of highly indebted borrowers with mortgage-to-income ratios above 450 per cent reached 18 per cent in the third quarter of 2016, up from 13 per cent two years earlier.

The report said high home prices have helped fuel growth in the proportion of these highly indebted borrowers in cities like Toronto, where in the last two years it increased to 49 per cent from 32 per cent, and in Vancouver, where it rose to 39 per cent from 31 per cent.

But the bank predicted that stricter housing finance rules introduced in recent months by federal, provincial and municipal authorities will help ease household indebtedness and improve the quality of future borrowing.

In October, the federal government announced changes aimed at addressing hot housing markets and rising debt loads. Ottawa’s new rules made it tougher for prospective borrowers to qualify for mortgages and restricted insurance eligibility for high-ratio mortgages.

The central bank also underlined new rules in Vancouver including a 15 per cent tax on foreign buyers and a tax on homes that are left empty.

All of these measures appear to have somewhat eased concerns expressed by Bank of Canada governor Stephen Poloz, who warned in June that surging housing prices in Vancouver and Toronto were outpacing local economic fundamentals in those areas like job creation and income growth.

“Accordingly, these policies will help mitigate financial stability risks over time,” Poloz said in a statement that accompanied the report.

While the bank said the probability of an economic shock materializing remains low, it noted that such an event could have “significant” consequences for the economy and the financial system.

The report said that Canada’s financial system also remains vulnerable to the continued rise in house prices across the country. The bank said real estate prices have hit a level of just under six times the average household income — the highest ever recorded.

At a regional level, it said housing prices remain particularly high in the Toronto and Vancouver areas. The Vancouver market, however, has begun to slow, the bank added.

The report also explored what it described as key risk scenarios — or “trigger events” — to the Canadian financial system. Overall, it said these risks were largely unchanged compared to the June report.

Among the identified risks, it said a large and persistent rise in unemployment across Canada would create financial stress on indebted families, reduce consumer spending and lead to housing price corrections, particularly in markets like Toronto and Vancouver.

While the probability remains low, the likelihood that country-wide financial stress and a housing correction will materialize had “increased modestly” since June, the bank said. The severity of such an event, should it occur, has also increased, it added.

The report also pointed to other risks, including stress out of China and other emerging markets, a sudden increase in long-term interest rates driven by changes in global economic conditions and a prolonged weakness in resource prices.

“Nonetheless, the Canadian financial system remains resilient,” the bank said in a statement.

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