BARBARA SHECTER, FINANCIAL POST
The key vulnerabilities to the Canadian financial system continue to be elevated household debt, imbalances in the housing market across the country, and “fragile” fixed-income market liquidity, the Bank of Canada said Thursday in its year-end review.
But the central bank says new “household vulnerabilities” will be mitigated over time by new housing finance rules, which are expected to slow the housing market.
In the December report, the second of two assessments of risk each year, the Bank of Canada noted that mortgage rates are rising in response to government and regulatory changes to housing finance rules, as well as higher long-term bond yields that are increasing lender funding costs.
However, though global economic growth has picked up in the second half of the year, Canadians continue to labour under record debt loads.
“On a national basis, household indebtedness has continued to rise and, more importantly, so has the proportion of highly indebted households in many Canadian cities,” the report said.
Highly indebted individuals are key targets of the new federal measures aimed at cooling the housing market, but it will take time for the changes to have the desired effect, Carolyn Wilkins, senior deputy governor of the Bank of Canada, said at a news conference Thursday.
“It’s not something that will be a matter of weeks. That’ll be over the next few years, so it will take some time for that risk to come down,” she said.
Since the Bank of Canada’s last report on financial system stability in June, federal, provincial and municipal authorities have introduced policies and rules aimed at tamping down skyrocketing home prices, particularly in Toronto and Vancouver. These include British Columbia’s land transfer tax that applies to foreign buyers, and more stringent federal requirements to qualify for insured mortgages across the country. In addition, the Office of the Superintendent of Financial Institutions is ratcheting up the amount of capital banks must hold against riskier mortgages.
“Taken together, the changes will have the greatest effect on household indebtedness by improving the quality of future borrowing,” the Bank of Canada report says.
If new measures requiring a higher qualifying rate for borrowers had been in place during the 12 months leading up to September of 2016, 31 per cent of high-ratio mortgages issued nationally would not have qualified, the report says. High-ratio mortgages are those with a loan to value of more than 80 per cent.
The report notes that tightened rules for obtaining portfolio insurance or other low-ratio mortgage insurance should also influence household debt by making refinancing and long-amortization transactions more expensive or less available.
For now, the national ratio of debt to disposable income is approaching 170 per cent, with strong growth in mortgage credit, and consumer credit. And it is growing at or slightly above the rate of income growth.
“The proportion of borrowers with high mortgage debt relative to income continues to increase in many Canadian cities,” the report said.
“This trend is partly fuelled by rising house prices, particularly in Toronto and Vancouver.”
Almost half of the high-ratio mortgages originated in Toronto in the third quarter had loan-to-income ratios that exceeded 450 per cent, up from 41 per cent a year earlier.
What’s more, the Bank of Canada report says, high loan-to-income mortgages are spreading beyond Toronto to nearby cities including Oshawa and Hamilton. It these cities, the proportion of high-ratio mortgages with loan-to-income ratios exceeding 450 per cent has more than doubled over the past three years to 25 per cent.
One area where risk has diminished slightly since the Bank of Canada’s report in June is the potential fallout from low commodity prices.
To some extent, “we’ve come past that,” Stephen Poloz, Governor of the Bank of Canada, said at Thursday’s news conference. He said prices have come up from lows and shown more stability in the past six months. Still, the central bank is keeping an eye on the continuing impacts on households in oil-dependent provinces.
“We don’t see it as a major risk, but it’s important to understand that it’s not over,” Poloz said.
Beyond household debt and the mortgage market, the central bank’s report also weighed in a segment of the capital markets that is drawing attention at the international level: bond market liquidity.
An in-depth market survey conducted by the Canadian Fixed-Income Forum, an industry group assembled by the central bank, found that there are “pockets where liquidity problems are more evident,” Bank of Canada Governor Stephen Poloz said in a statement Thursday.
These pockets include corporate bonds and certain repo markets.
However, it is too early to determine that regulatory changes are behind the liquidity issues, since markets have yet to fully adapt to the new regulatory requirements, Poloz said. In addition, he said comparisons to the market before the 2008 financial crisis may not be the best standard for comparison “because liquidity was excessive and virtually costless at that time.”
Poloz said the Bank of Canada will keep tabs on the fixed income market, particularly since new regulations are likely to make liquidity marginally more costly, and market-making less lucrative.
“We will continue to monitor market behaviour and to engage with market participants, while pursuing work on the impact of regulatory reforms at the international level,” he said.