BoC warns of risks for clients with mortgages

Bank of Canada governor Stephen Poloz is having trouble sleeping at night. But it’s not visions of sugarplums that are dancing in his head; it’s threats to Canada’s financial system.

In a speech Thursday, Poloz itemized these prime concerns:

• high house prices and household debt,
• cyber threats,
• cryptocurrencies and
• the labour market.

Housing concerns contain a message for clients

Though vulnerabilities in housing and household debt have shown signs of easing, “these vulnerabilities are elevated, and are likely to remain so for a long time,” said Poloz, according to prepared remarks of his address to the Canadian Club of Toronto.

Read: BoC sees some improvement in debt, housing market

Beyond the level of debt, he said its composition and distribution is concerning. “More than 80% of household debt is composed of mortgages and home equity lines of credit (HELOCs),” he said. “Increasingly, mortgages are being combined with HELOCs, to the point where about 40% of all housing-backed loans are blended with a HELOC component.”

Though HELOCs can be a convenient tool, the governor noted their risks, such as when clients make interest payments only, or use HELOCs to speculate (i.e., fund a down payment on a second house to flip the property).

“Given the potential for volatility in house prices and for higher interest rates, such activity may be adding to the overall vulnerability of the [financial] system,” he said.

He noted that macroprundential measures introduced last year aimed at high-ratio mortgages have resulted in “a sharp drop” in the number of highly indebted Canadians obtaining such mortgages. (He defined “highly indebted” as those Canadians with a debt-to-income ratio above 450%).

Guidelines for low-ratio mortgages that come into effect in 2018 should likewise limit the number of low-ratio mortgages going to highly indebted households, he said.

Read: Mortgage stress test to temper home prices: report

But the measures aren’t meant to control house prices. “Ultimately, the laws of supply and demand will determine the direction of house prices,” he said.

And in 2018, if clients are tempted to visit an unregulated lender for a mortgage—one not bound by the new lending guidelines—Poloz had this advice: “Testing yourself to make sure you could handle your mortgage payments if interest rates were higher at renewal is a very good idea, whether it is a rule or not.”

Safeguarding against cyber threats

Poloz also noted that connectivity within the financial system creates vulnerability: “A problem in one institution may spread to others and be amplified. […] We need to be prepared to recover our systems should a cyber attack succeed.”

He said the central bank is working with financial institutions and payment systems to ensure “robust joint recovery plans” are in place.

Where cyptocurrency is headed

The governor said cryptocurrencies aren’t reliable stores of value, nor can they be easily spent. “What their true value is may be anyone’s guess—perhaps the most one can say is that buying these things means buying risk, which makes it closer to gambling than investing.”

Read: Bitcoin buoyed by investor behaviour

Their elusive nature doesn’t provide shelter from the taxman, however. Poloz reminded the audience that CRA considers cryptocurrencies as securities. “That means, if you buy and sell them at a profit, you have income that needs to be reported for tax purposes,” he said.

He also said the central bank, like all central banks, is exploring the possibility of issuing its own digital currency, as demand for digital cash grows.

Remarks on monetary policy focus on labour market

Poloz also commented on the central bank’s monetary policy, saying that, with the economy running at close to full tilt, a mechanical approach to setting interest rates would suggest higher borrowing rates should already be in place.

But he said the central bank is scrutinizing some unusual factors at play—including encouraging signs that companies are starting to expand their capacity by investing in equipment and by hiring more people.

Wages have been growing, and the workforce has seen a sudden jump in participation by young people, he said.

Poloz acknowledged the bank’s current benchmark rate of 1% remains quite stimulative. However, there’s still more room for the labour market to grow before it starts pushing inflation higher, he said.

The central bank introduced two rate hikes this year due to the strong economy: once in July and again in September. But since then, Poloz has kept the rate on hold, including at last week’s announcement when he pointed to uncertainty over trade and a greater-than-expected weakness in exports.

Still, he continues to warn that higher interest rates will likely be required over time, even though the bank will proceed with caution by focusing on incoming data.

Read the full speech.