Household debt and housing remain key risks for financial system

Canada’s housing market and high consumer indebtedness remain the top vulnerabilities for the financial system, but both have shown signs of easing, according to the Bank of Canada.

The central bank said in a report released Thursday that worries about the amount Canadians owe have begun to pull back, but because of the sheer size of the debt, it will remain a concern for some time.

“The two main vulnerabilities we have been watching closely are showing continued signs of easing, which is encouraging,” Bank of Canada governor Stephen Poloz said in a statement.

“Combined, the impact of higher interest rates and the changes to the mortgage guidelines have reduced credit growth and improved the quality of new lending.”

The assessment came in the Bank of Canada’s latest financial system review, which assesses key vulnerabilities that could amplify or propagate economic shocks.

Mortgage lending rules have been tightening in recent years with the application of stress tests on borrowers. New rules implemented at the start of this year introduced a test for borrowers who do not require mortgage insurance and had not previously been subject to stress testing. The housing market has been noticeably cooling since the beginning of this year.

The central bank said it will monitor the extent to which borrowers who want a larger loan than they qualify for under the new federal guidelines seek out alternative lenders, such as credit unions and private lenders, who are not always subject to the federal rules.

Read: How mortgage rules will impact market

In assessing the housing market risk, the report noted that housing price growth has slowed, led by a drop in the Greater Toronto Area. However, it said the condominium markets in Toronto and Vancouver remain strong with some evidence of speculative activity.

Read: Single homes in Vancouver nudge mark where prices can fall: board

Risk to GDP

The central bank estimates that the new mortgage rules will subtract about 0.2% from GDP by the end of 2019. It also provides evidence that household indebtedness and housing market imbalances have weighed on “GDP at risk” since 2016—even while macroeconomic performance has improved.

“By constraining vulnerabilities, financial sector policy may improve GDP at risk,” says the report. “For example, recent policy actions are expected to slow the accumulation of household debt and dampen house price growth.”

Referring to the central bank’s comments, Royce Mendes, director and senior economist at CIBC, says, “That still leaves the [central] bank on course to tighten policy, but interest rate hikes will come at a gradual pace and settle at lower levels than in prior cycles.”

The large stock of outstanding debt makes each rate hike “all the more powerful,” he says, adding that he still expects a July hike.

In addition to household debt and the housing market, the report also identified cyberattacks as a key area of concern.

“Even as defensive capacity improves across the financial system, some attacks will inevitability succeed,” the report said. “Having strong recovery plans can help to quickly restore financial system functioning and prevent a loss in confidence.”

Financial system review to become annual report

The Bank of Canada also announced Thursday that it will no longer publish its financial system review report twice a year.

The report will become an annual review published in June and a member of the bank’s governing council will make a speech in the fall to update its assessment of the vulnerabilities and risks to the financial system.

It will also create a new financial system hub on its website that will publish research and analysis throughout the year.

The Bank of Canada’s quarterly monetary policy report will also include a more in-depth discussion of the relevant issues as warranted.

The central bank has raised its key interest rate three times since last summer, moves that have prompted the big Canadian banks to raise their prime rates, which are used to set the rates charged for variable-rate mortgages and other floating-rate loans. The cost of new fixed-rate mortgages have also climbed in recent months as bond yields have risen.

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