Regulators’ successful efforts to cool an overheated housing market has reduced risk to the financial system, suggests Fitch Ratings in a new report.
The rating agency said that the “sustained cooling of the Canadian housing market” due to regulatory measures — such as tougher mortgage underwriting standards and a foreign buyer tax in Vancouver and Toronto — has reduced the likelihood of a “severe shock to the financial system.”
Fitch said these policy reforms have helped move housing prices into better alignment with the underlying market fundamentals.
It noted that the Canada Mortgage and Housing Corp. (CMHC) recently reduced its assessment of housing market imbalances from “high” to “moderate,” and that the Bank of Canada’s latest Financial System Review indicated that household indebtedness is moderating too.
“The softening of Canadian housing market prices represents the turning point of an unsustainable appreciation trend,” Fitch said. “Continued modest home price stabilization and declines are expected over the next two years due to tighter credit standards and rising regulatory capital requirements.”
Indeed, banking regulators recently boosted the capital buffer required from the domestic systemically important banks (D-SIBs).
“Regulators now have increased protection from downside risk,” Fitch said, adding that by demonstrating their willingness to raise the buffer, they are “building credibility to lower the buffer in the future when the cycle changes.”
Despite the overall cooling in the housing market, Fitch said that Toronto and Vancouver remain overvalued. As a result, it said banks “remain vulnerable to a significant housing price correction,” particularly in those markets.
“Debt to income levels remain at record levels, with exposure to rising household debt amid a softening housing market a continued vulnerability for Canadian banks,” it said, adding that the banks’ exposure to uninsured household debt is “substantial.”