Stringent Borrowing Rules and Higher Interest Rates to Curb Riskier Borrowing

While the Central Bank warned that the effort to mitigate risky borrowing may take time, it is optimistic that strict regulatory efforts and increased mortgage interest rates will be a milestone in this direction. As such, the Central Bank believes that this move will make the financial system in the country even more resilient. Through its semi-annual stability report, the Central Bank pointed out that the fundamental steps, in the direction of improved lending quality, had been take; particularly in the cites with the highest house prices, such as Toronto.

However, the Bank has also acknowledged that the key risks, such as the high household debts, are still at elevated level in the country. This being the case, the Bank says that collecting the repayments from the most indebted households may take time.

In a statement, Governor Stephen Poloz also shared his opinion, regarding the country’s financial system. According to the Governor, the financial system in the country is still resilient, which he believes is because of job creation, coupled with a stronger growth. His views were echoed by the Central bank in its last Review of the financial system, back in June. In this review, the Central bank observed that the resiliency of its financial system was strengthening, amid the improving economy. So, what led to the drop in the two rate increases that was witnessed in July and September?

Why the Backdrop?

Following this report by the Central Bank, the Canadian dollar managed to pair a few of its intraday losses. As a result, the Canadian dollar was down by 0.2 percent to C$1.2798, against the U.S dollar, as of 10:48 am, as depicted on Toronto trading. The Central Bank is optimistic that the risks in the country will be mitigated because of three main things:

  • Income Growth
  • Higher mortgage rates
  • A strict mortgage finance policy

The new regulations imposed by the federal government in 2016, along with the banking regulator introduced last month go a long way in preventing the creation of additional highly-indebted households. This will, in turn, lower the demand in the expensive markets, such as Toronto. The effect of the improved mortgage rules that were enforced last year is already being felt in the improved quality in insured lending. The Central Bank is for the opinion that a combination of these three factors will do away with vulnerability in the country with time.

What of the Uninsured Mortgages?

One of the problems that the Central Bank is trying to address with these changes is the growing number of uninsured mortgages in the country today, where the borrower is at a loan to value ratio of 80 percent or below. The higher home prices in Vancouver and Toronto, along with the strict qualification requirements for insured mortgages are partly to blame for this crisis. While this is the case, the Central Bank also noted that a considerable number of these mortgages were already showing riskier characteristics.

Based on this report, the ratio of low-ratio loans to the indebted households is on the increase, while a good number of these mortgages are taking more than 25 years to amortize. Again, this problem is prevalent in the expensive markets like Toronto.

After analysing the effects of regulatory changes imposed by the Office of the Superintendent of Financial Institutions in October, the Central Bank revealed that there was a decline in the number of highly-indebted households among new borrowers in the country. While the federal government is doing everything possible to mitigate riskier borrowing, you need to understand that it may take time to realise the objective. Again, the results in this case are uncertain.

Since some of the new mortgage regulations are yet to be implemented, the Central Bank will have to give the public time to adapt to the new guidelines before trying to assess how effective they are at alleviating vulnerability. If we were to base out argument on the measures enforced in 2016, in this regard, it may take up to six months for the effects of the new regulations to be seen. Again, the debt level in the country is very high and may take several years for a significant effect on debt alleviation to be felt.

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