Canada’s Bank Regulator Says Smaller Down Payments Would Sacrifice Safety: OSFI

Canada’s new top dog at the bank regulator wants you to know they’re taking housing risks seriously. Office of the Superintendent of Financial Institutions (OSFI) Superintendent Peter Routledge discussed their housing priorities this week. In a speech to Vancouver CFAs, he said the financial system is safe but will get more regulations to keep it that way. He also shot down the idea of weakening the stress test or lowering down payments.

Canadian Mortgage Market To Get Stronger Regulations

The regulator doesn’t see much risk for the financial system but has a few concerns. In the speech, OSFI boasted of the smaller debt burdens households now face. They neglected to mention their own research shows a deterioration in loan quality. However, it appears they did keep the threat in mind, reiterating new regulations are coming.

OSFI reminded the public a new round of regulations will be released soon. “The results of our consultation and the final guidelines will be released in the coming weeks and they include reforms to requirements for residential lending exposures to address potential fragility and protect the financial system and taxpayers from severe financial stress, however, they are not our only actions,” said Routledge. 

Weakening The Mortgage Stress Test Might Boost Home Prices

One point of conflict with OSFI has been the minimum quality rate (MQR) for mortgages. OSFI-regulated banks are required to use the MQR to “stress test” borrowers. This involves making them qualify at an interest rate higher than they’ll pay. It helps to ensure a borrower can afford an additional debt burden if needed. 

Some lenders argue they can manage their own risk and don’t need an MQR. It’s an odd point of conflict since OSFI allows them to manage their own risk anyway. They can skip the stress test if the lender takes risk mitigation measures. Some even launched programs to exempt clients from the stress test. Just don’t tell the public.

The agency argues the stress test is needed and helps to contain home prices. “… It attenuates some of the exuberance (not all, I grant you) that would otherwise drive house prices even higher than they have risen in the past year,” he said. 

You might not appreciate that little statement but it was an important one. It may have been the first time Canadian regulators linked credit to home prices openly. Higher interest rates throttle credit but sometimes the market can’t raise rates. By using a stress test, it’s almost like rates were hiked for mortgages, without the extra cost. Though this only applies at OSFI regulated lenders. 

The BoC has yet to publicly acknowledge the role credit plays in driving home prices higher. They do recognize the impact of credit and home prices though. When updating their internal modeling system, they called it a “new innovation.”

Smaller Down Payments Would Sacrifice The System’s Safety

Recently a lot of noise has been made about down payments and the length of time it takes to save. It can take up to 36 years to save a sufficient down payment for a home on the median household salary in Canada. Even if you can afford to make the payments, you might not be able to get a down payment in a reasonable amount of time. 

The bank regulator shot down the suggestion, saying there are risks to consider. “But sacrificing this margin of safety is not the optimal solution. Particularly when there are near term and long-term risks to consider when looking at Canada’s mortgage market.” 

Though the Fed has promised to increase the maximum mortgage size for insured mortgages. This would allow people with smaller down payments to buy more house. Effectively, this is the same thing. Ironically, his statement implies this move would create risks too. Of course, that’s different. Those are ultimately backed by taxpayers, as opposed to uninsured mortgages backed by investors.