Canadian indebtedness, specifically with regards to mortgage debt, is having a greater impact on the country’s economy and the central bank’s decision-making.
In remarks issued on Thursday, Bank of Canada Governor Stephen Poloz acknowledged that Canada faces significant financial vulnerabilities, which arose from an extended low-interest-rate regime.
“Normally, the economic cycle is short enough that the risks [from household and business borrowing] are relatively minor,” Poloz said. “Of course, the past 10 years have been far from normal … The inevitable result has been strong demand for housing, rising house prices and an accumulation of household debt of historic proportions.”
He pointed to the federal government’s efforts to contain the vulnerabilities, particularly the B-20 guideline that imposes a stress test on mortgages issued by federally regulated financial institutions. The bank has seen fewer mortgages being taken out at debt-to-income ratios over 450%, and mortgage borrowing growth has slowed this year to just over 3%.
Borrowing has slowed because of the combination of the stress tests, higher interest rates, and housing policies set at the provincial and municipal levels , Poloz said, adding that the bank is taking steps to be able to determine how much of an impact interest rate moves have on economic activity.
“First, a new concept that was developed at the International Monetary Fund—growth at risk—is now being used by Bank staff,” he said, explaining that the model allows them to estimate both the usual direct effects of interest-rate changes on the economy, as well as indirect effects that arise because of growing financial vulnerabilities.
The bank has also upgraded its main economic model to incorporate household debt accumulation. It captures the economy’s increased sensitivity to interest-rate movements in times of high debt levels, as well as the link between debt accumulation and rising house prices.
“Third, Bank staff are working with new sources of microdata to deepen our understanding of how higher interest rates affect mortgage holders,” Poloz said. The central bank is now able to access anonymized individual-loan-level data — including mortgage size, household income, interest rate at origination, mortgage term, and amortization period — going back to 2014, which captures about 85% of mortgage borrowing over the period.
“[T]o date, most households have been renewing at mortgage rates that are pretty similar to the rates they signed up for five years ago,” he said. “As we go forward, people will increasingly face higher interest rates when they renew, and we will learn more about how people are adjusting.”
The central bank governor also noted a number of other trends, including a rising share of mortgages that originate outside federal jurisdiction and a greater share of highly indebted borrowers taking out variable-rate mortgages. While the quality of new lending has improved and the stock of risky mortgages should decline as they are slowly paid down, he said, vulnerability from risky mortgages remains high and should persist for many years.
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