OSFI chief defends buffers to protect Canada's financial system

Peter Routledge says its protections mean Canadians have been better placed to keep up mortgage payments as rates increased

OSFI chief defends buffers to protect Canada's financial system

Calls for Canada’s banking regulator to take a softer stance on mortgage lending have been rebuffed by its chief.

The Office of the Superintendent of Financial Institutions (OSFI) helps maintain the resilience of the Canadian financial system with several safeguards including a capital buffer for banks and other large financial institutions.

It also requires mortgage lenders to conduct a stress test on borrowers to help ensure that, if interest rates rise, homeowners are likely to cope with higher monthly payments.

The Minimum Qualified Rate (MQR) for uninsured mortgages clearly adds a barrier to homeownership for some people, with lenders required to qualify borrowers at a higher rate (currently the highest of 2% above contract rate or 5.25%).

Peter Routledge, OSFI superintendent, says that there have been calls in recent months for the MQR to be reduced or scrapped altogether as it is seen as putting undue pressure on homebuyers. But he maintains that it must stay.

“We see great risk in speculating on the mortgage rate cycle and we do not consider the MQR to be a tool to manage the demand for housing,” he said. “In fact, we see the MQR as an underwriting practice that adds an important safety buffer to residential mortgage portfolios, the largest exposure Canadian lenders have on their books.”

Low rates

The superintendent noted that, due to the very low interest rates from 2020-2022, most lenders qualified borrowers at 5.25% in this period, which has proved to be positive as rates have surged from 0.25% at the start of 2022 to 4.25% now.

“This margin of safety made it easier for Canadian homeowners to continue to pay their mortgages and stay in their homes when rates rose later in 2022,” he said. “That is one reason, we believe, why residential mortgage defaults remain at, or are near, historic lows.”

The regulator will publish its annual review this month and will also update its Guideline B-20 which sets out mortgage underwriting guidance including the MQR.

Banks buffer

In the OSFI statement, the superintendent also mentioned the Domestic Stability Buffer (DSB) which requires Canada's six largest banks, also known as Domestic Systemically Important Banks, to hold additional capital as a buffer to mitigate hard times.

The banks are expected to maintain their Common Equity Tier 1 capital above 11% of risk-weighted assets, versus a minimum level for capital adequacy of 8.0%.

Routledge explains that during economic downturns, bank loan losses rise, and bank capital ratios fall. This is a normal characteristic of this part of the business cycle.

“When this happens, OSFI will lower the DSB by a considerable amount and will be comfortable moving capital requirements towards the 8.0%, adequately capitalized floor,” he said. “In other words, when the next recession occurs, OSFI will lower the DSB and expect banks to use this "rainy day fund" to help weather the storm. When conditions improve, we will gradually and non-disruptively raise the DSB and replenish the reserve for the future.”