A senior official from Canada’s banking regulator defended a stress test on new mortgages against an array of criticisms, arguing it has improved lending standards across the industry.
The stress test has attracted intense public scrutiny since it was introduced 13 months ago, including calls from some mortgage professionals and politicians to relax its terms or scrap it entirely. They have argued it put some borrowers at a disadvantage and could have unintended consequences, such as increasing risky, unregulated borrowing. At a lunchtime speech in Toronto on Tuesday, Carolyn Rogers, the assistant superintendent for regulation at the Office of the Superintendent of Financial Institutions (OSFI), showed no sign of wavering in the regulator’s conviction that the stress test has been a necessary check on loose lending.
Escalating home ownership costs and the knock-on impact on Canada’s economy are “a problem that is proving very challenging to address,” she said. But she defended the regulator’s stress test – which has made it harder for some borrowers to qualify for mortgages – by arguing that the answer to the problem “cannot be more consumer debt fuelled by lax underwriting standards.” OSFI had been concerned that some lenders were focusing too much on a home’s collateral value, and not enough on the borrower’s ability to repay the loan.
“We look at, what has it done to underwriting standards in banks? And in that sense, we’re pleased with what it’s done. It’s been effective, it’s done what we intended it to do, it’s tightened up the mortgage underwriting standards, it’s made banks more prudent,” Ms. Rogers said in an interview.
The stress test was the most significant of a series of changes that came into force at the start of 2018, after months of public debate. The test requires borrowers taking on a new, uninsured mortgage to prove they could afford payments at an interest rate two percentage points higher than their lender’s offer, or a five-year Bank of Canada benchmark rate – whichever is higher.
She acknowledged that regulating mortgages “requires judgment" and that market conditions can change. But Ms. Rogers argued that the stress test is doing what it was designed to do. It was never designed to compensate for low interest rates, or to cool especially hot housing markets in Toronto or Vancouver, she said. “The stress test is, quite simply, a safety buffer that ensures a borrower doesn’t stretch their borrowing capacity to its maximum, and leave no room to absorb unforeseen events,” she said in prepared remarks. “This is simply prudent. It’s prudent for the bank, and it’s prudent for the borrower.”
And Ms. Rogers dismissed any notion that as the Bank of Canada has raised interest rates, the stress test has become less necessary, citing continuing risks to the economy.
"Interest rates, although they have gone up, remain at historically low levels, and personal debt at historically high levels. A margin of safety in these conditions is just sensible," Ms. Rogers said in her speech. "Now, should that margin of safety be monitored, and should it be changed and adjusted if conditions in the environment change? Of course it should. OSFI monitors the environment on a continual basis."
Even if OSFI elected to make changes, it would require months of further public consultations and a grace period to give the industry time to prepare, she said.
Some critics of the stress test warned that it would encourage borrowers struggling to qualify for loans to turn to unregulated private lenders charging punitive interest rates. In some regions, Bank of Canada data suggest private lenders account for up to 9 per cent of mortgages, and Ms. Rogers said that is “a legitimate concern." But for the regulator, “it cannot be a reason not to act," she said. Instead, she appeared to shift the onus to mortgage professionals. “If you see risks, if you think these options put your borrower in a vulnerable position, you should steer them away,” she said.
Borrowers who renew mortgages with the same lender are exempt from the stress test, which has boosted banks' renewal rates, prompting concerns that bankers would have less incentive to offer competitive renewal rates. In response, OSFI created a tracking system, and “to date we haven’t seen any evidence that banks are taking advantage of this to the detriment of borrowers," Ms. Rogers said. But that monitoring is continuing, “and if we see the need to take action, we will."