Around this time last year, Canada’s top banking regulator was vigorously defending stress-testing rules for uninsured mortgages.
Speaking at a housing finance forum in Cambridge, Ont., Superintendent Jeremy Rudin had a message for critics: It’s not the job of the Office of the Superintendent of Financial Institutions (OSFI) to help Canadians buy homes they cannot afford.
Introduced in 2018, the stress test requires home buyers with a down payment of at least 20 per cent to prove they can afford loan payments if their mortgage rate increases to the Bank of Canada’s average five-year conventional mortgage rate, or to their contractual rate plus two percentage points – whichever is higher. To say those rules rankled the real estate industry is an understatement.
“OSFI oversight of mortgage underwriting standards gives us a tool that we need to ensure the safety and stability of Canadian banks and the Canadian financial system," Mr. Rudin said during his speech on Feb. 8, 2019. "What it doesn’t give us is a dial we can turn up and down to try to get particular outcomes in the housing market.”
These days, however, the federal government is leaning on OSFI to do just that. Assistant Superintendent Ben Gully told a private event in late January that OSFI is considering changes to the stress test, obliquely suggesting it has become too conservative. It was as if an occult hand had prompted the regulator to contradict itself.
Although Mr. Gully took pains to point out the stress test is reducing risk by improving loan quality and weeding out borrowers with lower credit scores, he also expressed concern it could be setting the bar too high for prospective home buyers. (He wasn’t that direct, of course. Regulators have a propensity to provide cryptic commentary.)
If you’re wondering why OSFI is suddenly considering fiddling with the stress test as froth builds in the Vancouver and Toronto housing markets, household debt remains high and consumer insolvencies are rising, look no further than Prime Minister Justin Trudeau and his waning political fortunes. Now leading a Liberal minority government, Mr. Trudeau instructed Finance Minister Bill Morneau, who is responsible for OSFI, to figure out a way to make “the borrower stress test more dynamic."
It’s a ploy to curry favour with millennial voters who, according to real estate industry shills, are being sidelined by the stress test. Trouble is, the Liberal government is politicizing OSFI, and that meddling is bound to create unnecessary risks in the financial system at a time when interest rates are expected to remain low and Canadians are already assuming new mortgage debt.
OSFI finds itself in an awkward position. It’s obligated to provide advice on how to soften the rules it has defended for more than two years. Hence its newfound concern with the stress test – specifically its use of the Bank of Canada’s five-year conventional mortgage rate to set a floor, or lowest possible value, on the qualifying interest rate for uninsured mortgages.
On the one hand, without that Bank of Canada five-year rate functioning as a fail-safe, “some borrowers could select variable or shorter-term loans that may not be appropriate for their risks," Mr. Gully said. On the other, he pointed out that the spread between that rate and actual contract rates has widened recently, “suggesting that the benchmark is less responsive to market changes than when it was first proposed.” In other words, the floor is now too high.
“We chose the best available rate at the time,” Mr. Gully said, adding that banks’ posted rates are “not playing the role that we intended.”
Really? It’s no surprise that banks haven’t rushed to lower their posted mortgage rates. Their net interest margins, the difference between what banks pay for deposits and what they earn on loans, are squished. And OSFI has tolerated this type of stalling in the past. In 2015 and 2008, banks delayed adjusting their prime rates, which affect a slew of floating-rate loans including variable-rate mortgages, after cuts to the Bank of Canada’s trend-setting interest rate.
So it was curious that TD Bank cut its posted five-year mortgage rate last week, and said the reduction “aligns TD’s five-year fixed posted rate more closely with current customer rates." It’s almost as if its statement was written to assuage OSFI’s (read: Mr. Trudeau’s) concerns.
It could all be a coincidence, of course, including the nod Mr. Gully gave to consumers by saying “we recognize that Canadians’ ideal of home ownership is an aspirational goal for many.” To be clear, OSFI has no mandate to consider consumer issues and hasn’t since 2001.
The PMO needs a reality check. Widening spread or not, if borrowers don’t qualify under the stress test, they have no business owning a home. Lax mortgage underwriting caused the financial crisis. If anything, OSFI should err on the side of caution.
The United States and Europe have shown us what can go wrong when politicians interfere with banking regulations. For all our sakes, let’s hope the eggheads at OSFI have the temerity to push back.
Rita Trichur