Charles St-Arnaud is chief economist at Alberta Central.
Canadian households have shown resilience of late. Consumer spending remains robust and the housing market is showing signs of revival. In addition, many households managed to accumulate savings and increased their wealth during the COVID-19 pandemic. Key to this situation is the strength of the labour market, with low levels of unemployment and continued robust gains in employment.
But this resilience may be coming to an end.
Canadian households have been well-known to be among the most indebted in the Group of 20 nations for some years, making them vulnerable to adverse economic developments. Significant shocks over the past three years have tested households’ resilience, from the pandemic and inflation reaching its highest level since the 1980s, to the rapid rise in interest rates to prevent inflation from becoming permanent.
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Dubbed the Great Consumer Squeeze, Canadians are facing the outcomes of the twin shocks of declining purchasing power, as the cost-of-living is increasing faster than wages, and fast-rising interest rates, forcing consumers to devote a greater share of their income to debt repayment.
Now, despite these current positive signs of solid consumer confidence, there are alarming signs that a rising number of households are struggling with their debt. After a sharp drop during the pandemic because of the government’s income support measures, debt payment deferral program, and closing and backlog at courts, insolvencies are now rapidly returning to their prepandemic levels.
Unchecked, the rapid rise of these insolvencies could escalate into significant losses for banks, forcing them to curtail credit availability, and potentially renewed weakness in the housing market – with grave impact on the wider economy.
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While the number of insolvencies remains below 2019 levels, the increase in March should be an eye-opener. In some instances, particularly in British Columbia, Alberta and Manitoba, insolvencies are now above their prepandemic levels.
Interestingly, households in B.C. and Alberta are also among the most indebted in the country, thereby making them more vulnerable to the sort of shocks we have seen over the past year. In contrast, insolvencies in Atlantic Canada and Quebec, where households are the least indebted, still have insolvencies well below their prepandemic levels.
But the headline insolvencies numbers do not tell the full story. The proposal component of insolvencies, also referred to as a renegotiation of terms, is rising at a rapid pace, while bankruptcies remain subdued. Proposals in Canada are about 10 per cent above their 2019 levels and every province between Ontario and B.C. has proposals well above their prepandemic levels; in Manitoba, this figure is 50 per cent.
Although the fast-rising and high level of proposals may be a return to normal, it also suggests that an increasing proportion of households are falling behind on their financial obligations and require a change in their lending terms to avoid bankruptcy. With the strong labour market enabling a steady stream of income for borrowers, lenders prefer revising their lending terms instead of dealing with the higher costs of bankruptcy and foreclosure.
In this context, the labour market is the Achilles’ heel of the Canadian economy. A change in the labour market owing to a negative shock or a delayed adjustment to the sharp increase in interest rates has the potential to rapidly change the economic outlook. Given the high level of household debt and the high cost of servicing this debt, most Canadian households require two or more incomes to remain current on their payments.
A significant change in the employment conditions and job losses would likely lead to an even greater surge in insolvencies, compounding the impact on the wider economy. Over all, a drop in consumer spending and confidence, and the subsequent credit crunch from tightened lending will negatively affect growth.
Even in the absence of such a shock, we should expect insolvencies to continue to rise. As interest rates remain close to their highest level in a decade, more and more borrowers will be renewing their loans at higher interest rates, some of which may become insolvent because of the significant impact on their payments.
Moreover, as insolvencies are a lagging indicator of the economic cycle, peaking about a year after a shock, the current rise in insolvencies likely barely takes into account the full extent of the rate hikes of the past year.