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mortgage regulation

A real estate sign is pictured in front of a Vancouver home.Ben Nelms/The Globe and Mail

Canada's banking regulator will move ahead with controversial new mortgage stress-testing rules in an effort to curb risky lending practices at banks, but critics say the changes will drive more borrowers to unregulated alternative lenders and add risk to the financial system more broadly.

The Office of the Superintendent of Financial Institutions (OSFI) unveiled a final draft of new mortgage qualification rules Tuesday, tweaking its earlier proposal to ensure home buyers will not have an unintended incentive to sign up for shorter-term mortgages.

The new rules met with criticism that OSFI is offloading risk to the unregulated lending sector, which doesn't come under OSFI control – an outcome that OSFI superintendent Jeremy Rudin acknowledged Tuesday but said he cannot prevent from occurring.

Read more: How OSFI's new mortgage rules will affect home affordability

Read also: OSFI's proposed mortgage stress test is unnecessary, harmful: study

"That would not be an intended consequence, nor would it be a completely unanticipated consequence," he told reporters.

Mr. Rudin said his mandate is to ensure federally regulated banks have secure lending practices. He said OSFI has "ongoing contacts" with provincial regulators that oversee many credit unions and alternative lenders, but "we can't control what we can't control."

Paul Taylor, president of Mortgage Professionals Canada – an industry association representing lenders, mortgage brokers and mortgage insurers – said he understands OSFI has a narrow mandate, but there should be broader policy debate about the risks of encouraging more people to borrow at higher rates in the unregulated "grey market."

He said Canada's housing sector weathered the 2008 financial crisis because banks had high underwriting standards and the system was backstopped by strong mortgage insurance coverage. However, recent changes in Canada have made it harder for borrowers to qualify for insured mortgages, he said, and now reforms are going to encourage more unregulated borrowing.

"In the last 18 months, it seems as though the government is withdrawing from the insured market place and is encouraging the growth of the unregulated market, and is moving closer to the kind of market that is more at risk of a meltdown," Mr. Taylor said.

"They seem not to be convinced by the proof of the success of our regulatory environment in the past."

OSFI's new rules will require buyers who are making down payments of more than 20 per cent of a home's value – who do not need mortgage insurance – to prove they could still afford their mortgage payments if interest rates were 200 basis points (two percentage points) higher than the rate they negotiated.

Some groups criticized the proposal because it could give borrowers an incentive to favour shorter-term mortgages because they typically have lower interest rates, making it easier to pass the stress-test rules. Critics said it would make borrowers more vulnerable to interest rate increases if mortgages come up for renewal more often.

In the final version of the guidelines Tuesday, OSFI added an additional feature to its original proposal, saying buyers would have to qualify at the greater of the five-year benchmark rate published by the Bank of Canada, or the original negotiated rate plus two percentage points. The change is aimed at removing the incentive to favour a shorter-term mortgage.

"We didn't want to create an artificial incentive for borrowers to shorten term because of the regulation," Mr. Rudin told reporters.

He said OSFI is making the mortgage changes because it is concerned about the risks posed by high household indebtedness, rising interest rates and growing property values in some large cities.

However, some working in the real estate sector warned that the changes will go too far to cut home sales in Canada and reduce prices, especially in weaker markets.

Tim Hudak, CEO of the Ontario Real Estate Association, which represents 70,000 real estate agents, said Ontario has "borne the brunt" of repeated policy changes in the past year, and governments need to "hit the brakes" on further regulatory changes.

"OSFI's new stress test for uninsured mortgages is overkill," Mr. Hudak said. "These changes will hurt middle-class families and punish careful savers the most, forcing them to take on more debt and higher interest payments."

Phil Soper, CEO of Royal LePage, said the changes will also be a drag on house prices in regions such as Atlantic Canada and the Prairies, which didn't need new measures aimed at cooling overheated demand. "It runs the risk of triggering the end to the fragile recoveries in those regions."

The changes, which will take effect Jan. 1, are widely expected to reduce house sales across Canada, but forecasts of the impact vary.

Toronto-Dominion Bank economist Brian DePratto estimated in a report Tuesday that the OSFI changes will depress housing demand by 5 per cent to 10 per cent, and will reduce price growth by 2 per cent to 4 per cent over 2018. Mortgage Professionals Canada warned the changes could reduce the volume of home sales by 10 per cent to 15 per cent annually, resulting in 50,000 to 75,000 fewer home sales a year in Canada, when combined with other mortgage rule changes announced last year.

Leaders of Canada's largest banks have been supportive of OSFI's new guidelines, but have expressed concerns about the risks of driving more borrowers to the alternative market.

On Monday, Royal Bank of Canada chief executive officer Dave McKay said he was concerned that if risky borrowers simply migrate to alternative lenders, "then you haven't solved the problem, have you? So that's the back door to this whole strategy that they have to be careful of."

OSFI's new guidelines also clarified that borrowers who are renewing mortgages will not have to meet the new stress-test standard as long as they are staying with the same bank. However, renewals done with another lender will have to qualify under the revised standards because they require new underwriting.

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