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TORONTO, ONTARIO: FEBRUARY 09, 2012 - Bay Street in Toronto, Ontario is seen here Thursday Feb. 9, 2012. (Tim Fraser for The Globe and Mail) (For ROB story by n/a)Tim Fraser/The Globe and Mail

The federal government's efforts to cool the overheated housing market are raising concerns among Canada's biggest banks that the changes might hit the economy harder than intended, particularly if the new measures are left in place for too long.

Just over a week after Finance Minister Jim Flaherty introduced new mortgage rules designed to slow the pace of household borrowing, Royal Bank of Canada and Toronto-Dominion Bank have both signalled that the steps will have a dampening effect on the country's economy. Though both banks say they support the government's actions, RBC and TD caution there are also risks associated with trying to slow down the housing market.

"It's hard to argue that they shouldn't be doing something to slow this down," David McKay, head of Canadian banking at RBC, Canada's largest bank, said in an interview. "But what is the longer term implication of all this in a higher rate environment? And do we pull back too tightly on the reins?"

Though he argues rising household debt and escalating housing prices required Ottawa to step in, Mr. McKay said he is concerned the changes may only be needed on a temporary basis and could do inadvertent damage to the economy in the long run if they are permanent.

"This is not like turning a Ferrari," Mr. McKay said. "This is like a big ship. And it takes a while to turn. And sometimes if you over steer, you can't re-steer the other way."

In a bid to slow the pace of borrowing in Canada as consumers take advantage of low interest rates, Mr. Flaherty changed the maximum amortization on a government-backed mortgage to 25 years from 30 years.

He also reduced the amount consumers can borrow against their house to 80 per cent, down from 85 per cent.

Shortening the maximum amortization of a government-backed mortgage will result in higher monthly payments for many consumers who would otherwise have taken out a 30-year mortgage, but will also cool demand in the housing market. But Mr. McKay wonders whether it could hinder economic growth too much, once rates rise again. The government has been reluctant to raise interest rates, for fear of hindering the broader economic rebound, but needed other ways to lower appetite for household borrowing.

"Would we consider going back to a 30-year amortization when we are able to raise rates, to alleviate the strain on the consumer wallet, and balance growth in the economy?" Mr. McKay said. "That is obviously a long-term worry."

His comments come after a Toronto-Dominion Bank report said last week that the mortgage changes will likely dampen growth in Canada by 0.2 percentage points next year, creating a drag on the economy and keeping a lid on consumer spending.

The banks expect the changes to slow their loan growth in the next year. RBC forecasts growth in mortgages will be in the low single digits, down from more than 6 per cent.

Mr. Flaherty says the government is aware of the potential economic problems that could result from trying to slow the housing market, but said Ottawa is more concerned about avoiding a crash in housing prices.

"We are prepared to take that risk, quite frankly, because of the greater risk of the development over time of a housing bubble," Mr. Flaherty said on a conference call with reporters Friday. "I realize it may have some dampening effect on the economy and I realize it may have some dampening effect in the residential real estate market," he said.

Among the government's main concerns is the rise in average household debt in Canada to 152 per cent of income. Though it's not known what impact such record levels of household debt will ultimately have in Canada, some economists note that the housing markets in the United States and Great Britain ran into problems when figures reached similar heights.

"You know money is cheap these days. Mortgage rates are low, the banks are lending money at low rates and some people can't resist that temptation," Mr. Flaherty said. "So we are making it more difficult to obtain insured mortgages at low monthly payments by going to the 25-year amortization in particular."

A government official said it was too soon to know whether Ottawa will contemplate a return to 30-year amortizations.

Though banks are taking a cautious approach to the changes, most argue the steps are needed.

"It'll probably do a little bit to make people think twice about buying more home than they can afford or even getting a second home," said Peter Aceto, chief executive officer of ING Direct Canada.

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