BOC:Household Debt Still Chief Vulnerability But Should Ease>

--Financial System Continues To Be Resilient

By Courtney Tower

     OTTAWA (MNI) - Once again, as it has been for some years, 

historically high household debt in Canada is rated by the Bank of 

Canada as the chief vulnerability for financial stability in the 

country, especially the large share of debt held by households that are 

highly in debt. 

     In its semi-annual Financial Stability Review (FSR), issued 

Tuesday, the BOC overall identified the same risks and vulnerabilities 

to the financial system as in June. 

     However, it found that despite still "elevated" risks to the 

Canadian financial system, there were "preliminary signs of 

improvement." And going forward, "better economic conditions and several 

new policy measures support prospects for additional progress." 

     The BOC linked as vulnerabilities household debt, which mostly is 

in home mortgages, and related housing market imbalances, mainly in 

Greater Toronto and Vancouver, which together account for half of 

Canada's housing market. 

     While these two main vulnerabilities to the financial system in 

Canada are said by the BOC to still be "elevated," an improving economy 

and changes by governments to housing policy "should support an easing 

of these vulnerabilities over time," the central bank said. 

     A third vulnerability highlighted is the possibility of cyber 

attacks on the financial sector, in which an attack on one institution 

could affect the whole larger system, the BOC said. The central bank is 

working with key financial institutions on that, it said. 

     BOC Governor Stephen Poloz said in an accompanying statement that 

the Canadian financial system "continues to be resilient, and is being 

bolstered by stronger growth and job creation." However, he added, "we 

need to continue to watch financial vulnerabilities closely." 

     The high level of household debt continues to rise, with household 

credit still growing faster than income, driven by growth in mortgages 

and home equity lines of credit, the FSR said. These two constitute more 

than 80% of household debt, it noted. 

     Particular attention is paid in the Review to home equity lines of 

credit (HELOCs) that now constitute "roughly two of every five 

outstanding loans" by federally-regulated lenders. It notes that these 

HELOCs, 40% of which do not contain regular payments of interest and 

principal, can make "the financial system and economy more vulnerable to 

a rise in unemployment." 

     Overall, on household debt, the FSR looks to tighter policy changes 

on mortgages, along with higher interest rates now in effect, and growth 

in household income, to "continue to mitigate this vulnerability over 

time." 

     It added that a moderate increase in mortgage rates should be 

"manageable for most borrowers." 

     However, it says in this as it does with other possible 

improvements, "the pace and degree of these developments are uncertain." 

     The FSR relates 2016 and 2017 provision of stress tests by lenders 

to both low-ratio and high-ratio mortgages that, it says, "limit the 

creation of new highly indebted households." The quality of new 

high-ratio mortgages has improved, it says. 

     The proportion of highly indebted households among new borrowers 

has fallen from 19% to 7%, the report said. Large drops were noted among 

cities with the greatest share of highly indebted borrowers (Toronto, 

Vancouver, Victoria, Calgary). 

     On the other hand, the BOC sees some indications of increasing risk 

among low-ratio mortgages, which have included about 90% of new 

mortgages in Toronto and Vancouver. 

     As low-ratio lending increases, "a portion of it is displaying 

riskier characteristics" with more highly indebted borrowers and 

amortization periods longer than 25 years. 

     New stress tests and other guidelines to take effect at the 

beginning of 2018 should improve the quality of new lending by 

federally-regulated lenders, which provide the bulk of lending, the FSR 

said. 

     A major effect on highly indebted borrowers would be higher 

interest rates. The FSR  noted that a one percentage point increase in a 

mortgage rate would increase monthly payments by C$180 for a homeowner 

with a mortgage of C$360,000 and gross income of about C$63,000. 

     On the second vulnerability, household imbalances, the FSR notes 

that in Toronto and Vancouver and their surrounding areas, economic 

fundamentals remain strong: employment gains and immigration continue to 

boost housing demand, while supply is limited by geographic and land use 

constraints. 

     In Greater Toronto, prices are dropping, what the BOC calls 

"material slowing." For Vancouver and nearby cities, prices are up 14% 

year-over-year. All other regions have posted "a more modest pickup in 

prices" since the June FSR. 

     With all the expectations given that policy measures should 

mitigate housing market imbalances between supply and demand, so that 

price pressures decline, the FSR again cautions about "uncertainties." 

     Apart from the uncertainty about how borrowers and lenders will 

react to the new stress test and other changes, "there is also 

uncertainty around the sensitivity of the market to higher interest 

rates." 

     The third highlighted vulnerability, the possibility of cyber 

attacks, is in the interconnectedness of complex financial information 

technology platforms so that an attack on one institution can spread 

worldwide, the FSR notes. 

     The BOC says it is requiring financial market infrastructure 

institutions "to assess their cyber resilience against international 

standards." It is leading main participants in the wholesale payments 

system in setting up measures "to support rapid recovery should a key 

participant be affected by a serious cyber attack." 

     The BOC rates the chances of financial stress coming from a severe 

national recession as being "elevated but decreasing" both in chances of 

occurring and in severity of impact should that occur. 

     It sees only a moderate chance of a house price correction in 

overheated markets. The risk of a sharp increase in long-term interest 

rates driven by higher global risk premiums is rated as "moderate but 

increasing."  Risks from severe financial disruption in China or other 

emerging market economies is considered elevated but decreasing. 

                    **OTTAWA ** 

     [TOPICS: M$C$$$,MACDS$]