Canada's Banking Regulator's Targeted Approach to High Household Indebtedness
- Wednesday, October 16, 2024
The Office of the Superintendent of Financial Institutions (OSFI) in Canada is adjusting its approach to mitigate lenders' risks associated with high household debt. With the goal of controlling prudential risk, the regulator plans to prioritize and sequence actions related to debt serviceability.
Feedback Considered and Changes Made
After receiving extensive feedback on various proposed measures, the OSFI has decided not to pursue regulatory limits on debt service coverage. While such limits would enhance consistency, they could diminish risk-based decision making and risk ownership on the part of lenders. Instead, the regulator sees value in lenders implementing an explicit, qualifying amortization limit to strengthen debt-service calculations. A principles-based expectation, bolstered by this amortization limit, is believed to be a more suitable approach.
Public Opposition to Debt-to-Income and Loan-to-Income Restrictions
Responses from financial institutions, mortgage brokers, the real estate industry, and the general public did not align with the regulator's plans for restrictions based on debt-to-income and loan-to-income ratios. These measures were seen as potential solutions for addressing high household indebtedness at a portfolio level. However, considering the complexity involved, the regulator has opted not to implement a total indebtedness restriction on lending at this time. Instead, they favor a proportional approach tailored to each lender's individual circumstances.
The OSFI acknowledges the potential unintended consequences of multiple measures and aims to strike a balance between risk management and avoiding negative impacts. Adequate time will be given to financial services companies to make necessary adjustments to their systems and internal processes.
As Canada's banking regulator, the OSFI is committed to ensuring a stable financial system while recognizing the importance of allowing lenders to make informed risk-based decisions.
High Loan-to-Income Lending on the Decline in Canada
High loan-to-income lending in Canada has shown a decline due to rising interest rates. However, the regulator emphasizes that high household indebtedness remains an important factor to consider when assessing credit risk, ensuring the safety and soundness of lenders, and maintaining overall stability in the financial system.
Masking Risk in a Low Interest Rate Environment
In an environment of low interest rates, higher levels of household debt become easier to handle, potentially masking the risks faced by both borrowers and lenders until conditions change. The regulator recognizes the need to address this issue to prevent any unexpected consequences.
Public Consultation and Consideration of Fresh Measures
To tackle this issue, the regulator initiated a public consultation in January. The goal was to gather input on potential debt-serviceability measures, such as loan-to-income and debt-to-income restrictions, as well as interest-rate affordability stress tests. This initiative aimed to complement the residential mortgage underwriting rules that were implemented in 2012.
Mixed Response and Continued Reflection
The responses received during the consultation did not strongly support proposed changes to interest rate affordability tests. In light of this feedback, the regulator will continue to reflect on how best to encourage lenders to apply more rigorous testing methods.
Ongoing Study of Debt Serviceability Measures
While the viability of other debt serviceability measures is being studied by the regulator, there are currently no plans to issue regulatory guidance on non-mortgage retail credit exposures. Although risks in this segment have increased, ongoing supervisory attention will be devoted to monitoring it. Furthermore, the regulator does not intend to implement geography-based measures; however, it acknowledges that housing-related risks tend to be more acute in large urban centers.
In conclusion, while high loan-to-income lending has decreased in Canada, the regulator remains committed to addressing the issue of high household indebtedness through careful consideration of various debt-serviceability measures. By doing so, they aim to ensure the continued stability of the financial system and protect both borrowers and lenders from potential risks.
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