Bank of Canada Finds Dramatic Fall in Highly Indebted Borrowers

(Bloomberg) -- Higher interest rates and tougher mortgage qualification rules have significantly improved the quality of new lending in Canada, the country’s central bank said in a report Wednesday, adding to evidence of easing risks to the financial system from elevated consumer debt.

The share of new mortgages going to highly indebted borrowers -- those with loan to income ratios of above 450 percent -- dropped to 13 percent in the second quarter of this year, down from more than 18 percent last year, the Bank of Canada said in an analysis of recent developments to the housing finance market.

The report was part of a batch of research released Wednesday as part of the Ottawa-based central bank’s launch of a new Financial System Hub, including a survey of risk management professionals and an analysis of the banking system’s resiliency to a housing market correction.

Key Insights

  • The findings of the reports are consistent with the central bank’s main messaging of strengthening resiliency in the financial system, aided in part by an improving economy that has prompted five rate increases since the middle part of last year
  • The report on the mortgage market found that not only are new mortgage borrowers on the decline but the riskiest ones are being weeded out. The number of new uninsured borrowers considered highly-indebted fell by 39 percent in the second quarter from last year, with Toronto posting the biggest declines
  • The bank said it can’t precisely determine the contributions of each factor at play in the slowdown -- tighter regulations, higher interest rates or more broadly changing housing trends -- but said it expects to be able to better understand the dynamics in the future as policy makers receive more data
  • The tighter regulations have had one side effect, shifting market share away from the country’s six biggest banks to other institutions like credit unions and private lenders -- potentially a new source of risk

Key Quotes

  • The overall riskiness of new mortgages has decreased “because the proportion of risky borrowers has declined across cities,” the report found. “As well, the regional composition has shifted, with a somewhat larger share of new mortgages recently coming from areas outside Toronto and Vancouver.”

Other Details

  • The Bank of Canada released its semi-annual Financial System Survey of risk professionals that found that perceived risks to the financial system have increased slightly over the past six months, but with extreme confidence (95% of participants) the financial system could handle an adverse high-impact event
  • A similar conclusion was found in a separate article released Wednesday on the possible impact of a hypothetical housing price correction in Toronto and Vancouver. The conclusion: “The large banks remain resilient through the risk scenario, supported by their international diversification and their ability to replenish capital with retained earnings.”
  • Toronto saw the share of new borrowers who are highly-indebted fall to 28 percent in the second quarter, from as much as 39 percent at the end of last year
  • Total uninsured mortgages were down 15 percent in the second quarter from a year earlier. The declines were broad-based, among all types of borrowers and regions

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