Canada’s Banking regulator tells some banks to test resilience to sharp drop in home prices

A number of financial institutions have been urged by Canada’s banking regulator to stress-test a 50 per cent decline in house prices in Greater Vancouver, as well as a 40% dive in Greater Toronto, the country’s hottest housing markets.

The Superintendent of Financial Institutions recommends a 30% house price decline test across the entire country.

However, the country’s largest bank HSBC Canada are not included, said an OSFI spokesperson. Laurentian, which is Canada’s next largest bank and other small-scale institutions will be part of the new tests, and the results are to be presented to OSFI, said an analyst.

According to OSFI, speculations regarding the declines in the Vancouver and Toronto housing markets are to be raised from an earlier assumed downturn of 30% in all markets across the entire country.

Jason Mercer, an analyst at Moody’s Investors Services reported that insured mortgages are not used to calculate capital requirements. As an alternative, he recommends that they are included in the leverage ratio. As a result, their impact would be captured by the new stress test requirements

“In theory, a bank could beat the stress [test on capital] by assuming it starts insuring the remainder of its mortgage portfolio,” he said. “The leverage ratio would then pick this up” and could fall below the required threshold even if capital did not.

Mercer added that the regulator’s stepped-up stress tests are “not surprising given the recent concerns about housing and household debt.”

During the first quarter of 2016, OSFI suggested changes to the amount of capital the country’s top banks must hold against some residential mortgages in order to keep up with the persistent increase in house prices.

OSFI Superintendent Jeremy Rudin also sent a letter to the country’s leading banks, wherein he laid out enhanced expectations regarding mortgage lending practices including income verification.

“The risks are getting larger,” he said in a statement on last week. “OSFI wants to see sound mortgage underwriting procedures in place that adapt to the ever-changing circumstances in this area.”