Canadian Banks To Undergo Mortgage Stress Tests

Addressing the country’s overheating housing market, Canada’s top market banking regulator has demanded that lenders prove that their capital levels could endure severe drops in the price of houses in Vancouver and Toronto.

The Office of the Superintendent of Financial Institutions (OSFI) has enforced a tighter checklist for stress tests, the hypothetical settings utilized in measuring the impact of downturns in areas that concern banks the most, such as housing, employment and economic activity. Lenders will now be mandated to check and analyze how a decline of at least 50 percent in house values for Greater Vancouver and at least 40 percent for the Greater Toronto Area will affect them.

The evaluations will test various areas of the country and will have to assume a fall of 30 percent in conjunction with OSFI’s previous requirements, which failed in singling out specific markets.

The alterations will be applicable to smaller federally regulated lenders including Canadian Western Bank and Equitable Bank. There is no knowledge as to whether the Big Six banks will undergo similar changes to their own stress tests, as OSFI keeps the criteria required for the stress tests in these institutions confidential.

This marks the first time that OSFI updated its real estate testing requirements for lenders since it was implemented during the 2008 financial crisis.

Although stress tests are not reliable forecasts for how house prices could go, the tighter testing schemes fuel the growing concern among regulators and watchers, that there has been an increase in the risks surrounding Canada’s housing market due to the surge in prices.

According to the Teranet-National Bank house price index, June saw national house prices rising by 10 percent yearly. The increases were, however, higher in Vancouver and Toronto, because of consumers reacting to low borrowing rates and a shortage of homes for sale.

As a result, regulators are doing their best to pump the brakes to a housing market that has grown although the economy is weak and incomes are stagnant.

OSFI, in an open letter, earlier this month, that regarded the concerns about lending standards, stated that banks and other mortgage providers must increase their inspection of borrowers’ incomes, debt levels and credit scores.

In the previous month, the Bank of Canada cautioned on “increased riskiness” in the mortgage industry.

Banks on their own have also voiced their concerns regarding Canada’s housing market.

Bank of Nova Scotia chief executive officer, Brian Porter, in June was of the opinion that the federal government ought to raise minimum down payments, increase the qualifying rate for five-year fixed mortgages and impose a tax on foreign buyers.

Although the Big Six lenders, who are recognized as domestic systemically important banks (D-SIBs) and are tested by OSFI and the Bank of Canada, were not told about the changes t stress testing by OSFI, it is likely that these larger banks may face their own change requirements.

An OSFI spokesperson, in a statement, said “As the macro stress tests for the D-SIBs are based on detailed and specific instructions for each institution, the instructions are not shared.”