Canada's Condominium Magazine
Canada’s financial system, which most of us take for granted as being sound and stable and solid as the Rock of Gibraltar, is overseen by the Bank of Canada. So well did the Bank’s governor, Mark Carney, do his job of “promoting the economic and financial welfare of Canada” that the Brits decided they needed him, and he will now be doing that for Britain.
The Bank of Canada just published its latest review of the financial system (called Financial System Review). The purpose of the review is to identify potential risks to the system, and highlight the Bank’s efforts at mitigating those risks. It is by definition a negative, or at least prescriptive, assessment, focused as it is on risk and how to mitigate it.
And what are the key risks to the system today? There are four, ranked in descending order of severity: the Euro-area crisis; deficient global demand; Canadian household finances and the housing market; low interest rate environment. The overall level of risk is rated as High, but lower than it was in the last review.
This is also true for the biggest risk, the Euro crisis, which is Very High, but lower than before, and the housing market, rated High, but lower than before.
The problem in Canada with the household sector, the Bank explains, is that imbalances have built up over a number of years, and they will take “some time” to correct. It is the familiar argument that persisting low interest rates have encouraged too many Canadians to take on too much debt. Canada’s banks need to be more careful with their lending practices, and actively monitor their risks.
While there has been a “constructive evolution of imbalances” in household finances since last December—the pace of household indebtedness has slowed and the housing market has moderated—concerns remain.
Overall, the Governing Council judges that the risks associated with high levels of household debt and housing market imbalances have decreased, but remain within the “elevated” category.
Bank of Canada
Overvaluation is one of these concerns. It persists, the Bank says, with housing prices in some markets remaining high relative to income. Also, construction activity remains strong, especially in the condo sector, and especially in Toronto. And here we enter the territory of the hypothetical as the Bank limns a worst-case scenario of falling housing prices, lowered net worth, lower consumer spending, tighter lending conditions at the banks, and even further declines in housing. If a large proportion of Toronto’s new condos are being bought by investors, and if the supply of condos is not “absorbed” as it comes onto the market, there could be a “supply-demand discrepancy” that would increase the risk of an “abrupt” correction in prices and construction activity.
The Bank conducted a “stress test,” creating a scenario in which unemployment in Canada suddenly rises by 3 percentage points. If such an “adverse income shock” were to occur, the number of “vulnerable” households, meaning those with unmanageable debt, quite naturally, would increase, and the number of mortgages in arrears would more than double. And that would be bad for the banks.
What can be done to avert such a catastrophe? The average Canadian householder has no way to control the labour market. But this report isn’t really about the average Canadian householder, it’s about the financial “system” and it can do what is has been doing all along. The big banks will have to continue to improve their risk management practices, and the government has already taken steps to limit the use of portfolio insurance on low-ratio (the borrower has more than 20 per cent down payment on the home) mortgages. Those steps will serve to protect the banks.
As for consumers, the Bank’s message is simple: live within your means. If you have to borrow, make sure you can pay the money back, even if interest rates rise, which they inevitably will. And again, be prepared for tighter lending conditions at the bank.