Canada’s chief banking regulator is evaluating whether to replace the current mortgage stress test with stricter oversight of banks rather than individual borrowers.
Blacklock's Reporter says Superintendent of Financial Institutions Peter Routledge indicated in a memo that a decision would follow a full year of assessment.
“If the test functions as expected, we anticipate it could serve as an alternative or complement to the minimum qualifying rate,” stated the November 6 memo.
“We’ll ensure any adjustments are done correctly after thorough testing.”
Currently, the stress test mandates that uninsured homeowners demonstrate their ability to afford mortgage payments at 5.25%.
The memo suggested the borrower-focused test could be replaced by a regulation restricting banks’ ability to lend to high-risk borrowers whose debt exceeds four times their earnings.
“Our analysis found that the minimum qualifying rate did not prevent a substantial accumulation of mortgages with extremely high loan-to-income ratios, exceeding 450%,” the memo explained.
“The loan-to-income test evaluates lenders’ portfolios rather than imposing a requirement on individual borrowers.”
The memo also outlined that banks and federally regulated lenders can allocate only 15% of their quarterly mortgages to borrowers with loan-to-income ratios above 450%. This cap aims to curb risk concentration in lending portfolios.
The 450% loan-to-income rule took effect for all federally regulated lenders on January 31. A final decision on whether to adopt this rule as a full replacement for stress tests will be made after year-end, the memo noted.
Superintendent Routledge previously warned in 2022 that removing the stress test without alternative lending controls would pose significant risks.
“Speculating on the mortgage cycle carries great risk,” he said, emphasizing that the stress test provided an essential safeguard for banks.
A downturn in housing prices in 1982 led to the collapse of 36 federally insured loan and trust companies, along with two banks — Canadian Commercial and Northland of Alberta — resulting in $1.3 billion in federal deposit insurance payouts.
The Bank of British Columbia and Continental Bank were also forced to merge with larger institutions to survive.
Former Canada Mortgage and Housing Corporation CEO Romy Bowers testified in 2017 that economic downturns pose significant risks to the housing market. CMHC stress tests its insurance portfolio to withstand a 30% drop in average home prices and an 11.5% unemployment rate, last observed in 1983.
“I reference a 30% national house price decline,” Bowers stated. “Canada has never experienced such a downturn — knock on wood — but we must prepare for potential risks.”
