Regulators should reconsider a stress test for uninsured mortgages that was imposed amid an already slowing housing market and that has helped fuel an alternative-lending boom, a Canadian Imperial Bank of Commerce economist said Tuesday.
Since the stress test was brought in last January, the Bank of Canada has hiked its key interest rate by 75 basis points and the five-year mortgage rate has increased by 35 basis points, says Benjamin Tal, the deputy chief economist at CIBC World Markets.
“Accordingly, regulators should revisit B-20,” Tal wrote in a report. “We need a more flexible benchmark, potentially a narrower spread over the contract rate when interest rates approach cyclical peak, and perhaps to establish a reasonable floor under which the qualifying rate will never drop below.”
Tal’s comments come as the housing market has cooled, but as some Canadians are still finding real estate out of their price range. In its budget last month, the federal government introduced a first-time homebuyer incentive program to try to give those would-be owners a hand.
A softer housing market has also weighed on firms that do business in the sector. Canadian banks have seen their rate of mortgage originations slow and the real-estate industry has complained that the stress test has made it tougher for homebuyers to get a loan.
On Monday, the Bank of Canada released its latest business outlook survey, which noted “continued weakness in housing-related activity in some regions.”
“During 2018, growth in mortgage originations continued to decline,” Tal wrote. “The value of new mortgages fell by eight per cent (or $25 billion) during the year. Note, however, that the slowing in the pace of mortgage origination growth started well before B-20 was introduced.”
The stress test was part of a revised guideline for residential mortgage underwriting, which was known as B-20. It sets out that the minimum qualifying rate on uninsured mortgages of whichever is higher: the Bank of Canada’s five-year benchmark rate or the rate on the contract plus 200 basis points. It also preceded a stress-test that was slapped on insured mortgages back in 2016.
The Office of the Superintendent of Financial Institutions, which oversees federally regulated lenders, introduced the new stress test for uninsured mortgages. In February, an assistant superintendent defended the measure as prudent during a lunchtime speech in downtown Toronto, although they also suggested that the regulator could make changes if necessary.
Tal said that the stress test was probably necessary when it was introduced, “since there was a need to save some Canadian borrowers from themselves.”
“But is 200 basis points the right number?” he asked. “At the end of the day, there is no real science behind that number.”
The economist added that the income of borrowers is likely to rise during their mortgage term and that the B-20 stress test does not consider decreasing borrower risk with a longer term.
“And finally, B-20 is in part behind the strong rise in alternative lending,” Tal wrote.
Based on information from the Ontario Land Registry, Tal wrote that alternative lenders now account for nearly 12 per cent of total real-estate transactions, and about 15 per cent of deals in the Greater Toronto Area.
“A year ago, that number was close to 10 per cent, meaning that alternative lenders’ share has risen since the introduction of B-20,” Tal said. “Behind the scenes, there is a transfer of risk from the regulated to the less regulated segment of the market—from where there is light to where it’s dark. That was certainly not the intent of B-20, and any other mortgage-related change to regulations.”
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