The Bank of Canada is expecting new mortgage rules to help ease a continued rise in household indebtedness that it says has left the country increasingly exposed to an economic shock.
The central bank warns that the still-climbing levels of debt and the growing proportion of highly indebted households in many cities have opened up a larger weak spot in Canada’s financial stability.
Debt levels are a risk to the economy that could be dangerous in an economic crisis, Bank of Canada governor Stephen Poloz told reporters Thursday in Ottawa.
“The metaphor we’ve used in the past is that of a large tree that has a crack in it,” he said.
“The situation may improve or worsen over time, but there’s no immediate crisis until the wrong kind of storm comes along.”
In its latest financial system review, the bank says at a national level the proportion of highly indebted borrowers with mortgage-to-income ratios above 450 per cent reached 18 per cent in the third quarter of 2016, up from 13 per cent two years earlier.
READ: Canadians owe $1.67 for every dollar of disposable income: Statistics Canada
The report says high home prices have helped fuel growth in the proportion of these highly indebted borrowers in cities like Toronto, where in the last two years the proportion of highly indebted borrowers increased to 49 per cent from 32 per cent, and in Vancouver, where it rose to 39 per cent from 31 per cent.
“Households carrying high levels of debt could find it more difficult to adjust to a loss in income or other financial shock,” the report warns.
“They may be forced to sharply cut back on their spending and, in severe cases, may default on loans. The consequences for the economy and the financial system could be significant.”
But the bank is predicting that stricter housing finance rules introduced in recent months by federal, provincial and municipal authorities will help ease household indebtedness and improve the quality of future borrowing.
READ: ‘Sudden’ spike in interest rates could trigger housing crash, unemployment spike: CMHC
The bank flagged a sharp increase in interest rates as a danger to the economy. A worsening global economy could cause this, the report warned, or “market overreaction to a surprise change in monetary policy by the central bank of a major advanced economy.”
The new policies appear to have somewhat eased concerns expressed that Poloz expressed in June, when he warned that surging housing prices in the hot markets of Vancouver and Toronto were outpacing local economic fundamentals in those areas like job creation and income growth.
READ: Soaring house prices in Toronto, Vancouver are unsustainable, Bank of Canada warns
WATCH: The US Federal Reserve hiked its key interest rate a quarter point today. And more increases are predicted for next year, a sign that the American economy is improving steadily. A strong US economy is encouraging news for Canadian exports, though higher rates in the US than Canada could push down the value of the Canadian dollar. Eric Sorensen reports.
While the bank says the probability of an economic shock materializing remains low, it notes that such an event could have “significant” consequences for the economy and the financial system.
The bank’s report is the third this week to raise alarms about Canadians’ indebtedness, and where it could lead.
Statistics Canada said Wednesday the ratio of household credit market debt to adjusted disposable income crept up to 166.9 per cent in the third quarter, up from 166.4 per cent in the second quarter.
How often do you buy things – that you can’t really afford? A local financial advisor says a rising number of Okanagan residents are drowning in debt and even the slightest rise in interest rates could take a big toll on people paying off large loans, like mortgages.
That means, on average, Canadians owed $1.67 in credit market debt – mortgages, other loans and consumer credit – for every dollar of disposable income.
The good news is that that number isn’t growing as fast as it was a few years ago, but it is still growing.
And on Monday, the Bank for International Settlements, an organization of the world’s central banks, warned that Canada had one of the highest ratios of credit to households in relation to GDP in the developed world.
In November, the Canada Mortgage and Housing Corporation warned that a sudden rise in interest rates could cause a housing market crash that would see home prices fall by 30 per cent and unemployment rise above 10 per cent.
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