The head of the Office of the Superintendent of Financial Institutions said Thursday that Canada’s top banking regulator will not heed calls to loosen mortgage underwriting standards as interest rates rise, a condition that has made qualifying to buy a home or renew a mortgage more onerous.
“The uncertainty and anxiety caused by a rising interest rate environment have, understandably, caused some Canadians to advocate for a loosening of the underwriting standards in Guideline B-20,” Peter Routledge acknowledged in prepared remarks for a speech in Toronto.
“Let me reassure those of you who oppose a loosening of underwriting standards that OSFI will not do that,” he said.
The Bank of Canada hiked the key overnight rate by 75 basis points to 3.25 per cent on Wednesday, as it continued to aggressively raise rates to combat inflation.
The Toronto Regional Real Estate Board is among those calling for more flexibility in the mortgage “stress test,” particularly for those trying to renew a mortgage who must re-qualify at the current rate plus two percentage points.
Routledge, who cut his teeth as an analyst at debt ratings agency Moody’s Canada, noted that OSFI, in fact, tightened underwriting standards in June of this year when rates were already rising, issuing new expectations for the treatment of innovative residential real estate lending products, such as reverse mortgages, mortgages with shared equity features and combined loan plans.
“We tightened our expectations so that lenders will have to ensure their residential, uninsured mortgage clients with loan-to-value amounts above 65 per cent do not repeatedly borrow against their principal or the price appreciation on their homes, which would sustain their indebtedness,” he said.
OSFI has committed to review the comprehensive B-20 residential mortgage underwriting practices guideline to ensure underwriting by federal regulated financial institutions meets high standards, Routledge noted, including the minimum qualifying rate stress test that measures uninsured borrowers’ capacity to service debt through economic cycles.
“We are constantly evaluating the MQR (stress test) to measure its efficacy in sustaining sound residential mortgage underwriting,” Routledge said.
In a wide-ranging speech, he warned that tactics and strategies used in the past may not be effective in combatting increasingly volatile economic and financial conditions, and signalled a more interventionist approach.
“We must emphasize early actions and responses to emerging risks in our environment,” he said.
“When evaluating supervisory or regulatory strategies, OSFI must accept the risks of acting early to minimize the costs of acting too late.”
His speech laid out his vision for the coming year, and suggested banks should buckle up for intensified focus on residential mortgage underwriting.
OSFI will also demand “greater margins of safety” to combat uncertainty that includes the spectre of further hikes in interest rates.
All banks should be maintaining capital and liquidity buffers “well above” their through-the-cycle averages, Routledge said.
“The market will not impose great costs on financial institutions that maintain large, plentiful, and safe buffers; in hard times, the market will, however, impose severe costs on those financial institutions that fail in this regard.”
The prudential regulator, which is responsible for ensuring the soundness of Canada’s banks, will also finalize demands for climate-risk management by the end of its fiscal year, “an area of inquiry that will affect not just the balance sheets of banks and insurers, but funding for energy and infrastructure projects as well as firms in virtually every sector of the economy,” Routledge said.
OSFI has also pledged to develop digital asset regulation and supervision “based on the principle of same activity, same risk, same regulation.”
“Digital asset innovations are occurring within the system but also outside of it, and sometimes both simultaneously,” Routledge said. “OSFI believes that if digital asset innovations offer Canadians the same financial services and activities, with the same risks, then they should be subject to the same regulation.”
As risks intensify across the financial system, Routledge said OSFI will be leaning on boards of directors at banks, noting that they play a “crucial role in the financial system” and crediting governance for the outperformance of Canadian banks over the past 20 years relative to global peers.
“Their job is to protect the underlying franchises so that they have the resources to withstand more dangerous times and then prosper through periods of growth,” he said.
“We count on them to focus intently on the long-term, and to realize that a dollar applied to capital or liquidity safety margins today is not a cost, but an investment in the long-term sustainability of franchise value.”
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For its part, OSFI says it is reviewing the design and range of the Domestic Stability Buffer, which determines the size of an additional capital buffer systemically important domestic banks must hold. During times of economic difficulty, this can be released to make more credit available. In June, OSFI left the DSB at its upper range of 2.5 per cent.
Routledge said the regulator is also conducting a comprehensive review of its Pillar 2 capital framework, which addresses “idiosyncratic” risks that are not captured by other capital requirements and buffers.
“This work will provide us with better tools to continue to verify that individual banks’ capital levels are robust to their unique risk profiles while considering their allowances, capital assessments and plans, and stress testing results,” he said.