As we are all aware, these are challenging times. Although we are seeing some signs of improved conditions in the U.S., and of course here at home, the problems in Europe have not gone away. Advanced economies have entered into a long process of deleveraging, or reducing their debt levels. Many countries and their banks are being downgraded. Interest rates are still at historical lows, creating challenging issues for life insurance companies and pension plans. And Canada has a particular vulnerability in its record-high consumer debt.
Mortgage Underwriting in Canada
I now want to turn to the real estate market. Canada’s financial institutions are playing from a position of strength: they have good levels of capital and liquidity, they have undertaken robust stress testing and they are adopting new international requirements. But, Canada faces an uncertain global environment, along with the vulnerability created by high household indebtedness. In such a climate, the role played by boards of directors is all the more crucial.This leads me to explain why OSFI’s draft guideline (B-20) on Sound Residential Mortgage Underwriting Practices and Procedures, which we made public on March 19th, begins with the statement that boards must establish real estate underwriting policies. In fact, most boards have already established such policies. This makes sense; housing is the largest asset class exposure of banks – almost 42 per cent of total bank assets.
While these policies will have to be updated to reflect the new guidance, going forward senior management will have to provide a declaration to the board that the financial institution is in compliance with the OSFI guideline. This was added because we had noticed cases where board approved polices were not being followed.
One of the main risks to financial stability in Canada is financial stress in the Canadian household as well as, among other things, the risk arising from a prolonged period of low interest rates, which may encourage imprudent risk taking. Real estate secured lending is tied to both of these risks. Thus, mortgage lending is clearly something in which OSFI wants boards of directors involved, especially in the context of the current environment.
The guideline sets out OSFI’s current expectations for prudent residential mortgage underwriting and builds on our domestic supervisory work, as well as the Financial Stability Board’s draft international Principles for Sound Residential Mortgage Underwriting Practices, which were released in the fall of 2011.
The other new area is that the guideline does set out some firm rules that all institutions will need to adhere to – specifically that home equity lines of credit – or HELOCS – can have a loan to value ratio no greater than 65%, and all institutions must institute a minimum test for qualifying borrowers, while also using judgement to think about the impacts that borrowers could face when rates move above currently historical low levels.
We issued the guidance in draft to allow industry and other vested parties to provide input on best practices for mortgage lending. The guideline does not affect the rules for insured mortgages, which are set by the government.