Canada's financial system is growing more vulnerable to soaring home prices and record debt loads amid signs more homeowners are moving toward riskier borrowing, the Bank of Canada said Thursday.
And with speculators helping drive prices higher in Vancouver and Toronto, “just about anything” could trigger a correction, warned Governor Stephen Poloz.
With financial system vulnerabilities moving higher in the past six months, the bank is eyeing two specific risks that could crash the housing market in its biannual Financial System Review.
The first: a severe, nation-wide recession triggered by an event outside Canada's borders.
The second: a "significant" price correction in Toronto and Vancouver. The bank judges the probability of a correction to the hot markets as higher than that of a nation-wide recession.
“Price increases in Vancouver and Toronto have an element of speculation to them,” Poloz said during a news conference following the release of the report.
Which of these is the biggest risk for Canada’s financial system?
The economic damage would be concentrated mostly in British Columbia and Ontario, with some moderate spillover effects for the rest of the country.
The report also raises concerns about Canadians borrowing against the value of their homes, using home equity lines of credit.
Despite those vulnerabilities and risks, the bank insists the "financial system remains resilient."
That said, the bank has concerns about shifts in the mortgage lending landscape.
"Some riskier characteristics are increasingly evident" in lending where the buyer does not require mortgage insurance, the bank said in its review.
The share of highly-indebted households -- those who owe more than $4.50 in mortgage debt for every dollar of annual disposable income -- is on the rise among those with non-insured mortgages. It reached 17 per cent of borrowers in 2016, the central bank said.
And the bank has concerns about where those buyers are getting their down payments to afford their pricey homes.
"A financial stability concern could arise if a significant proportion of the funding for down payments comes from other forms of borrowing, rather than from personal savings or friends and family," the bank said.
Those other forms include loans from private lenders, such as unregulated mortgage investment corporations.
Ottawa turned the screws on mortgage lending last fall, and many Canadians who couldn’t scrape together a larger down payment were priced out of the housing market.
While the bank says the new rules have improved the quality of insured mortgages -- where the buyer puts less than 20 per cent down on the home purchase -- lending in the uninsured space is growing, particularly in the greater Toronto and Vancouver markets.
The bank also took the unusual move Thursday of highlighting a particular financial institution: Home Capital Group.
The problems at Home Capital, which include an exodus of deposits and a plunging share price in the wake allegations by the Ontario Securities Commission, are seen by the bank as “idiosyncratic” or contained to Home Capital.
“To date, (Home Capital Group) has been able to find a market-based solution,” the bank added.