During the early days of the mortgage business, brokers would require a lot of paperwork…
The Canadian banking regulator has confirmed that it will not pursue several proposed mortgage regulations, which it introduced earlier this summer after they received widespread criticism and concern during the public consultation period.
The Office of the Superintendent of Financial Institutions released today the results of the discussions it had with industry stakeholders nine months after releasing its proposed measures related to debt serviceability.
OSFI’s report, published today, concluded that “the majority of stakeholders agree that the risks to lenders from high household debt are important.” “However,” OSFI concluded, “stakeholders were not generally in favor of additional debt servicing measures.”
The respondents warned that OSFI’s latest proposed measures will have a disproportionate impact on smaller institutions, which may have unique business models. They also said they would not adequately address the root causes of Canada’s household debt crisis.
OSFI has confirmed, however, that at this point it will not pursue two of the proposals: restrictions on debt-to-income ratios (while still keeping LTI restrictions in place) and restrictions on debt service loan coverage.
These comments are included in the OSFI consultation feedback report. However, OSFI has not yet taken any final decisions regarding its implementation.
In January, OSFI sought public feedback on three regulatory changes to Guideline B-20 that were designed to limit mortgage lending as a response to the record levels of household debt.
Participants expressed concern over proposed changes
The proposals include restrictions on debt service coverage, restrictions on loan-to-income (LTI), and restrictions on debt-toincome (DTI). They also include “risk-sensitive stress tests” for interest rate affordability.
OSFI has received feedback on each proposal.
Restriction on debt-to income (DTI) and loan-to-income restrictions
According to OSFI’s semi-annual Risk Outlook, the proposed LTI/DTI restrictions would restrict lenders to a specific volume of loans exceeding a “prudent threshold” “to better manage the risk associated with significant accumulations of household debt on their loan books.”
The proposed LTI and DTI restrictions would limit lenders to a certain volume of loans that exceed a “prudent” threshold, according to OSFI’s semi-annual update on the Annual Risk Outlook.
According to feedback published on Monday by the Federal Reserve, respondents generally did not support the measure. They suggested that some of it would be redundant, implemented too late and would have a disproportionate impact on smaller lenders.
In the report, it stated that “we consider a DTI restriction (total debt) to be too complicated to implement at this point.”
We agree that, under certain circumstances, debt service ratios, i.e. GDS and TDS, can produce similar results to LTI/DTI, even though they focus on debt affordability rather than limiting exposure to excessive indebtedness. “We also acknowledge that the majority of lenders do not use LTI/DTI in underwriting,” added the report.
We also think that a proportionate implementation would be the best option, rather than a one size fits all approach, given the differences in FRFIs business models.
OSFI stated that “we appreciated lenders’ analyses on predictors and agreed that credit score and other factors can be better predictive than high LTI and DTI.” The OSFI noted that “high household debt is still relevant for credit risk, safety and soundness of FRFIs and the stability of the entire financial system.”
Restrictions on debt service coverage
It would be necessary to restrict the ongoing debt service obligations (principal and interest, as well as other expenses related) in relation to the borrower’s income.
The respondents expressed “mixed opinions”, with some in favour of a qualifying amortization cap, but the majority opposed to regulatory limits or alignment with insured mortgage criteria. Feedback found that lenders’ risk-based debt service limits and criteria were strongly supported.
OSFI stated that “we believe there is merit to lenders applying an explicit qualifying amortization limitation and we will continue evaluating this proposal.” This limit would improve the accuracy of debt service calculations for qualified borrowers while still allowing lenders to offer longer amortizations to certain qualified borrowers.
OSFI did add that, “after careful consideration of stakeholder input, we agree that regulatory limitations on debt service coverage are not appropriate.” These limits may result in more consistency but they will also remove the ability of lenders to make risk-based decisions and take on risk.
Stress test on interest rate affordability
This measure would require a “risk-sensitive test” beyond the current Minimum Qualification Rate (currently 5,25%), including different MRQs depending on product type.
The respondents were also opposed to MQR adaptions and other affordability tests due to their negative impact on public policy and concern over unintended effects.
OSFI says that it will implement any regulatory measures, including debt service coverage, “incrementally” and “sequentially”. The first priority is to adjust the MRQ. A LTI limit would then be the last resort.
We will continue to think about how to best encourage lenders to conduct more rigorous affordability checks, particularly when there are higher risk characteristics in a mortgage request. As evidence, we should be able observe variations in the qualifying debt service ratios,” OSFI stated.
From a risk perspective, it is beneficial to encourage longer borrowing terms as well as payment stability by using MQR.
The respondents commented not only on the three specific proposals but also on the importance that income verification plays in preventing mortgage fraud.
The OSFI suggested that it could work with Canada Revenue Agency (CRA), to allow independent verification of income, which Mortgage Professionals Canada had identified as a top priority in its advocacy efforts.
We welcome any initiative which advances our B-20 expectation for FRFIs to use income sources that can be independently verified and are difficult to falsify. OSFI stated that it and its federal financial sector partners were aware of the ongoing CRA initiatives in this area.
The respondents also suggested a greater focus on high-risk markets such as the Greater Toronto or Vancouver markets. However, OSFI stated that it is against any geographic-based measures because vulnerabilities and risks exist regardless of geography.
OSFI, along with other industry observers, agrees that the only way to truly address Canada’s affordability crisis in housing is by addressing the supply shortage.
The report states that “we believe that housing market inequalities are driven by both supply and demand-side factors.” The report states that “An adequate supply of housing that keeps up with demographic demands supports a stable and well-functioning Canadian mortgage market as well as the broader Canadian economic.”