Canadian Financial Watchdog Tightens Oversight of Banks

(The Globe and Mail)

Canada’s financial watchdog has stepped up its oversight of banks in light of rising consumer debt loads.

The Office of the Superintendent of Financial Institutions, which regulates Canadian banks and insurers, is requiring lenders to do more testing of the risks that consumer debt poses to their balance sheets.

In addition, it is asking “many more questions about how banks are monitoring portfolios, including secured loans,” OSFI head Julie Dickson said in a recent interview.

The heightened scrutiny is another sign that Ottawa has become concerned about the unprecedented amount of debt consumers are carrying.

By at least one measure, Canadians’ debt levels have exceeded those of Americans for the first time in 12 years. The ratio of household debt to disposable income is at a record 148.1 per cent, Statistics Canada said last week.

The record debt-to-income ratio in the third quarter is a 6.7-per-cent increase from a year ago. It tops the 147.2-per-cent ratio in the United States and comes as incomes fell 1.5 per cent during the same three-month period.

Bank of Canada Governor Mark Carney has recently warned borrowers and banks about the risks that high debt loads pose to both individual pocketbooks and the broader economy, especially given that interest rates are likely to rise significantly in the future.

He has also called on policy makers to keep an eye on rising debt loads and their impact, for instance on the housing market, and take any responsible measures they deem necessary to minimize the risks to consumers and banks.

Ottawa is considering tightening the rules for mortgage eligibility once again in its next federal budget, likely by reducing the maximum length of a mortgage or requiring higher down payments.

“I think that the points raised by the minister and the governor have merit,” Ms. Dickson said.

“We’re watching very closely bank underwriting practices,” she added. “While I would say that underwriting practices remain prudent, I think whenever you have something unusual going on – and what we have now would be historically low interest rates for an extended period of time – you definitely want to be cautious and examine all the angles.”

Bankers say that they have been making responsible decisions on when to tighten up.

“We stopped doing 40-year amortizations before CMHC stopped insuring them, and it was based on a conversation that I had with the minister of finance where he asked, ‘Do you think they’re sound?’ ” Bank of Montreal chief executive officer Bill Downe said. “We did some analysis, talked to a number of clients, and decided to curtail that.“We’re perfectly aligned with Governor Carney and his views that Canadians need to manage their debt,” he added.

OSFI is putting the banks through their paces by requiring them to conduct a greater amount of so-called “stress testing” than they did previously.

In stress tests, the banks create hypothetical scenarios – such as interest rates remaining at historic lows for years to come, a sharp increase in unemployment or a significant decrease in house prices – and determine what the impact would be on their balance sheets and capital levels.

This type of monitoring has become more necessary because highly indebted consumers are more vulnerable to economic shocks, and anything that hurts Canadian consumers will ultimately hurt Canadian banks.

The fear is that rising interest rates, falling house prices, job losses or an unforeseen economic shock could overwhelm some consumers and leave them unable to make their debt payments.Rising bankruptcies and loan losses at the banks could, in turn, result in further deterioration to the economy as consumer spending drops.