Stress test curbed credit growth while reducing risks for borrowers facing higher payments
Mortgage stress tests have proven to be effective in preventing an uptick in delinquencies despite recent interest rate hikes, according to a new Bank of Canada (BoC) report.
The federal government and the Office of the Superintendent of Financial Institutions (OSFI) first introduced mandatory stress tests for all insured mortgages in 2016, extending existing requirements previously limited to high-risk loans. By 2018, OSFI broadened the policy to cover low-ratio, fixed-rate mortgages.
The 2018 changes, according to BoC researchers, enhanced credit quality across the mortgage portfolio.
“The 2018 mortgage stress tests – a policy implemented for uninsured mortgages – improved credit quality across the entire mortgage portfolio, as intended,” BoC explained in a research note. “But it also had broader implications since it led to lower mortgage credit and house price growth.”
“Overall, we find that this change successfully slowed down the credit and house price booms. Areas more exposed to the 2018 policy experienced a more pronounced decline in the number of mortgages originated, average mortgage size and aggregate growth in local house prices than less exposed locations did.”
While the 2016 policy improved the credit scores of new borrowers and loan-to-value ratios of insured mortgages, it didn’t do much to cool the overheated mortgage and housing markets.
“The 2016 mortgage stress tests, a policy implemented only for insured mortgages, resulted in an improvement in standard measures of credit quality for new mortgages, such as credit scores and the distribution of loan-to-value and debt service ratios,” the report read. “However, due to its narrow scope, this policy had a limited impact on the mortgage market because it did not contribute to slowing down growth in mortgage credit and house prices in Canada.”
Even so, the 2016 stress tests played a key role in managing delinquencies among high-ratio mortgage borrowers as rates began to climb.
“While the 2016 policy did not manage to halt the credit boom in Canada, it did enhance the credit quality of high-ratio mortgage borrowers, as evidenced by a subdued increase in delinquencies,” the research paper said.
Read more: OSFI eliminated mortgage stress test to avoid losing public confidence: Routledge
Regions more affected by the 2016 policy shift saw fewer credit delinquencies, especially in credit card and auto loan defaults, among borrowers with mortgages holding loan-to-value ratios above 80%.
While some borrowers turned to alternative lending channels to bypass these stress tests, the Bank of Canada found that the overall effect of these policies bolstered the system’s resilience.
“Consequently, mortgage rate stress tests have fortified the ability of borrowers, especially those with high-ratio mortgages, to better navigate significant increases in mortgage payments,” researchers noted.
The BoC report concluded that mortgage stress tests have played a critical role in promoting financial stability, ensuring that households can manage increased mortgage payments without defaulting on other credit obligations.
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