Last week, the Office of the Superintendent of Financial Institutions (OSFI) released its first Annual Risk Outlook report detailing the risks facing Canada’s federally regulated financial institutions and how it aims to combat them. Along with topics like cybersecurity and climate change, the report details the potential risk of a housing market crash from factors like overleveraged borrowers.
According to OSFI, the real estate market in Canada has seen a massive run-up resulting from low-interest rates and supply/demand imbalances. The result is that Canadians are increasingly leveraging themselves in order to secure their real estate purchases.
While there are systems in place to ensure that borrowers are taking on mortgages they can truly afford, the report notes that there are “several common issues around underwriting, specifically income verification in areas that have been raised as being problematic”. In other words, buyers may have been able to slip through regulatory loopholes and purchase homes they may not be able to afford, introducing undue risk to the housing market.
The report notes that while banks seem resilient to housing market shocks for the time being, changing factors “could lead to borrower defaults, a disorderly market reaction and broader economic uncertainty and volatility.”
OSFI also raises concern about alternative lending products such as reverse mortgages, shared equity mortgages, and combined loan plans (CLPs). With the growing popularity of these products, there is greater importance now to clarify existing regulations and ensure that they are working as intended to protect the Canadian economy and borrowers.
The report also draws attention to difficulties that could face the commercial real estate sector. These particularly stem from how COVID restrictions and lifestyle changes have challenged the value of these assets, citing “uncertainty” for office and retail properties, and questioning the increase in valuation for industrial properties and how it could “lead to increased losses to institutions given that commercial real estate is a systemic exposure across the financial sector.”
Despite the risks presented to our residential and commercial real estate sectors, there is some good news: The OSFI has compiled this new report with the intention to identify risks so that they may be addressed before things progress beyond fixing. The report outlines OSFI’s plans to review existing regulations to identify weaknesses that put the market at risk. In particular, the report mentions the possibility of adjusting the minimum qualifying rate for the mortgage stress “at any time if conditions warrant.”
Overall, as we move from one unprecedented year to the next, it is clear that Canada will be facing many new challenges that could threaten the housing market and broader economic stability. It is important for organizations like the OSFI to be diligent in identifying these risks, though only with effective regulatory changes can we hope to fully mitigate these effects.