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Stress testing is a much-needed ‘margin of safety’ – OSFI

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Amid multiple criticisms of the tighter mortgage qualification rules introduced last year, the OSFI’s assistant superintendent stood by the B-20 mandated stress testing as a necessary element of caution.

“The stress test is, quite simply, a safety buffer that ensures a borrower doesn’t stretch their borrowing capacity to its maximum, leaving no room to absorb unforeseen events,” Carolyn Rogers said last week, as quoted by The Globe and Mail.

“This is simply prudent. It’s prudent for the bank and it’s prudent for the borrower, too.”

Rogers noted that while the regulatory regime should adapt to any market changes as appropriate, there are multiple factors to take into account.

“The simple design of the stress test – adjusting the interest rate upward for the purposes of qualifying a borrower’s capacity – might make it look like it’s simply there to front run a potential interest rate increase,” Rogers explained.

“But borrowers face other risks that can impact their ability to pay their mortgage that I mentioned earlier: changes to income or changes to expenses other than their mortgage. It’s prudent to have a buffer for these changes, as well,” she added. “A margin of safety in these conditions is prudent.”

Read more: Canadian homes are among the world's most overvalued – analysis

Robert Kavcic, senior economist with the Bank of Montreal, argued that the federal administration should revisit B-20, as the strict rules were meant for an era with record-low interest rates, a time when adding 2% to the BoC’s benchmark would place the rate into the central bank’s neutral territory.

“So, while the BoC is still plodding its way to neutral, the residential mortgage market is now, at least from a qualification perspective, well into restrictive territory,” Kavcic explained. “You can see this as well by looking at the five-year fixed mortgage rate – adjusting it for OSFI lifts the qualifying rate well above the long-run highs.”

“But, with the well-purposed spirit of the measure in mind, there might be a case to be made for the qualification rate to be scaled back in lock-step with underlying rate increases, especially now with those rates near neutral.”