IMF published its staff report and selected issues and analytical notes report on the 2017 Article IV consultation with Canada. Directors noted that Canada’s financial sector is well-capitalized and has strong profitability, but that there are rising vulnerabilities in the housing sector.
The staff report reveals that Canada’s large banks have a sizable exposure to the housing sector. The Big-6 banks, which account for 93% of the total banking system assets, allocate about 35% of their total assets to consumer and mortgage lending and draw 50% of their total revenues from these loans. Mortgage lending alone accounts for 45% of total loans, with the share of uninsured mortgages now exceeding insured mortgages. Tighter macro-prudential rules in the insured space has caused the shift to uninsured mortgages. OSFI has consistently updated its expectations of residential mortgage and insurance underwriting practices (B-20 and B-21 Guidelines), with a strong emphasis on rigorous income verification, nonconforming loans, debt service and loan-to-value (LTV) calculations, property appraisals and the risk profile of new mortgage loans, and full assessment of a borrower’s ability to withstand plausible financial and economic shocks. The Big-6 banks have strengthened their capital ratios from 10% a year ago to 11.3%; improved their leverage ratios to 5%; enjoy high profitability, averaging 15% return on equity; and maintain strong asset quality, with less than 1% of non-performing loan ratios (NPLs).
While Canada has a strong supervision culture, addressing gaps identified in the 2014 FSAP on regulatory mandates and operational independence would further strengthen the financial sector policy framework. Staff’s research indicates that macro-prudential measures have generally been effective in slowing the growth in mortgage credit and, to a lesser extent, house prices, and, to this end, financial stability. For macro-prudential policy to work effectively, more granular real estate data and close supervision to manage potential spillovers and other unintended consequences are needed. In addition, there has been little progress in addressing several major recommendations of the FSAP. However, addressing the following gaps identified in the 2014 FSAP would further strengthen the framework for financial sector policy:
Clear regulatory mandates to monitor systemic risk to facilitate macro-prudential oversight and carry out system-wide crisis preparedness continue to be missing.
Consistent with Basel Core Principles, legislation should be amended to give OSFI operational independence, without ministerial power to override supervisory judgment.
Legislation should be amended to give OSFI the authority to conduct group-wide supervision, a key component of the Insurance Core principles, to promote a consolidated view of risks and prevent arbitrage across differently regulated structures within the group.
The selected issues and analytical notes report discusses the proposed Canada Infrastructure Bank (CIB) and its expected role; analyzes the macroeconomic effects of public infrastructure in different Canadian provinces; presents lessons learned for Canada by examining how advanced economies tackle housing market imbalances; and assesses the effectiveness of macro-prudential measures in Canada. Canada’s macro-prudential policy seems to have lowered mortgage credit growth, thus moderating the surge in house prices on a national basis. International experience over 2000–16 suggests that tighter LTV limits and lower caps on debt service-to-income (DSTI) ratios could be effective in moderating both mortgage credit and house price growth.
Keywords: Americas, Canada, Banking, Insurance, Article IV, FSAP, OSFI, IMF
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