Tightening mortgage stress test could have fast impact on housing market, RBC CEO says

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The chief executive of Royal Bank of Canada on Thursday said that a proposed tweak to a mortgage stress test could have a swift effect on the housing market, which he also noted is currently beset by limited supply and a surge in demand.

RBC president and CEO Dave McKay said during a conference call with reporters that he did think some action will be necessary to cool demand in the market in the short term, but that it should be “modest” and that it could be a change to existing policy.

One possibility floated by McKay was using the Office of the Superintendent of Financial Institutions’ so-called B-20 guideline, which includes a minimum qualifying rate for mortgages not insured against the borrower defaulting. Making that stress test tougher could sideline some would-be buyers, according to McKay.

“There are mechanisms around our existing structure that we could tweak to help manage, potentially, a short to medium term issue,” he said. “At the same time, we have to solve for the medium to longer term on the supply side.”

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McKay’s comments came just before OSFI announced a proposed change to B-20’s minimum qualifying rate for uninsured mortgages.

OSFI’s proposal is that borrowers would have to qualify for their loan at whichever is higher: the rate on their contract plus two percentage points, or 5.25 per cent, which would become the new “floor” for the test. The regulator is also proposing to review the setting of the stress test at least once a year to ensure it is appropriate for the level of risk in the market.

“The current Canadian housing market conditions have the potential to put lenders at increased financial risk,” the regulator said in a press release. “OSFI is taking proactive action at this time so that banks will continue to be resilient.”

OSFI’s proposed tweak could make it harder for some borrowers to qualify for a loan. The current benchmark rate for the stress test is approximately 4.8 per cent, so the new one would be about 45 basis points higher, superintendent Jeremy Rudin told reporters.

While McKay hadn’t had a chance to look at OSFI’s proposed changes (the official announcement came during his call with reporters), he did note that the stress test is something that’s already built into the banks’ loan adjudication process.

“So we can implement this quickly, and make an immediate impact with it,” he added.

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The stress test aims to ensure borrowers can keep making their payments if there’s a change in their circumstances, such as a rise in mortgage rates. OSFI said it will now collect input on its proposal before publishing its finalized adjustments by May 24, with those changes coming into effect on June 1.

The regulator had proposed in early 2020 to swap out its current stress-test floor for one based on mortgage-insurance applications, plus an added buffer, matching a proposal from the finance minister for the federal government’s insured-mortgage stress test. That effort was shelved in March 2020 because of the COVID-19 pandemic (OSFI also said Thursday it received feedback that the benchmark proposed in 2020 “would be highly volatile”), although it potentially could have made it easier for some borrowers to qualify for a loan.

Now, though, OSFI is proposing to tweak its stress test in the middle of an epic run for the housing market. Low interest rates, the desire for more space and a fear of missing out are all contributing to a surge in home prices.

“At present, the overarching concern that we have is that the system needs to be ready for a return to pre-pandemic financial conditions, if indeed that takes place,” Rudin told reporters.

In a letter to the banks, OSFI noted that interest rates could rise when economic conditions permit and that, while Canadians may have built up their savings during the pandemic, there are still relatively high levels of household debt.

“These factors, temporary or prolonged, contribute to FRFI (federally regulated financial institution) vulnerabilities, which could generate significant loan losses if economic conditions deteriorate,” OSFI said.

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