Check yourself before you wreck yourself.
That’s the not-so-subtle subtext of a message from a federal financial regulator to Canada’s banks. The Office of the Superintendent of Financial Institutions issued a report Monday noting “a number of vulnerabilities in the financial sector" and instructed banks how to avoid a crisis in the housing market.
But the OSFI’s to-do list for banks was so basic, and so seemingly obvious, it raised the question of why the regulator felt compelled to release the report in the first place. Could it be Canadian banks are losing track of the basics of sound mortgage lending? Consider the following pieces of advice from the OSFI:
-- Check the background and credit history of prospective mortgage borrowers
-- Verify the borrower’s income
-- Maintain “sound” documentation of loans
-- Confirm the creditworthiness of co-signers/loan guarantors
-- Assess the adequacy of a borrowers’ income
… All of which leads observers to wonder: Are Canada’s banks NOT doing these things? In the view of the OSFI, that may actually be the case.
According to documents made public in January, the regulator is seriously concerned that Canada’s housing market is beginning to resemble the sub-prime lending mess in the United States, which has seen house prices drop to where they were a decade ago.
Some new loans “have some similarities to non-prime loans in the U.S. retail lending market,” the OSFI wrote, as reported at Bloomberg.
And that situation may be growing worse. All five of Canada's major banks dropped their base rate for a four- or five-year fixed mortgage to below 3 per cent recently, the second time this year that some of them took the extraordinary move. This despite continuing increases in house prices, and presumably, increases in mortgage revenue -- and also despite reported pressure from Finance Minister Jim Flaherty not to drop mortgage rates too low.
And as Canadians feast on record-low mortgage rates, their household debt is hitting record highs, exceeding 150 per cent of average household income last year, and reaching among the highest levels in the developed world.
The OSFI estimates that about 5 per cent of mortgages issued in Canada are now “sub-prime,” meaning essentially that they don’t meet the traditional, rigorous standards for lending.
Among the concerns the OSFI expressed were that banks are lending to borrowers without verifying income, and lending to recent immigrants who may not have the financial stability needed to take on long-term loans.
Now the OSFI is evidently putting pressure on the banks to stop these practices, and the reiteration of basic principles of lending appears to be a part of this campaign.
But the regulator is also focusing on injecting a new measure -- or at least sense -- of accountability within the banking community, asking banks to establish a policy as to how much mortgage risk they are willing to take on, then getting its board of directors to directly approve the policy.
The banks should then continue reporting to the board on how well they are adhering to their risk-management policies, the OSFI report stated.
It all appears to be an effort to ensure that the bankers making mortgage policy decisions feel a sense of personal accountability for the loans they issue.
And that may be a good thing. A U.S. federal inquiry on the housing crisis reported last year that a lack of accountability -- on the part of bankers and regulators -- contributed to this “avoidable” calamity.
“The greatest tragedy would be to accept the refrain that no one could have seen this coming and thus nothing could have been done,” the report concluded, as quoted by The New York Times. “If we accept this notion, it will happen again."
It seems that Canada’s financial regulator is taking that lesson to heart. Whether the banks will follow remains to be seen.