Bank of Canada: system could survive major household debt shock

Wed Feb 24, 2016 2:19pm EST
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By Alastair Sharp

GUELPH, Ontario (Reuters) - While the vulnerabilities associated with elevated household debt have increased in recent years, the Canadian financial system remains resilient and could withstand a major shock, a Bank of Canada official said on Wednesday.

Record-high consumer debt and hot home prices in parts of the country have raised worries that a sudden retrenching by over-extended Canadians could pose a risk to the economy and financial system.

The Bank of Canada's two interest rate cuts last year prompted criticism from some that the move encouraged more consumer borrowing, though the bank has said that by stimulating the economy it was mitigating such vulnerabilities.

"The financial vulnerability associated with elevated household debt has increased over the past decade," Deputy Governor Lawrence Schembri told the Guelph Chamber of Commerce.

"However, the Canadian financial system is very resilient and could withstand the triggering of this vulnerability."

To assess the risk stemming from indebted households, the bank simulated a persistent increase in the unemployment rate of 5 percentage points, Schembri said, although he noted the probability of this happening was low.

The bank found that household arrears rates could rise from 0.4 percent in 2014 to as high as 1.8 percent after three years, with about 20 percent of that attributable to the increase in debt and greater concentration that has been seen among highly indebted households since 2007.

This could force some homeowners to sell or default on their mortgages and other debt. While a rapid increase in defaults or home sales would have direct impacts on lenders and mortgage insurers, stress tests show that there are sufficient buffers in the financial system to withstand such a scenario, Schembri said.   Continued...

A Bay Street sign, a symbol of Canada's economic markets and where main financial institutions are located, is seen in Toronto, May 1, 2013. REUTERS/Mark Blinch