OTTAWA (Reuters) - Rising consumer debt in Canada and an increasingly unbalanced housing market have boosted household vulnerabilities in the last six months but the nation's financial system remains resilient, the Bank of Canada said on Thursday.
Pointing to Canada's two largest housing markets, Toronto and Vancouver, where prices have more than doubled in recent years, the bank said there is an "increased likelihood of a price correction that could lead to financial stress."
In its semi-annual Financial System Review, the central bank said household indebtedness and housing market imbalances, the most important vulnerabilities for the Canadian financial system, have increased since December 2016.
While new housing policy measures should help mitigate the vulnerabilities over time, the share of uninsured mortgages is growing and some mortgages are showing riskier characteristics, the bank said.
It warned that the overall level of mortgage debt relative to income continues to rise, and said the greater use of home equity lines of credit could be contributing to vulnerabilities because that borrowing makes it harder for lenders to spot emerging credit problems.
"While strong fundamentals are supporting price growth in both the Toronto and Vancouver areas, extrapolative expectations are also playing an important role," the bank said.
It said rapid price gains in Toronto suggest the market has entered a phase in which these expectations are becoming more pervasive and speculative buying is taking place.
"Under these circumstances, prices and price expectations can adjust rapidly to adverse demand shocks, suggesting that end-use buyers, investors, lenders and insurers face an increased likelihood of a rapid price correction and a rise in financial stress," the report said.
It said while an externally generated severe recession with job losses would make it harder for households to service their debts and cause broad financial system and economic stress, the likelihood of such a recession is low.
A more likely scenario would be a significant house price correction in Toronto, Vancouver and surrounding areas, which would have a less severe impact on the broader financial system and economy.
The bank said recent funding stress at Home Capital Group Inc (HCG.TO), an alternative mortgage lender, "highlighted the vulnerability associated with overreliance on less-stable funding sources."
It also outlined two risks outside the household and housing sectors, including a sharp increase in long-term interest rates driven by higher global risk premiums and stress emanating from China and other emerging market economies.
Reporting by Andrea Hopkins and Leah Schnurr; Editing by Meredith Mazzilli