October 21, 2016 / 2:03 PM / 10 months ago

Canada lays out possible changes to spread housing risk

A man crosses the street in front of a mortgage brokerage office above a bakery, on Danforth Avenue in Toronto, Ontario, Canada on September 17, 2013.Chris Helgren/File Photo

OTTAWA (Reuters) - Canada's finance department laid out possible ways to spread mortgage risk on Friday, kicking off consultations to force lenders to take on more responsibility for the loans they dole out amid fears the nation's hot housing market could end badly.

The call for submissions to change the way mortgage risk is shared between banks and insurers - including the government-backed Canada Mortage and Housing Corp - comes after criticism from the IMF and OECD that taxpayers could be on the hook if a U.S.-style housing collapse happened in Canada.

Under rules designed 60 years ago to encourage mortgage lending, banks and other lenders must take out insurance when borrowers put down less than 20 percent of a home's value. They often also insure mortgages even when buyers have more than 20 percent equity in their homes in a bid to transfer more risk to insurers in the case of default.

In addition to the CMHC, the changes would affect the risk level taken on by Genworth Financial Mortgage Insurance Co Canada and Canada Guaranty Mortgage Insurance Co.

The system has been criticized by the International Monetary Fund and the Organisation for Economic Cooperation and Development, among others, because it makes lenders less motivated to ensure their loans are good.

"Experiences in other countries have shown that high household indebtedness can exacerbate an adverse economic event, leading to negative impacts on borrowers, lenders, and the economy," the finance department said in its call for submissions.

"A high level of public sector involvement, for example through government guarantees of mortgage loans, may dampen market signals and lead to excessive risk taking."

The department outlined two ways to shift the risk back to lenders, including a "first loss" approach where lenders are responsible for losses up to a fixed amount of the outstanding loan balance in case of default.

Alternately, lenders could be responsible for "proportionate loss" calculated as a fixed percentage of total loan losses, putting a greater burden on lenders in the case of big loans that go bad.

Stakeholders, including banks, lenders, insurers and consumer protection groups have until Feb. 28, 2017, to submit proposals or concerns about the changes. The finance minister is expected to announce new rules in the spring.

Reporting by Andrea Hopkins; Editing by Chizu Nomiyama

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