February 24, 2016 / 6:00 PM / in 2 years

Bank of Canada: system could survive major household debt shock

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By Alastair Sharp

GUELPH, Ontario, Feb 24 (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 financial vulnerability associated with elevated household debt has increased over the past decade,” Deputy Governor Lawrence Schembri said in prepared remarks for delivery to 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 highly 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 reach as high as 1.8 percent after three years, with about 20 percent of the rise attributable to the increase in debt and greater concentration that has been seen among highly indebted households since 2007.

The rise in arrears 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.

“Despite the drop in the price of oil and some non-energy commodities, the probability of this risk being triggered remains low,” Schembri said.

The expected pick up in the economy will help stabilize household debt as growth, incomes and interest rates eventually rise, said Schembri. He also pointed to other measures that have been taken, including new rules from the Liberal government that will force people who want to buy more expensive homes to provide a bigger down payment.

Writing by Leah Schnurr and David Ljunggren Editing by W Simon

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