Tiff Macklem stresses need for vigilance, points to household debt as key risk in Canada’s financial system

The Bank of Canada highlighted early signs of financial stress among Canadian households as one of the key risks in the financial system. The unprecedented increase in interest rates has raised the costs for households, a vulnerability if a recession were to occur.

“Elevated interest rates and declining house prices have reduced the financial flexibility of many households,” reads the bank’s Financial System Review released on Thursday.

Due to the increased expense of servicing mortgages, homebuyers have relied more on credit card debt, which has exceeded pre-pandemic levels.

“We’re going through a transition to higher interest rates, higher interest rates than what people got used to and along that transition there are some risks,” said Bank of Canada governor Tiff Macklem in a press conference in Ottawa on Thursday. “It’s important that we are vigilant through this transition.”

The median debt service ratio of homebuyers, which looks at the gross income of households and the portion of it going towards paying off debt on their mortgages, has increased to 19 per cent in 2022. Close to 30 per cent of new mortgages have households paying a median of 25 per cent or more of their income to service their payments.

One-third of mortgages have seen an increase in payments since February of last year and all mortgages will have increased payments by 2025-26, when renewals occur.

The increase in costs will be highest among those households with fixed-rate mortgages, which will see their payments increase by 20 to 25 per cent in 2025 or 2026. Borrowers with fixed payments will see an increase of 40 per cent, that same year. Variable rate holders have already seen their payments go up by 50 per cent this past year.

“We highlighted in the report we are more concerned about the ability of households through this transition to manage their debts,” said Macklem.

The bank says households that bought into the housing market during its peak in pricing during the COVID-19 pandemic will face the most hardship moving forward.

To help alleviate the cost of those monthly payments, the share of new mortgages with an amortization longer than 25 years has increased from 34 per cent in 2019 to 46 per cent in 2022.

The bank does not see this as permanent, but as a short-term measure that homeowners are adopting to fight rising interest rates.

“Amortizations are a buffer that households can use if they find their payments go up and squeeze their budgets more than they can deal with,” said Bank of Canada Senior Deputy Governor Carolyn Rogers.

The central bank did not rule out increasing its policy rate last month. Despite expectations that inflation would continue to decrease, Statistics Canada reported inflation rose 4.4 per cent last month, up from its 4.3 per cent increase in March.

“Inflation is coming down, but we have some distance to travel to get inflation back to the 2 per cent target,” said Macklem.

Other top risks in the financial sector include the recent banking stresses in the United States, with the defaults of Silicon Valley Bank, Signature Bank, Credit Suisse and most recently, First Republic Bank this spring. The bank sees these defaults as an ongoing adjustment in the regional banking sector.

“The banking stress that we saw recently in the U.S. was an example of a small number of institutions that were not well positioned to deal with the sharp increase in interest rates,” said Rogers. “We saw some of the vulnerabilities play out and they created some very extreme stress for a smaller amount of institutions that had a ripple through the banking sector.”

The tightening of liquidity in the banking sector also remains a top concern, particularly as bank funding costs have increased. This remains a key risk if a recession were to occur.

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