Bank of Canada: Signs Emerge of Easing Risks to Financial System -- 2nd Update

By Paul Vieira Features Dow Jones Newswires

Canadian policy measures meant to damp real-estate speculation and excessive borrowing, coupled with an improving economy, are helping to contain vulnerabilities within the country's financial system, the Bank of Canada said Tuesday.

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The central bank's semiannual Financial System Review said consumer debt and the state of housing -- in particular Toronto and Vancouver, British Columbia -- posed the most immediate threat to financial stability. Nevertheless, the Bank of Canada said signs were emerging that risks are moderating. It cited new, tighter mortgage rules from Canada's banking watchdog set to take effect in January, which are expected to improve lending standards and lead to a decrease in the proportion of new loans being issued to highly indebted households.

"Policy changes affecting housing finance are clearly a step in the right direction," Bank of Canada governor Stephen Poloz said at a news conference following the release of the review.

Mr. Poloz said the vulnerabilities posed by household debt and housing-market conditions "continue to be elevated and it will take a long time for them to return to more sustainable levels." However, he added, improved economic growth, stronger housing-policy measures and higher borrowing costs "are working in the same direction to help bring about a gradual easing of these vulnerabilities."

The bank's semiannual review assesses vulnerabilities in the financial system and identifies potential risks to financial stability that might not necessarily be triggered. The central bank last published its review in June.

Compared with its previous assessment, the central bank is signaling some optimism regarding notable progress on consumer-debt levels and housing activity. However, the bank remains cautious given the large stock of household debt in Canada.

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"Right now we are forecasting an improvement because we have the ingredients coming together," Mr. Poloz said.

The ratio of household debt to after-tax income is nearing 170%, or among the highest in the industrialized world. Borrowing -- the bulk in mortgages and drawdowns on home-equity lines of credit -- has climbed at a roughly 5.5% pace from a year earlier in recent months. That is well above annual wage gains that have just started to cross the 2% level.

The Bank of Canada kept its policy rate on hold in October after two rate increases in July and September, and is widely expected to hold steady again next week. In recent communications, central bank officials said it was exhibiting caution because of several uncertainties, including how indebted households respond to higher rates and the impact of tighter mortgage-financing rules in January.

In its review of the financial system, the central bank said policy changes to housing finance, higher interest rates and an expected pickup in household income "should continue to mitigate" the vulnerability posed by household debt.

The report said that as of June 30, fewer mortgages with less than a 20% down payment were issued to highly-indebted borrowers -- defined as having mortgage-to-loan ratio of over 450% -- compared with a year ago. The central bank attributed the decline to another set of mortgage-lending rules issued in the fall of last year, which it said compelled home buyers to shift their focus to less-expensive homes.

As for housing, it said since its June report there were "some signs" that the Toronto housing market is stabilizing. The rate of housing-price inflation has eased considerably in Toronto and its surrounding exurbs -- earlier this year it rose above 30% or even 40% on a year-over-year basis in some instances -- after authorities in Ontario imposed a tax on foreign buyers to damp speculative activity.

Still, Mr. Poloz said the underlying fundamentals in the Canadian real-estate sector "remain strong," with demand supported by job growth and immigration, and supply limited due to land-use restrictions.

Overall, the central bank expects higher interests and housing policy measures at the federal and provincial levels to reduce housing demand, and thereby mitigate vulnerabilities.

Write to Paul Vieira at paul.vieira@wsj.com

(END) Dow Jones Newswires

November 28, 2017 14:19 ET (19:19 GMT)