In today’s release of the Financial System Review, the Bank of Canada judges that the risks to the stability of Canada’s financial system remain high and are primarily due to external factors, specifically, a further escalation of the euro-area sovereign debt crisis.
The most important financial risk domestically is the elevated level of household indebtedness. Of increasing concern is the continued high level of activity and stretched valuations in some segments of the housing market.
Overall, the risks associated with high levels of household debt and a potential correction in the housing market are elevated as was the case in December’s review.
An encouraging stat is that the popularity of fixed-rate mortgages has risen noticeably over the past six months, indicating that some households are less sensitive to increases in interest rates than was previously the case.
But the Bank of Canada warns that households still remain exposed to interest rate risk. According to Bank estimates, “under a hypothetical scenario where the policy rate rises by 325 basis points by mid-2015 and households do not proactively manage their exposures to the proportion of total household sector debt held by households with a debt-service ratio equal to or above 40 per cent would rise from 11.5% in 2011 to about 20% by 2016.” This would further heighten the sensitivity of households to adverse shocks.
Since the last BOC review, both activity in the housing market and the
growth of house prices have “been firmer than anticipated” with house prices continuing to remain high relative to both income and rent. Housing affordability could become a concern as interest rates start to normalize.
The level of condos under construction in Toronto is also concerning as market segments that have a “persistent oversupply of housing units face a higher risk of price declines.”
As an example of the risks of overbuilding, the BOC references the experience we faced here in Calgary when the construction of multiple-unit dwellings (largely condominiums) peaked in 2008. This was followed by a significant increase in unsold inventory, and condominiums experienced a cumulative price decline of 20% between 2007 and 2010.
You can download the entire report here