OSFI head flags rising cost of debt for strained households as biggest risk heading into 2023.

Mandeep Toor

Dec 20

By Stephanie Hughes Financial Post.

With Canadians owing $1.83 for every dollar of income, financial watchdog not taking any chances by relaxing rules.

Peter Routledge says he's paid to be a worrier. And there's plenty to worry about these days. At any given time, the head of Canada's federal banking regulator may be fretting over issues ranging from the risk climate change poses to the financial system to the implications of the digitization of banking services. But the single biggest thing keeping him up at night, he says, is how high household debt is going to play against the backdrop of the fastest interest rate hiking cycle in recent memory.

Routledge, who took the helm at the Office of the Superintendent of Financial Institutions in June 2021, says that while higher borrowing costs are putting a strain on the already stretched pocketbooks of Canadians, the silver lining is that regulators have had the tools needed to handle the financial turbulence.

"I would say, so far, the financial system and businesses and households have proved quite resilient," Routledge said. "The domestic stability buffer, I think, was an important part of that story — not the only part of it. So, I'm not saying 'All clear', I'm not saying we're through the tough part. I'm just saying that we've got resilience so far."

If Canadians needed assurance that OSFI was taking the debt dilemma seriously, they could find it in the regulator's latest policy moves before closing the book on 2022. On Dec. 8, the regulator raised the capital buffer financial institutions must hold to three per cent. OSFI also boosted the capital buffer's range, a tool that gives it greater leeway to protect the banking system, to between zero to four per cent starting in February, up from the zero to 2.5 per cent range.

A week later, OSFI opted to leave the stress test for uninsured mortgages unchanged at the greater of either the mortgage contract rate plus two per cent, or 5.25 per cent. The regulator held the test steady despite speculation leading up to the announcement that OSFI might ease the test since the Bank of Canada's December rate hike pushed the qualifying rate above eight per cent.

OSFI is maintaining a cautious stance as the seasonally adjusted household debt to disposable income ratio rose to 183.3 per cent in the third quarter from 180.6 per cent at the beginning of the year, according to Statistics Canada. The rising figure is enough to make the regulator uneasy, especially as it nears the record of 184.6 per cent in the third quarter of 2018.

Routledge said this figure is high by historic standards and relative to other G7 peers. However, he said the regulations and safeguards put in place since the global financial crisis in 2008 have acted as a buffer that has served Canada well.

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"I cannot overstate the strengthening of underwriting standards since that time and the strengthening of underwriting standards in Canada," Routledge said. "I'm quite confident that if you overlay the same set of exogenous events on the Canadian housing market now that you had back in the mid-2000s, Canadian credit losses would be an order of magnitude lower."

In other words, Routledge said he believes the underwriting quality will protect Canada's financial system from excessive credit losses in the face of a recession.

"If you would have told me a year ago today with perfect precision what was happening, I wouldn't have said the base case is this good," Routledge said. "So now, the turn and the shift for 2023 is: will it stay this constructive? Or could things deteriorate beyond what we're comfortable with and how would we react? And that's day by day, week by week, what we're asking ourselves."

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