Lender risk sharing could exacerbate a housing downturn, fed draft report says

A federal proposal to have lenders shoulder more of the risk for potential mortgage defaults could dampen lending or intensify a decline in house prices, according to internal documents from the Department of Finance.

Proponents of lender risk sharing say it would encourage banks to be more cautious when lending to high-risk borrowers, thereby mitigating the impact of a correction in property prices.

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But a draft report, obtained by The Canadian Press through an access-to-information request, says exposing financial institutions to a portion of mortgage default losses through a deductible, for example could actually make the housing market less stable in the event of a downturn.

That's because lender risk sharing could exacerbate the downside of the lending cycle, during which banks typically become hesitant to hand out loans, the report says.

The Department of Finance has been exploring so-called lender risk sharing since before the election of Justin Trudeau's Liberal government in 2015. The draft report was prepared within the first several months of Trudeau's cabinet being sworn in.

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Evan Siddall, CEO of Canada Mortgage and Housing Corp., says the federal government is in the process of reviewing submissions it received during consultations on lender risk sharing.

"Those are being reviewed, and they are now looking for additional information from lenders, quantitative information from lenders, to further analyze the idea," Siddall said following a speech he delivered in Toronto last month.

"We won't have that data until later this year at the earliest."

Rapidly escalating house prices in the Toronto and Vancouver areas have caused some Canadians to take on record amounts of debt relative to their incomes, sparking concerns about growing risk in the real estate market.

The International Monetary Fund and the OECD have called on Ottawa to minimize the potential costs to taxpayers in the event of a housing market crash.

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Currently, homebuyers with less than a 20 per cent down payment are required to buy mortgage default insurance from CMHC or one of two private mortgage insurers. The insurance covers the banks in the event of a default by the borrower.

Claims are generally covered by the premiums paid by policyholders. But because mortgage default insurance is ultimately backstopped by Ottawa, that means that in the event of a severe housing market crash, taxpayers could be left holding the bill.

The Department of Finance said says it will provide updates on developments as appropriate.

"The government recognizes that lender risk sharing would represent a meaningful change to the mortgage insurance framework, and the importance of fully understanding the potential issues and impacts that could be associated with it," a spokeswoman for the department said in an email.

"The Department of Finance continues to review and refine input received from stakeholders through the public consultation process."

The proposal has been met with some criticism, notably from the Canadian Bankers Association, which wrote to CMHC in 2014 saying that lender risk sharing could hurt the country's financial stability.

The industry group also made a submission to the government earlier this year, arguing that a mortgage insurance deductible would likely increase costs for borrowers and leave smaller, regional lenders at a competitive disadvantage.

'Blunt and ineffective tool'

In a report last week, the C.D. Howe Institute said lender risk sharing is a "blunt and ineffective tool" to address concerns about risky lending. The think-tank said a better way of dealing with excessive lending to high-risk borrowers would be to couple a change in the pricing regime for mortgage insurance with changes to the regulation of the mortgage insurance system.

RBC chief financial officer Rod Bolger says the bank has been in consultations with the government on the issue, but chatter about the proposal has died down at industry events as of late.

"That doesn't mean that the teams aren't working on it. It just means that it might be one of those periods where the work is happening from the consultation," said Bolger.

"The analysis is happening. It doesn't mean that it's dead or anything like that."