Canada's mortgage stress test is 'imperfect'; review ongoing -regulator head

The moon rises over the Toronto city skyline as seen from Milton, Ontario

TORONTO (Reuters) - The head of Canada's banking regulator said on Thursday its mortgage stress test was "imperfect" and "incomplete" as homeowners on a variable rate mortgages struggle to repay their loans after the central bank's series of interest rate hikes.

Office of the Superintendent of Financial Institutions' (OFSI) Superintendent Peter Routledge, speaking at the Scotiabank Financials Summit, addressed the rising financial pressure Canadians are facing such as payment shock at the time of renewal as their fixed payment largely covers only the interest portion of their mortgage.

He estimates that variable-rate, fixed-payment mortgages stood at C$369 billion ($269.70 billion) in a mortgage market of C$2.1 trillion. Banks offering these products have reported that about C$260 billion of these amortize after 35 years, he added.

The stress test rules amended in 2021 require borrowers to prove they can handle mortgage repayment 200 basis points above their contracted rate and they will have to re-qualify if moving to a different lender at the time of renewal.

"As effective as that stress test was, it was not perfect," Routledge said, noting that many consumer opted for variable-rate, fixed-payment mortgages when interest rates were low during the pandemic. "Perhaps it is better to call it incomplete."

Those consumers will have to qualify at a higher rate if they choose to move to a different lender.

"We seek an integrated set of common-sense protections that work effectively both when interest rates are higher than normal, like today, and when interest rate are lower than normal, like during the COVID years."

The Bank of Canada on Wednesday held its key rate steady at a 22-year high of 5%, up from a record low of 0.25% from March 2020 to March 2022.

Routledge noted that the risk environment was growing for the Canadian financial system and the OSFI was working on a new supervisory framework, which will be in effect in 2024 and will be the first in-depth revision in the last 25 years.

Canadian banks' home loans with a tenor of more than 30 years edged lower in the third quarter but analysts say risks remain elevated with borrowing costs expected to stay higher for longer, forcing banks to set aside more funds for bad loan provisions.

OSFI is currently reviewing its mortgage guidelines for lenders and is expected to release an update in October.

It has also consulted with jurisdictions such Britain, which faces a similar mortgage crisis.

"There's no question that the risk environment is growing more complex. But we can't – and won't - slow down. This is our new normal," Routledge said.

($1 = 1.3682 Canadian dollars)

(Reporting by Nivedita Balu in Toronto; Editing by Jamie Freed)