Canada’s bank regulator is getting ahead of any rate cuts with new limits on leverage. The Office of the Superintendent of Financial Institutions (OSFI) has notified lenders to prepare for a new loan to income (LTI) rule. The new rule will limit federally regulated financial institutions (FRFIs) mortgage portfolios to a multiple of the income used to service those loans. The regulator says the new limits are designed to help limit a buildup of risky leverage during low interest rate periods .
Canadian Banks To Limit Mortgage Leverage Before Rate Cuts
Canadian mortgage lenders are preparing for new limits to mortgage lending. Mortgage portfolios will soon be limited to 4.5x borrower income in a quarter. Only a small share will be allowed to exceed the limit, designed to reduce portfolio risk.
“The LTI measure we are implementing is a portfolio test that is designed to prevent the buildup of highly leveraged loans during low interest rate periods,” explained a spokesperson for OSFI.
OSFI Is Eliminating Excess Leverage, Not Over-leveraged Borrowers
Generally speaking, a borrower is considered “over-leveraged” when their loan exceeds 450% of income. This has led to some confusion after a piece titled “Canada’s banking regulator OSFI to cap mortgages to highly indebted borrowers” broke the news.
However, it’s important to note that OSFI’s role is to ensure a functioning financial system. It’s not to protect individuals from risk or tell FRFIs which clients are too risky. “This measure doesn’t apply to any one person,” explains OSFI.
“It applies to the institution’s portfolio of underwritten mortgages that originate that quarter and needs to be managed by the institutions.”
Institutions are just being asked to balance their risk. Every risk taken by the lender needs to be balanced to avoid any catastrophic concentration of vulnerability.
“This institution specific portfolio limit will not bind any one institution’s underwriting method, under the current rate environment. This approach allows institutions to continue competing in the same way they have been in the past on a relative basis.”
The new rule is one of the many being rolled out to reduce public exposure to private debt. Since the global financial crisis, global regulators have been working together to better quantify risk. This has led to tighter lending, especially when it comes to investors.
