Top Risks to Canada’s Financial System: Banking Regulator Identifies Mortgage Lending and Real Estate Sector as Key Concerns
Real estate secured lending and rising mortgage payments pose significant risks to Canada’s financial system due to high borrowing costs, according to Canada’s top banking regulator.
With 76% of outstanding mortgages set to renew by 2026, homeowners could face “payment shock” from higher interest rates compared to when they initially secured their mortgages, Superintendent of Financial Institutions Peter Routledge warned in his annual risk outlook. Those who secured mortgages during lower interest rate periods from 2020 to 2022 will be particularly vulnerable.
“Households with high leverage and variable rate mortgages with fixed payments will feel this shock more severely,” Mr. Routledge stated in the Office of the Superintendent of Financial Institutions (OSFI) report.
“We anticipate that payment increases will lead to a higher number of residential mortgage loans falling into arrears or defaults.”
Variable-rate mortgages with fixed payments make up around 15% of outstanding residential mortgages in Canada and are a specific concern for the OSFI due to some mortgages negatively amortizing, resulting in payments that do not cover full interest costs or principal.
“In these cases, lenders offset the shortfall by increasing the remaining principal balance. While most institutions extend the amortization periods, the mortgage term remains unchanged until refinanced,” the report explains.
Borrowers with uninsured fixed variable-rate mortgages may face higher outstanding principal balances and potential payment shocks, leading to the need for large lump sum payments or significant increases in monthly payments to return to their original contract terms.
Higher mortgage payments consuming a larger portion of household income could result in homeowners defaulting on other debts, impacting banks and financial institutions, the report highlights. Banks could also face challenges if residential real estate markets weaken, causing higher defaults and lower recovery rates.
The central bank projected a 45% increase in payments for high loan-to-income ratio variable rate mortgage holders upon renewal in 2025–2026. The overall monthly payment increase for mortgages originating in 2020–2021 was forecasted to be 30%.
Other OSFI Concerns
Additional concerns highlighted by the OSFI include wholesale credit risks from commercial real estate lending, corporate and commercial debts, and funding and liquidity risks.
“Corporate credit and commercial real estate (CRE), especially in construction, development, and office sectors, continue to face challenges and uncertainty,” Mr. Routledge stated.
The report also points out risks related to social and political conflicts, warning that major geopolitical events could disrupt markets and create instability for institutions. The escalation of political tensions and geopolitical issues could make Canadian institutions vulnerable to politically motivated attacks.
The Canadian Press and Reuters contributed to this report.
