Changing the stress test may raise credit risk for banks says Fitch

The proposed change to the federal mortgage guidelines that would reduce the stress test requirement for borrowers could adversely affect the credit risk of Canada’s big banks.

That’s according to Fitch Ratings which says that the lower threshold for lending along with the potential for further interest rate cuts amid concerns of economic slowdown, could spark activity in the housing market and raise the overall risk for lenders.

Currently, the stress tests require that home buyers demonstrate their ability to afford a mortgage at a benchmark rate based on the "posted" median of 5-year fixed rates at large banks, which is roughly 5.19%, or 250bps (basis points) higher than current market rates.

The proposed stress test would replace this posted rate with a more market-based benchmark, plus a buffer of 200bps, or approximately 4.8% based on current rates.

Fitch warns that if borrowers take on larger mortgages and, while the change to the B-20 mortgage guideline alone will not “significantly increase borrower purchasing power” it could ignite the market – especially in Toronto – supporting the current surge in prices.

Along with other household debt levels, the risk to the banks’ credit losses would come from an escalating of household debt coupled with an economic downturn.