Canada’s financial system is seriously compromised by elevated risk in the country’s housing market according to the Office of the Superintendent of Financial Institutions (OSFI), who pointed to an overheating market and over-leveraged buyers in an inaugural report.

As a result, the banking regulator has suggested that it might expand Guideline B-20, its mortgage stress test to other products like reverse mortgages, which are growing in popularity.

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In particular, OSFI’s recent supervisory reviews have shone a light on problems pertaining to the mortgage underwriting process, namely among income verification in the business for self, rentals, exceptions to income, and collateral management categories.

B-20 might even extend beyond the scope of conventional mortgages to reverse mortgages, shared equity mortgages, and combined loan plans (CLP), which the regulatory body indicated have grown in recent years. OSFI’s report expressed particular concern about CLPs because they have grown in popularity -- and, by extension, risk --as a result of the range in underwriting practices among lenders. OSFI intends to hold an industry session this spring for all residential mortgage lending financial institutions to clarify its guidelines.

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As the housing market’s susceptibility to overheating and a significant downturn persist, OSFI’s report said it will keep adjusting its regulatory guidance for mortgage underwriting where and when it sees fit, because COVID-19-era growth in both housing prices and the number of homebuyers has effectively compromised lenders.

OSFI’s supervisory review work has uncovered a need to protect lenders with additional guidance to ensure that their underwriting practices don’t deviate too far from the B-20 mandate. CLPs, for example, are risky to borrowers and lenders alike, because they’re especially vulnerable to negative shocks to the market. However, prudent limits and specific risk management guidelines governing CLPs would enable lenders to service borrowers’ credit needs in a sustainable way, the report said.

OSFI also said that it is going to issue a supplementary advisory to B-20 this spring that will explain lending expectations for CLPs and other non-traditional loans attached to residential real estate.

B-20 was announced in October 2017 and implemented at the beginning of 2018. As of its last amendment in June, it stress tests mortgages at a qualifying rate of 5.25% or 2% above the contract rate, whichever is higher.