Mortgage Stress Test in Canada

Why do we have the Stress Test (B-20 Mortgage Stress Test) in Canada and where did it come from?

Banks are regulated because their safety and stability is fundamental to our economy. That provides us with confidence knowing money we deposit today will be available to us when we need it, and the banks the ability to lend through every economic cycle. The global financial crisis in 2008 was a stark reminder of just how much damage excessive risk-taking by banks and a loss of public confidence in the banking system can do to the real economy.

In Canada, OSFI – Office of the Superintendent of Financial Institutions - is the federal regulator of our banks. Their mandate requires them to protect the interests of depositors and other creditors while allowing financial institutions to compete and take reasonable risks. Canadian banks did not suffer nearly the impacts of the global financial crisis that other countries did, due in part to regulations that prevented banks from taking on risky investments at a time when so many other banks around the world felt the risky investments were not only prudent, but necessary. OSFI issued their first version of B-20 in 2012. At that time, the role that weak mortgage underwriting had played in the global financial crisis was clear, and OSFI proactively set out clear expectations for strong mortgage underwriting in Canadian banks.

The prevailing sentiment that house prices would only go up and interest rates would only go down was, in OSFI’s view, contributing to an over reliance on collateral value and not enough scrutiny of a borrower’s ability to repay a loan, particularly if conditions were to change. OSFI decided such speculation needed to be reined in, which led to changes to B-20 in January 2018; the most significant of those being the stress test. The stress test requires a borrower be qualified for their mortgage with a buffer of affordability built in to ensure they can continue to pay their mortgage if conditions change.

Those conditions could be a rise in interest rates that increase their payment obligation, or they could be a loss or reduction of income or an increase in other, non-mortgage expenses. It is a safety buffer that ensures a borrower doesn’t stretch their borrowing capacity to its maximum, leaving no room to absorb unforeseen events.