Photo: James Bombales

The Canadian financial system is facing a number of risks, according to the Bank of Canada’s biannual Financial System Review, released this week.

Those risks include a rising rate of household indebtedness and housing market imbalances. But the one potential problem that may be surprising to industry observers? New mortgage rules set to come into effect on January 1.

Last month, the Office of the Superintendent of Financial Institutions (OSFI) announced a new stress test which will require all uninsured mortgage borrowers to qualify against the Bank of Canada’s five-year benchmark rate, or at their contract mortgage rate plus an additional 2 per cent.

The test is intended to ensure that uninsured borrowers can withstand higher interest rates, protecting Canada’s financial system from a potential wave of mortgage defaults. The overnight rate — which influences mortgage rates and sat at a historically low 0.5 per cent earlier this year — has been raised 50 basis points by the Bank of Canada since July, with further hikes predicted in 2018.

However, 17 per cent of outstanding uninsured mortgages are held by credit unions, which are not regulated by OSFI. It’s these mortgages that the Bank says could pose a problem.

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“Migration of higher-risk mortgages outside the prudentially regulated financial system will be monitored,” writes the Bank. “As borrowers and lenders adapt to the new OSFI guidelines, it will take some time to assess the extent to which this vulnerability is being alleviated.”

TD Senior Economist Brian DePratto notes that the Bank is likely wary of high risk borrower activity shifting away from the more highly regulated areas of the financial system. However, he sees the Bank as saying that things are moving “in the right direction.”

“For both high household indebtedness and housing market imbalances, changes to [mortgage rules] and rising interest rates are having, or are expected to have, the desired effect,” writes DePratto, in a recent note.

DePratto writes that rising interest rates, combined with a strong economic performance in 2017, should reduce vulnerabilities through time.

“The Bank sees things as moving in the right direction — towards reduced financial risk — a scenario consistent with continued gradual tightening of monetary policy in 2018,” he writes.

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