Skip to content

Household debt a risk to country's financial stability

Deputy governor of the Bank of Canada warns of risks of high household debt.
20160224 schembri ro
Deputy governor of the Bank of Canada, Lawrence Schembri, spoke at the Guelph Economic Leadership Forum on Wednesday.

Household debt is a risk to the stability of Canada’s financial system, but it is a relatively low risk at this time, a Bank of Canada official told a Guelph audience Wednesday.

About 60 people, many of them from the financial sector, were on hand for the Guelph Chamber of Commerce Guelph Economic Leadership Forum at Cutten Fields. Lawrence Schembri, deputy governor of the Bank of Canada, gave a 30-minute presentation which had cautionary overtones, and some alarm bells related to Canada’s growing level of household debt.

The risk to, and vulnerability of Canada’s financial stability is much lower that other countries around the world, Schembri said during a question and answer portion of the event. Strong regulatory oversight in this country has kept our financial house in relatively good shape.

Nevertheless, household debt, particularly among younger, more vulnerable households, is something to worry about.

The Bank of Canada, he said, is focused on understanding the sources of stress on the financial system, so that the impact of financial crises can be limited or prevented.

The recent dramatic drop in oil prices is certainly an adverse shock to the system. Its effects are most acutely felt in areas of the country heavily reliant on the oil industry.

“Focusing explicitly on vulnerabilities in the Canadian financial system allows us to highlight where the fragilities lie and how they are evolving,” he said in his presentation.

Canada was spared some of the most severe negative consequences of the global financial crisis of 2008 because of the country’s “strong financial regulatory and supervisory framework and the effectiveness of our policy response,” he said. That policy response included a reduction in the Bank of Canada interest rate to stabilize inflationary pressures.

The Canadian economy recovered quickly with the support of strong growth in household spending, but much of that spending that was supported by a buildup of household debt. That debt now “has increased the vulnerability of the economy and the financial system to adverse shocks to incomes and interest rates,” he said.

In times of economic stress, families that are heavily indebted will cut back on their spending. High household debt can “amplify the impact of a shock,” and can, in extreme cases, lead to an increase in household defaults. Such defaults mean losses for banks, other lenders and mortgage insurers, he said.

“In the worst case, if the losses were extensive and spillovers were large, the increase in stress could potentially deplete the capital buffers built into the financial system to absorb losses, impairing its functioning, with large negative effects on economic activity,” Schembri said.     

Among Canadians there is a category of highly indebted households, ones with a debt-to-gross-income ratio equal to or more than 350 per cent. Most in this subgroup are under the age of 45.

The size of this group has doubled since the financial crisis, making up about eight per cent of indebted households. There are 720,000 households in this group holding $400 billion in debt, about one-fifth of the overall household debt in the country.

A disproportionate number of these households are in British Columbia, Alberta and Ontario, where house prices are highest.

“Members of highly indebted households are more likely to lose their jobs because they tend to be younger and are less likely to have a post-secondary degree or training,” Schembri said, adding that those households would be less able to make debt payments after an economic shock. A persistent increase in the unemployment rate, while an unlikely scenario, would significantly increase the rate of arrears. Defaults on mortgages and other consumer debt could result in a sharp drop in house prices across the country.

The debt load and arrears currently in Canada are “not nearly as high” as in U.S. households at the beginning of the financial crisis, Schembri said. And there are “significant buffers in the financial system to withstand such a scenario.”

“Nonetheless, if such a decline in house prices occurred, the impact on the broader Canadian economy and the financial system would be large,” he added. The probability of such a risk being triggered remains low.

To promote the stability of the financial system the Bank of Canada is enacting a number of policy responses, including encouraging prudence on the part of borrowers and lenders.  


Comments

Verified reader

If you would like to apply to become a verified commenter, please fill out this form.




Rob O'Flanagan

About the Author: Rob O'Flanagan

Rob O’Flanagan has been a newspaper reporter, photojournalist and columnist for over twenty years. He has won numerous Ontario Newspaper Awards and a National Newspaper Award.
Read more