High household debt and a heated housing market remain the biggest domestic threats to Canada's financial system, the Bank of Canada said on Thursday, despite tighter mortgage rules introduced by the government in July.
"The most important domestic risk to financial stability in Canada continues to stem from the elevated level of household indebtedness and stretched valuations in some segments of the housing market," the central bank said in its semi-annual Financial System Review.
Canada's financial system remains robust but the overall risks to the stability of the banking sector remained high, unchanged from June, it said. The bank ranked the European debt crisis as "very high," the highest of its four levels of risk, and it described ongoing US fiscal negotiations as a major near-term threat.
The danger from the one trouble spot the bank can potentially address through policy action - household borrowing - was also unchanged from June at "high." Housing prices and construction in Canada roared higher in 2011 amid low interest rates, sparking fears of a US-style bubble. The market started to slow after the government tightened rules on mortgage lending in July, the fourth time it had acted to curb borrowing since 2008.
The Bank of Canada's two-year freeze on interest rates is also seen as a reason for the credit binge and the bank has said it could, as a last resort, use monetary policy to address the problem. The bank said on Thursday it was too early to say if the cooling seen in recent weeks would endure.
Canada's debt-to-disposable income continues to rise even though credit growth has moderated. Housing resales and housing prices have cooled, although prices are 16 percent higher than the previous peak in August 2008. Housing starts, particularly in the multiple-unit or condo market, have stayed strong and point to potential oversupply in that market, the bank warned.
"These fragilities could themselves trigger financial stress or significantly amplify the adverse effects of other shocks on the financial system," the bank said. If the unemployment rate were to rise by 3 percentage points by early 2014, the proportion of household loans in arrears would rise to 1.2 percent in early 2015 from about 0.4 percent in the second quarter of this year, the bank projected.