In late March, Canada’s competition agency recommended that policymakers make it easier for mortgage holders facing a mortgage renewal.
Specifically, the Competition Bureau recommended regulators waive a “stress test” rule for uninsured mortgage borrowers who switch lenders.
“When consumers renew their mortgages, their ability to switch to a competitive mortgage offer is critical to ensure they obtain the best rate and terms to serve their needs,” the bureau’s report says.
Disappointingly, this week, the Office of the Superintendent of Financial Institutions rejected this recommendation. In so doing, it has missed an opportunity to help address two acute Canadian challenges: affordability and low productivity.
Some readers may recall that last fall Ottawa announced a new Canadian Mortgage Charter, ostensibly to provide relief to stretched borrowers. The announcement was more show than substance, since all of the measures either existed already or are optional for lenders.
But one of the charter measures that got significant attention was the promise that insured mortgage holders were not subject to a stress test requirement when switching lenders. As Canadian Affairs reported at the time, this measure did little to help most borrowers, since 73 per cent of Canadian mortgage holders are uninsured.
It is these uninsured borrowers who thus still face a stress test requirement, and who, in the current high interest rate environment, may be unable to switch lenders as a result. When a borrower cannot pass a stress test, the current lender “can offer higher rates to these captive borrowers without fear of losing their business,” the bureau’s report says.
And this is exactly what happens. Bank of Canada data shows that borrowers who switch lenders at renewal time pay on average interest rates that are 10.2 basis points lower than those who stay with the same lender. By contrast, borrowers who renew their mortgage with an existing lender pay on average 6.1 basis points more than new borrowers. (A basis point is one-hundredth of one percentage point.)
While these numbers are not big on their own, a spread of 16 basis points on a $1-million mortgage is a difference of $1,600 per year. Some consumers could potentially save even more by shopping around.
The fact that locked-in borrowers pay more should surprise no one. Banks, like all businesses, respond to incentives — or lack thereof. If banks know a borrower can’t switch, they have little incentive to work to retain customers by offering competitive rates.
This matters not simply to consumers who are struggling with high costs of living, but also on a macro level. As Canadian Affairs discussed in a recent editorial, lack of competition, especially in federally-regulated sectors, is a key factor contributing to Canada’s productivity problem.
The Competition Bureau was explicit that its recommendation to waive the stress test was one way to boost competition in a highly-concentrated banking sector that desperately needs it. This problem has only become more acute with RBC’s recent acquisition of HSBC Canada, a bank that was known for offering the lowest posted mortgage rates. While HSBC may have represented a small share of the overall mortgage market, its rates gave consumers a tool for negotiating with other lenders.Â
The Office of the Superintendent of Financial Institutions, which regulates Canada’s financial institutions, takes a different position on the matter. In an emailed statement to Canadian Affairs, it explained its reason for rejecting the bureau’s recommendation:Â
“When an uninsured borrower switches lenders, the new lender takes on the credit risk of that mortgage loan and needs to assess the ability of the borrower to pay back the loan. Because different lenders have different risk appetites, each lender needs to assess the risk of the loan in the context of their own risk appetite” [their emphasis].
This reasoning is contradictory. The stress test is mandatory for all lenders, and therefore does not permit lenders to make their own risk assessments.
Moreover, the risk that an uninsured borrower poses to the stability of the financial system does not change if a borrower moves their mortgage from, say, TD to BMO.Â
This is why the Competition Bureau noted in its report that “Such a change need not compromise other financial sector public policy goals. There are other rules in place to protect the safety of [federally regulated financial institutions] and ensure they adopt good loan approval practices.”
OSFI’s decision is surprising, not least because it reports to Parliament through the Minister of Finance. Meanwhile, the Competition Bureau’s recommendation to waive the stress test requirement was formed in response to Department of Finance consultations on strengthening competition in the financial sector.
With the release of the federal budget next week, the government should provide clear direction to OSFI to make the change that the bureau has, for good reason, recommended.
