Ottawa Proposes Lender Risk Sharing for Insured Mortgages

The federal government is reviewing the distribution of risk in Canada’s housing finance system and considering risk sharing for mortgage lenders.

In a consultation paper released Friday, the government proposes that mortgage lenders would have to manage a portion of loan losses on insured mortgages that default.

Currently, lenders transfer nearly all of the risks to mortgage insurers and indirectly to taxpayers.

The consultation paper says lender risk sharing would transfer some risk taken by mortgage insurers and taxpayers to lenders, which would ensure that the incentives of all parties to an insured mortgage are aligned towards managing housing risks throughout different economic cycles.

“Experiences in other countries have shown that high household indebtedness can exacerbate an adverse economic event, leading to negative impacts on borrowers, lenders, and the economy,” the paper states. “A high level of public sector involvement, for example through government guarantees of mortgage loans, may dampen market signals and lead to excessive risk taking.”

The government has proposed two potential approaches for calculating a lender’s portion of loan losses:

• The “first loss” approach involves making lenders responsible for losses up to a fixed portion of the outstanding loan balance at loan default. Under this approach, the lender would be responsible for losses up to the determined amount, with mortgage insurers only responsible for losses in excess of this level.

• The “proportionate loss” approach would base the lender portion of loan losses on a percentage of total loan losses. By setting a lender’s portion of loan losses to a fixed percentage of total loan losses, the lender’s dollar-value loss would vary proportionately with the dollar value of the total loan loss.

The paper predicts that a modest level of lender risk sharing will have an impact on average lender costs. A preliminary analysis suggests the average increase in lender costs over a five-year period could be 20 to 30 basis points. That means mortgage rates will likely increase.

Individuals or organizations interested can submit their comments about the suggested changes to [email protected] by Feb. 28, 2017.