Subprime Lending - Canada

Canada

New types of “exotic” mortgages became popular in the U.S in the years leading up to the economic downturn. These mortgages often featured “teaser rates” that kept initial monthly payments artificially low, only to have them increase significantly later in the mortgage. Features such as this were never adopted by major Canadian mortgage lenders. The sub-prime market did not take hold in Canada to the extent that it did in the U.S., where the vast majority of mortgages were originated by third parties and then packaged and sold to investors who often did not understand the associated risk. Most mortgages in Canada, on the other hand, are originated and retained by institutions whose goal is to maintain a long-term relationship with the borrower. CMHC does not insure sub-prime mortgages.

Canadian banks, trust companies and credit unions tend to have a broader relationship with their customers than just a mortgage, also offering credit cards, car loans and investments. They have a financial interest in ensuring that borrowers do not take on unmanageable debt, which reinforces their motivation to prudently underwrite mortgages.

The Canadian banking system is dominated by five or six large banks that together hold the majority of domestic banking assets. The large banks are in turn diversified geographically and across product lines, while the non-traditional, or shadow, banking system is relatively limited in scope compared with that of the U.S. Oversight is facilitated by a single authority (the Office of the Superintendent of Financial Institutions, or OSFI), which has responsibility for the prudential oversight of these federally incorporated institutions. Communication with the banking community is thus reasonably straightforward. There is a strong focus on the quality of the banks’ risk-management practices. While this is often attributed to a traditionally conservative business culture in Canada, an important factor here is the difficult lessons learned from previous banking problems. An example is the economic difficulties in the early 1990s, which included a significant housing downturn. Canadian banks therefore entered the recent period of financial stress with better risk-management practices, focused on limiting credit losses, than in previous episodes. This helped to limit their exposure to some potentially riskier sectors and products. For example, subprime mortgages, as they occurred in the U.S. market, remained a relatively limited phenomenon in Canada.