OTTAWA - Bank of Canada governor Mark Carney issued a caution to Canadians and the chartered banks Wednesday: interest rates are going up and they should take care not to get caught out.
Expanding on previous warnings, the bank governor told a business audience in Toronto that the current low interest rate environment may be luring Canadians to borrow too much, and banks to extend loans they will later regret.
Canadians have taken on more debt even during the recession, which is unusual, Carney said.
But while Canadians may be able to afford the added debt burden now when interest rates are at historic lows, they may get caught short when rates return to more normal levels.
"The combination of sustained growth of household debt relative to income and a rising interest rate environment could increase the vulnerability of households to an adverse shock," he said in notes on the speech released by the central bank in Ottawa.
The bank governor did not say when he expects interest rates to start rising, although economists believe Carney will make his first move on his lower-bound 0.25 per cent policy rate in mid-2010. That would be after the bank's conditional commitment to stand still on the rate until the end of June.
It is not the first time Carney and the central bank have voiced such concerns, most recently last Thursday in the central bank's semi-annual Financial Systems Review, which cited household debt as the number one risk factor to Canada's economic well-being.
Since then there has been more evidence that Canadians have not paid heed. The Canadian Real Estate Association reported Tuesday that Canadians continued to snap up houses at near-record levels, increasing their purchases of resale homes by 73 per cent in November.
Although the finances of Canadian households are still healthy the situation bears watching, Carney said.
"When risks are still manageable is precisely the best time to act," he said. "It is the responsibility of households now to ensure that in the future, when the recovery takes hold and extraordinary measures are unwound, they can still service their debts."
Among signs that Canadians may be getting in over their heads was a 41 per cent jump in personal bankruptcies in the July-to-September period from a year ago. Personal bankruptcies are now at the highest level as a proportion of the population since 1991.
As well, delinquency rates are rising and the proportion of mortgage payments in arrears by three months or more have increased by 50 per cent in the past year.
The Canadian economy is particularly vulnerable to household defaults since consumers are expected to be the key driver of economic recovery, the governor said.
But Carney added that while Canadian consumers have a responsibility to avoid credit risks, so do financial institutions.
"Financial institutions should actively monitor risk stemming from households and not take comfort from mortgage insurance and past performance of household credit," he said.
"As our simulations suggest, the overall credit profile of Canadian households could well shift if debt continues to grow at current rates."
Carney noted that he still believes the Canadian economy is coming out of the recession and will grow in the next few years.
He said he expects Canada to outperform the other G7 countries with a three per cent advance in 2010, but said growth going forward will be more modest than previous post-recession bounce-backs and more reliant on domestic demand.
"The behaviour of Canadian households will thus be particularly important," Carney said.
An important lesson of the American experience was that the costs of the collapse of the U.S. housing bubble were not confined to the most vulnerable households, the governor observed.
Problems in the subprime-mortgage market spread quickly and virtually every financial asset in the world was repriced. "Financial stability is as much about linkages as it is about specific risks," he said.
The finances of Canadian households were in better shape going into the crisis than those of American households, Governor Carney told the National Forum (Canadian Club of Toronto and Empire Club of Canada). "As a consequence, when the crisis struck, Canadian households were less vulnerable," the Governor noted.
Still, in its latest Financial System Review, the Bank judges that the risks related to household balance sheets have increased. "The vulnerability of Canadian households to adverse wealth and income shocks has grown in recent years," Governor Carney observed. "Aggregate debt levels have risen sharply relative to income."
Lenders also have responsibilities, as do policy-makers and regulators, Governor Carney said. Lenders should actively monitor risk stemming from households and continue to apply their high standards of risk management. Policy-makers and regulators, including the Bank of Canada, must continue their work to ensure Canada has a resilient, secure financial system that enhances the economic and financial welfare of all Canadians.
