OSFI warns banks to have more scrutiny in their mortgage business

Canada's top banking regulator is telling the big banks to pay more attention to who they are giving mortgages to, and warning them that it is stepping up its scrutiny of their loan books.

The Office of the Superintendent of Financial Institutions Canada has sent a letter to all federally regulated financial institutions reminding them that it expects them to have "prudent underwriting of residential mortgage loans."

Like many in the housing sector, OSFI has recently become concerned with elevated debt levels, specifically as it regards to the risks that banks are taking on by loaning more and more money to people eager to buy into Canada's housing market.

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"With rapid price increases in some areas and current exceptionally low interest rates, the risks are getting larger," OSFI head Jeremy Rudin said. "Given this environment, OSFI has enhanced its supervisory oversight and identified a number of issues that warrant close attention by mortgage lenders."

Among them, the regulator singles out some practices that are thus far believed to be rare in Canada, but growing, such as:

• Income verification (where lenders loan money to borrowers without accurately monitoring their income).

• Non-conforming loans (where banks give out loans that don't meet their own internal parameters).

• Debt service ratios (where borrowers are borrowing a dangerously high amount compared to their ability to pay it).

• Appraisals (where loans are given out based on incorrect assumptions of the property's actual value).

• Loan-to-value (LTV) ratio calculations (Where the proportion of a home's value is out of whack).

• Institutional risk appetite (where banks are ignoring their own risk guidelines in handing out loans).

"OSFI expects mortgage lenders to verify that their mortgage operations are well supported by prudent underwriting practices, as well as sound risk management and internal controls that are commensurate with these operations," the regulator said.

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On the subject of income verification, the regulator was blunt: "OSFI is aware of incidents where financial institutions have encountered misrepresentation of income and/or employment."

"Income that cannot be verified by reliable well-documented sources should be treated cautiously when assessing the ability of a borrower to service debt."

OSFI says it is also pushing ahead with plans first announced last December to ensure banks have enough capital on hand as a percentage of how much they have loaned out, "to better position them to withstand potential losses."