Households without a mortgage have more difficulty making ends meet than those with one. How to explain this?
This is because of rent prices which have increased rapidly, but it is not only because of that. It’s also because interest rates on consumer loans and auto loans have increased. Food also costs more. Renters generally have lower incomes than homeowners, and that explains why defaults on credit cards and auto loans among households without a mortgage are increasing and have returned to pre-pandemic levels while defaults among Borrowers who have a mortgage loan are low and stable.
Half of mortgage holders have already renewed their loans at higher interest rates and the default rate remains very low at 0.5%. Do you expect this rate to increase further?
The default rate is low, but that doesn’t mean it’s not difficult for these households. They adjusted by reducing their spending. They pay their mortgages, they pay their credit cards and they pay their car loans. But interest rates are higher and they have less money for other expenses. They adjusted their consumption. It hasn’t had a big effect on financial stability (so far).
It would not be surprising if the default rate rises in the next two years because households who renew their mortgages will have a larger change in interest rate than those who have already renewed. We also know that these households have less equity in their homes and that they have taken out higher mortgages on average depending on their income. For these reasons, the adjustment in the next two years could be more difficult. On the other hand, employment is quite good, households have seen an increase in their salaries and they have saved during the pandemic. So there are things that go in the other direction.
The number of business bankruptcies is rising sharply. Should we be worried?
It is worrying for these companies which are bankrupt, but in terms of financial stability, it is not so worrying because there are good reasons to think that certain elements of this sharp increase in bankruptcies reflect a certain catch-up . During the pandemic, bankruptcies were very low, well below a normal bankruptcy rate, because interest rates were very low and there were several programs to help small businesses.
After a three-year period with a very low number of bankruptcies, it is not so surprising that bankruptcies are increasing. Yes, it’s higher than normal. If it’s catching up, it should decrease. The most recent data shows some decline, but it’s a little early to conclude that it will continue to decline. In terms of the impact on financial stability, most of these failed companies are very small and if you look at the entire corporate loan portfolio at the banks, the default rates are low in total. Big companies are doing pretty well.
The last Financial Stability Report is more optimistic than last year. As interest rates are expected to fall, what is the main risk to the stability of the financial system?
The most worrying thing is the adaptation of households to higher interest rates. Most households will adapt. Among those who have a mortgage, there is another 50% who will renew over the next two years and we know that these renewals will be with a greater increase in interest rates. It’s something we look at closely.
Yes, the market anticipates that interest rates will fall, but if there was an inflation shock and interest rates did not fall, the problem would be more severe. The economy may slow down faster and the unemployment rate may rise and household income may fall and it becomes harder to pay mortgages. This is not our base scenario, but it is true that households in Canada are more in debt.
As I mentioned, I don’t think interest rates will come down very quickly and I don’t anticipate them going back to where they were during the pandemic. They don’t even go decrease to the level they were before the pandemic.
As a rate cut becomes more likely, we see dissension appear within the Bank’s board of directors over the appropriate time to initiate the rate cut. Are your meetings getting longer or is the tone of the discussions rising?
A certain diversity of perspectives is good. Everyone comes with different expertise and different experiences and we work together. I like this discussion. I think it’s a very good way to make decisions. In Canada, it’s not one person, one vote [comme c’est le cas dans d’autres banques centrales]. It is our responsibility to work together to find the best decision and for that, we need to listen to our colleagues.
But the meetings are getting longer?
They are richer. You can have different perspectives without being angry with your colleague. I’m the chairman of the board and it’s really up to me to try to find the decision where everyone comes together.