Overview: Lender Risk Sharing for Government-Backed Insured Mortgages
As part of a long-term review of Canada’s housing finance framework, the Government of Canada is examining whether the distribution of risk in Canada’s housing finance system is balanced, and appropriately reflects all parties’ abilities to share in the management of housing risks.
The government is launching a public consultation on a policy option that would require mortgage lenders to manage a portion of loan losses on insured mortgages that default, known as “lender risk sharing”. Currently, lenders transfer virtually all the risk of insured mortgages to mortgage insurers, and indirectly to taxpayers through the government guarantee.
What is Lender Risk Sharing?
The exposure of mortgage insurers and the government to the risks associated with insured mortgages is significant. In contrast, lenders’ loss exposure for insured mortgages is limited and does not vary in proportion to the risk characteristics of a specific insured loan (Figure 1). Lenders’ risk exposure to insured mortgages also differs from lenders’ risk exposure to uninsured mortgages, where lenders are fully responsible for managing risk.
Lender risk sharing would aim to rebalance the distribution of risk in the housing finance system by requiring lenders to bear a modest portion of loan losses on any insured mortgage that defaults (Figure 2). This would transfer some risk borne by mortgage insurers and taxpayers to lenders, ensuring that the incentives of all parties to an insured mortgage are aligned towards managing housing risks throughout the economic cycle.
At the same time, a lender risk sharing policy would maintain sufficient government backing to support financial stability in a severe stress scenario and borrower access to mortgage financing. This would protect key aspects of the current system that have supported economic and financial stability.
All parties with an interest in the housing sector are encouraged to share their views on these important issues. Comments to the Department of Finance Canada are invited by February 28, 2017. For further details, please see the consultation paper.
Federal statutes require federally regulated lenders to obtain mortgage default insurance (“mortgage insurance”) for homebuyers who make a down payment of less than 20 per cent of the property purchase price. Mortgage insurance is also available to other mortgage lenders, and for mortgages with down payments of at least 20 per cent of the property purchase price, to support access to low-cost mortgage funding and promote greater competition amongst lenders.
All mortgage insurance in Canada currently covers 100 per cent of eligible lender claims for insured mortgages that default. Mortgage insurance is provided by Canada Mortgage and Housing Corporation (CMHC), a federal Crown corporation, and two private mortgage insurers, Genworth Financial Mortgage Insurance Company Canada and Canada Guaranty Mortgage Insurance Company.
As a federal Crown corporation, CMHC is fully backed by the government. To support competition in mortgage insurance, the government guarantees private insurers’ obligations to lenders, subject to a 10 per cent lender guarantee deductible. The government guarantee of mortgage insurance is intended to protect against severe risks that could threaten financial stability.
As the total residential mortgage market has grown in Canada, so too has the portion that is insured with government-backing (Figure 3). Insured mortgages represent an estimated 56 per cent1 of total outstanding residential mortgage credit, and mortgage insurance is used by all types of lenders (see annex) to insure about 40 per cent of new mortgages today.2
1 Department of Finance Canada calculation, as of March 31, 2015, based on Public Accounts of Canada and Bank of Canada data.
2 Department of Finance Canada estimate of the insured share of the dollar value of mortgage originations in 2015.