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Addressing Canadian Consumer Debt: Do Regulators Really Want To?

A recent article in the Financial Post (FP), ?Surge in number of Canadians who can’t pay their debts has economists worried ? and scratching their heads? and related articles listed within (Shrinking disposable income pushes more Canadians into debt; More than a third of Canadians have no retirement savings, half live paycheque to paycheque, poll finds; With the Bank of Canada on hold, watch our $2.19 trillion household debt load grow) all point to the increasing concern about consumer debt for Canadians.

Then going back to an article in the Huffington Post (HP) in April of this: ?Household Debt Leaves Canadians ‘Maxed Out’ With No Plan for Repayment: Survey?, I started to wonder ? ?what is being done??

The article went on to say, ?This isn’t news for the Bank of Canada, whose governor, Stephen Poloz, has cited stressed consumers as a key reason the bank is holding off on rate hikes for the time being.

Between the summer of 2017 and the fall of 2018, the bank raised its key lending rate five times, to 1.75 per cent from 0.5 per cent. While that is still a very low lending rate by historical standards, it’s the highest Canada has seen since the financial crisis a decade ago.

These hikes, coupled with tougher new mortgage regulations, finally put a stopper in Canadian households’ debt binge ? almost. Household borrowing has fallen to its lowest level in more than three decades, but is still growing, and hit another record high at the end of 2018.

In my own research, I found that Canadians seeking relief from creditors rose 9.2 per cent in October 2018 over the previous year. The trend is consistent with rate hikes from the Bank of Canada in the past. A recent report by CAIRP ? the Canadian Association of Insolvency and Restructuring Professionals ? found rate increases and insolvencies go hand-in-glove; and this is clearly one of the reasons that the Bank of Canada is being cautious in its monetary policy and rate reviews.

The association?s report stated rate hikes from 1996-2000 saw an increase in insolvencies of 22 per cent from 1998-2003. Similarly, rate hikes in 2004-2009 were followed by a 54 per cent increase in insolvencies from 2006-2009.

The latest round of rate increases started in 2017 and already insolvency numbers are up 9.2 per cent. As reported in the FP ?Surge? article, ?some 11,935 consumers filed for insolvency in September, according to the Office of the Superintendent of Bankruptcy ? a 19 per cent increase from a year earlier and the biggest annual gain since 2009. So far in 2019, there have been 102,023 consumer insolvencies, the second-most for the first nine months of a year in records dating back to 1987?.

At the same time the Bank of Canada reports consumer debt growth is at a 35 year low. While the Bank may take comfort in these numbers, a question may persist. Is the deadening of consumer debt due to people spending less and paying off credit cards quicker? Or have Canadians hit the wall on how much debt they can carry?

The recent survey sited in the (Hp) article referred to would indicate the wall is imminent.

In the past few years the Office of the Superintendent of Financial Institutions (OSFI) strengthened rules around mortgage lending practices in Canada. The OSFI Pillar dated October 2018, the Federal financial institution (FI) regulator explained its purpose in strengthening its guidelines as necessary after identifying ?potential risks and vulnerabilities caused by high household indebtedness and imbalances in some real estate markets that left unchecked, could add greater risk to financial institutions and possible disruptions to the financial system?.

Some of the measures adopted included ?greater rigor in income verification? and stress testing for ability to repay at minimum qualifying rates. These and some of the rule tightening around valuation lending are and have been good adjustments for FI?s to make.

OSFI is also quick to point out in this release that through ?the consultation period prior to the B-20 revisions, OSFI was made aware of several concerns, including that the ?changes could lead borrowers to look outside the federally regulated system for loans.? Intimating this might somehow lead to a process of circumventing the good work of those strong and ethical banks that they regulate.

However, I would argue the changes OSFI made to address ?high household indebtedness? doesn?t go nearly far enough and these renewed focus articles would seem to support that position.

While gathering securely guarded information on consumer debt from banks, if you research hard enough you can start to piece together some interesting facts and the consolidation of that information has lead me to some conclusions that I believe are worth a more relevant study.

According to Bloomberg News, dated in April 2018, Canadian household credit totalled $2.3 trillion (2.19 quoted in the FP article) that included 28 per cent in credit cards, revolving credit (primarily consumer lines of credit – not Home Equity Lines of Credit or HELOCs) and auto loans. In September of 2015, it was reported by the Financial Post that the car loan business was at about $64 billion in Canadian consumer credit.

Putting these two statements together, one could assume that consumer debt attributed to credit cards, revolving credit and car loans is approximately $644 billion (28% of the $2.3 billion) with car loans attributing roughly 10 per cent of the total. That would leave credit cards and revolving credit at somewhere north of $500 billion.

However, the key point in this set of assumptions is that the total of $500 billion is referring to debt being ?utilized?, and the difference is significant. Most consumers have credit limits much higher than the actual balances being utilized.

In fact, according to 2016 Experian data, a global leader in consumer and business credit reporting, the average approved limit for Canadian revolving credit (mostly credit cards) is $8,071; and TransUnion, a major Canadian credit reporting company, estimated the average credit card balance in 2016 was $3904. If these ratios have continued (and I would pose they have), this translates to an approximate utilization rate of about 50 per cent.

If you?re following the assumptions and doing the math, this means that there is roughly $1.2 trillion in accessible revolving credit in Canada, with no stress testing requirements.

Now consider the following industry understandings; Canadian consumers can obtain credit cards very easily from even the largest of banks. You can go online and find that most banks will grant credit cards with little criteria. One advertisement I found on my first search offered a ?Platinum card? with these statements:

?Transfer your credit card balance and 0 per cent interest for up to 10 months! Only pay a 1 per cent balance transfer fee. Annual fee $0. Minimum annual income $15,000 household. Interest rate 19.99 per cent for purchases. 22.99 per cent for cash. Valuable insurance included with your card.?

Let me point out the obvious absurdity ? Minimum annual income of $15,000 can get you into a Platinum credit card. Makes one wonder aloud about its target market and interestingly I also wonder if this had not been a big bank advertisement, would there be more outrage or action to protect consumers?

The Federal government and their regulator, OSFI are often quick to point out non-Federally regulated FI?s as part of the problem in driving up Canadian?s rising debt issues because they are not accountable to OSFI and therefore can skirt some of those new mortgage rules.

I do not disagree with some of that criticism, however, if you think of the larger consumer debt problems in Canada, I think this is a more critical set of reasoning that deserves greater scrutiny.

I would posit that the mortgage market and its stress-testing solutions such as ?B20?, while healthy processes, are only addressing part of the problem and I would boldly suggest that it?s not even the major part of the problem. Levelling criticism on non-Federally regulated institutions as a problematic focus, simply takes a more appropriate focus away from dealing with Canadian?s real consumer debt problem.

That problem is consumer reliance on credit through car loans and credit cards. It is pretty clear that when consumers are debt-stressed, they first rely on easy credit in an attempt to stay ahead and/or convince themselves that they just need some temporary relief. This is how they get into the ?rob Peter to pay Paul? game that ultimately becomes their undoing.

Reliance on credit cards is one way to make that game work?. for a while. And when you consider that the majority of credit card exposure comes around (or just after) the time that they take out their mortgage, the ability to rely on this credit escalates. It leads consumers beyond that mortgage enabled new credit vehicle, at times, to other resorts such as payday loans and other accesses to keep up the shell game of staying ahead of the debt obligations they?ve grown into.

Often, even in the best intended case where they?ve saved and bought that first home or dream home the right way, they are faced with expenses not anticipated in the buying process (window coverings, furniture, landscaping, etc.) and even more likely is it that the FI believes that once you have their mortgage, consumer ?stickiness? is best secured by giving them a credit card as an added ?bonus? to the mortgage ? even if it maxes out that consumer in the future.

Remember, once a consumer has qualified for the mortgage, even with stricter underwriting rules, there are no such rules for subsequent credit ? even from the same FI. And let?s face it, this is very big business for FI?s, especially the major banks that hold the majority of the credit card debt.

On the Bankruptcy Canada website, they list the most common reasons for bankruptcy in Canada:

The Top 10 Causes of Bankruptcy in Canada are:

1. Causes of Bankruptcy ? Overextension of Credit

Overextension of credit and over-spending is the leading cause of bankruptcy in Canada. Having access to too much credit, easy ways to shop online, and poor financial habits due to poor financial literacy skills can easily lead to too much debt.

It is very easy to acquire consumer credit, as seen in the advertisement example. There are no stress-testing requirements for approval, and where there are, they are loose and easily worked around. If an individual FI does show responsibility in insisting on stress-testing criteria, there are rarely requirements to re-evaluate that stress testing on an annual basis. Add to this relatively easy credit, that there are no or relatively low stress-testing requirements for car loan applications (mostly done through a broker model, which can pose its own manipulation concerns); nor in the payday lending environment.

So if credit card debt and other easily accessed consumer credit holds so much potential damage for consumers, is of significant volume of debt (providing the earlier assumptions are even close to accurate), and is certainly a primary reason for most consumer debt failures; why hasn?t OSFI addressed the need to stress test for that credit with the same rigour that they have for mortgages?

The total market dollars (in excess of $1 billion) are certainly not immaterial, especially when considering the rates charged. The consumer trending toward easy credit is indisputable. The administration for such testing isn?t onerous; once made part of the regulatory expectation for FI?s, it has to be followed like any other rules. And it is an undisputable fact that consumers will pay their mortgage or rent before they pay their credit card, leaving the unsecured debts much more exposed.

So why ignore the bigger consumer debt problem and focus solely on the mortgage market and then push off the question on non-Federally regulated FI?s for their likely failings? There is no clear answer to that question but if I were being gracious, I would say it perhaps is just one of those common situations where you sometimes miss the forest for the trees. The housing market has been a major concern and deals with major funds (as an individual debt vehicle) but it should be clear that without the added pressure of ancillary consumer debt, weathering future storms would be much more effective.

Cynically one might suggest that issue is one that will bring major bank lobby pressures and while no politician or bureaucrat will ever admit to that pressure as a significant consideration, we are trying to think of things practically here.

The big six make hundreds of millions of dollars in profit from their credit card books; and even if the write-offs are significant, when you factor the rates, the fees and the magnitude of the use and possible escalating use, this is a significant part of the big bank?s profits. Imagine having to curtail that source of income, based on a regulatory insistence to be guardians of consumer good, and take responsibility in better ensuring customers do not access more debt than they should. Would they do this or support this? Highly doubtful – it?s a profit reduction proposition.

As a side note, up until my retirement as President& CEO of the FirstOntario Credit Union, my organization stress tested all consumer revolving credit for our members ? at the upper credit limit that they were assigned – to ensure that should they need to ?flip? that revolving vehicle into a term loan, their debt servicing is within their grasp even should they be at their top approved limit. If they did not qualify for this credit in this way, they did not get it, regardless of the money we might make with approval. And of course, we were one of those Financial Institutions that are ?outside the federally regulated system for loans.?

I imagine some would argue that a more onerous regulation only slows the ability to create capital flow for business growth and offer valuable short term consumer services; and that consumers spending money is how the economy moves forward. Hindering credit access would therefore slow the economy.

Really? Given the concerns about consumer debt and its possible impacts to the economy?s future, that case should ring hollow to any objective review. The continued practices that seem quite irresponsible on the FI?s part, suggest any such economic progress made is creating a falseness to those advances; they seem to be built on a shaky house of cards.

It is likely time to insist that consumer financial health in Canada needs real address to ensure the future of our economy. Accessing debt is a valuable economic tool but accessing debt that over-leverages you is not. The regulators in Canada can ensure a strong role in this process, if they choose to.

OSFI, CMHC and the Federal Government can point to the Canadian housing market as the main contributor of the currently unacceptable Canadian Household debt as the main culprit but that is not, in my opinion, accurate. The credit card, revolving credit and auto loan environment are much more the catalyst(s) for actual consumer debt struggles and they need to be given appropriate focus. Failing to do so or to even acknowledge the Federal environment?s watchdog?s role in this reality, is a conscious ignorance to fact. Either you want to address household debt or you do not.