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Bank of Canada warns against record high debt as interest rates stay ultra-low

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The Bank of Canada is stepping up its warning to Canadians about the dangers of record household debt amid expectations that interest rates could stay very low for some time.

The central bank is continuing to keep a close eye on record household borrowing – much of it concentrated in the hands of a relatively small group of younger heavily indebted borrowers in Ontario, B.C. and Alberta, deputy governor Lawrence Schembri said Wednesday.

“The bank is concerned about high household debt and will continue to monitor it closely,” Mr. Schembri said in notes prepared for a speech to the Guelph Chamber of Commerce.

But the bank made it clear it has no plans to use higher rates as a means to quell Canadians’ appetite for debt. Raising rates, he said, is “a very blunt instrument” that could derail the economy.

“We believe that there are other instruments measures, including public policies and private remedial actions, better suited to targeting and reducing these vulnerabilities than monetary policy, which affects the entire economy,” he said.

In particular, Mr. Schembri said the bank has been warning borrowers and lenders to “exercise appropriate caution.”

“In particular, borrowers and lenders should take into account the impact of higher borrowing rates in the future on the cost of servicing mortgages and other loans,” he explained.

The central bank has cut its key overnight lending right twice since the start of 2015 to deal with the fallout from the commodities price collapse. The rate now stands at 0.5 per cent, and some economists believe the bank could cut again this year if the economy does not pick up.

The central bank says biggest threat to Canada’s financial system would be a severe recession, which leads to a spike in unemployment and causes many homeowners to default on their mortgages. If that happens, Mr. Schembri said, the share of borrowers behind on loan payments would more than quadruple to 1.8 per cent from 0.4 per cent now.

Mr. Schembri also pointed out that excessive borrowing has become increasingly concentrated in a clutch of households with extremely high debt-to-income ratios. As the Bank of Canada pointed out in its most recent Financial System Review, there are roughly 720,000 Canadian households with debts equal to more than three-and-a-half times what they earn every year. They hold about a fifth of all household debt, or $400-billion.

The share of these highly indebted households has jumped to 8 per cent from 4 per cent before the financial crisis.

The bank said these borrowers are at the greatest risk of defaulting on their loans because they tend to be younger, earn less money and live in the provinces where house prices have climbed the most in recent years: Ontario, B.C. and Alberta.

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