Moody's Investors Service says that Canadian banks should be able to weather a housing crash without incurring catastrophic losses.

In a report released on June 20, Moody's points out that the amount of outstanding mortgage debt in Canada has more than doubled over the last decade, while the ratio of home prices to disposable income has increased by 25%. What would happen if we were to experience a crash similar to the ones the Americans suffered? Moody's has run a simulation to determine the effect a crisis would have on Canadian banks and mortgage creditor insurers.

Housing prices to drop by 25%

If overall housing prices were to drop by 25%, and if hot markets in Ontario and British Columbia experienced an additional 10% decline, the stress test found that Canadian lenders would be able absorb the resulting losses of nearly $18 billion. Moody's says that in this scenario the Royal Bank of Canada would suffer the largest absolute loss, while CIBC's capital would be most at risk due to its focus on retail lending.

Moody's argues that a Canadian housing crash would not be as severe as the one in the United States because the mortgage market is structured differently. In particular, the report notes that the government backs mortgage insurance in Canada, and there are also lower rates of subprime lending and fewer "originate-to-distribute" securitization practices.

Significant structural changes

"Canadian policymakers have made significant structural changes to the market, some informed by the US example, that would help contain the effects that a severe housing shock could have on the country's banks," comments Moody's assistant vice president Jason Mercer.