The Strategic Response of Banks to Macroprudential Policies: Evidence from Mortgage Stress Tests in Canada*

Abstract

Following the crisis, macroprudential regulations targeting mortgage-market vulnerabilities were widely adopted, their success often relying on the response of financial intermediaries. We provide evidence from Canada suggesting banks may have behaved strategically to limit the effectiveness of recently implemented mortgage stress tests. Before implementation, borrowers had to prove they could make mortgage payments based on the interest rate specified in the contract. The new tests require borrowers to show they can afford payments based on a typically higher qualifying rate, derived from the mode of 5-year rates posted by the six largest banks. The government’s objective was to cool credit markets, but, since many mortgages are government-insured, the big banks’ interests were not aligned. We find evidence of rate manipulation using a difference-in-differences approach comparing changes in spreads for 5-year mortgages with 3-year spreads, unaffected by the policy. The qualifying rates were lowered encouraging continued borrowing, muting the tests’ impact.

European Bank Margins at the Zero Lower Bound

“…To investigate potential compensation effects, we assume that banks price loans as a spread above the prevailing market rate (e.g. 5-year OIS rate), in line with Clark & Li (2022). 20 This lending margin, the difference between the lending rate and the long-term market rate, reflects, among other things, the riskiness of the loan, but banks might also use it to compensate for falling deposit margins.…”

CCAR Stress Testing Impacts on Home Equity Loan Originations and Purchases

“…In terms of home equity loans/credits, the authors confirm that higher capital shocks are linked to reduced overall mortgage credit quantities, primarily driven by a lower number of new loans originated while the average loan amount interest rates stayed higher. Similarly, [12] found that Canadian banks moved strategically to mute the effect of regulatory mortgage stress test by manipulating rates using a difference-in-differences method. This allowed for the comparison of the changes in spreads for 5-year mortgages with that of 3-year mortgages that were not affected by the policy.…”

Debt‐relief programs and money left on the table: Evidence from Canada's response to COVID‐19

“…This is not as surprising as it might seem: deferrers tend to have high loan‐to‐value (LTV) mortgages, meaning that they are insured by the government. Insured mortgages are required to meet an income stress‐test (Clark and Li 2021 ). A buffer therefore is already built into the mortgage.…”