Banks in AAA Jurisdictions Face Rising Household Debt Risk


Tuesday, April 16, 2019  04:53 PM / Fitch Ratings


Banks in several 'AAA' rated countries face rising risk from the household sector amid a build-up of financial imbalances, Fitch Ratings says in a new report. In Australia, Canada, Norway and Sweden, high household debt amid slowing housing markets represent a growing risk to banks in those countries, which are among the world's most exposed to residential mortgage lending. The major banks also have, to varying degrees, a reliance on wholesale funding, which can increase their vulnerabilities during a market stress. 

Fitch expects modest home-price falls to continue in these countries' major cities over the next two years due to tighter credit standards and regulations, declining consumer confidence and the possibility of higher interest rates. As benign macroeconomic conditions recede, banks may face higher credit losses, particularly if unemployment increases. However, we expect major banks to maintain their risk discipline. This should support asset quality through the cycle. 

Proactive policy-setting in the form of targeted macro-prudential policies and increasing supervisory scrutiny have reduced vulnerabilities and mitigate rising macro risks. Increased capital requirements have improved major banks' resilience to macroeconomic risks. Supervisory stress tests for Australia, Norway and Sweden, and a Fitch stress test for Canada, demonstrate banks' resilience to plausible but harsh scenarios.


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The supervisory stress tests for Australia, Norway and Sweden were all based on pronounced economic downturns, with significant increases in unemployment and steep falls in house prices. Each banking sector's common equity Tier 1 (CET1) ratio fell by about 3pp. A Fitch stress test on major Canadian banks' uninsured residential mortgage portfolios had a similar impact. The test assumed peak loss rates of between 11%-12%, similar to those in the Irish real estate crisis, but much higher than the annual net charge-off rates of 2%-3% in the US during 2008-2011. 

We would not expect widespread multi-notch bank downgrades given this resilience. Average capital ratios did not fall significantly below regulatory minimums under the stress tests, despite their severity. However, resilience varies between banks, and their ratings could be affected differently. 

Low interest rates since the financial crisis have encouraged high debt accumulation throughout developed economies. Slower economic growth through a tightening of domestic consumption, and substantial house price falls, are the most likely source of losses for banks.


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Borrower sensitivity to a sharp rise in interest rates is relatively high in Australia, Norway and Sweden because mortgages are mostly floating-rate. However, the risk is mitigated by debt-servicing requirements that incorporate headroom allowing for significantly higher interest rates. Canadian borrowers are less exposed to rate rises because Canadian mortgages are mostly fixed-rate, although they involve regular refinancing risk as the typical term is only five years. 

A key distinguishing feature of the mortgage markets in all four countries is that mortgages have dual recourse to the financed property and the borrower. This greatly reduces borrower incentives to walk away from obligations as many defaulting borrowers did during the US subprime mortgage crisis.

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