Canada's banks are particularly exposed to risks stemming from overheated housing markets, says a new report from Moody's Investors Service.
Banks in Canada, Sweden and Australia "are increasingly sensitive to adverse economic developments that could result if house prices were to slump," the report warns.
According to the report, housing prices have surged in each country between 2000 and 2016. Over that period, house prices rose by 115% in Canada, 144% in Sweden, and by 113% in Australia. At the same time, household indebtedness has risen sharply in each country, it says; mortgages now account for 63% of the total loan books in Australia, 48% in Sweden, and 39% in Canada.
"Banks in these countries are exposed to second order effects. Namely, a material economic slowdown that would likely accompany a substantial house price correction would lead to higher losses on consumer loans, commercial real estate loans, and loans to consumer-exposed corporates," says Louise Lundberg, vice president and senior credit officer at Moody's, in a statement.
Moody's base case is that house prices will continue to climb in Canada and Australia, although at a slower pace, over the next 12 to 18 months. In Sweden, preliminary data suggests that the housing market may be already turning, the report says.
Notwithstanding the elevated risks, the structure of the countries' mortgage markets and banks' underwriting practices would limit mortgage losses, according to the report. In most scenarios, banks in all three countries would be able to absorb any loan losses through their earnings, the report says.
"Any impact on their capital levels, which we currently assess as strong to adequate, would likely be limited," it says, noting that loan losses could increase to 2.2% of gross loans in Canada from 0.4% in 2016 before they start eating into capital.