Regulator ups ‘stability buffer’ to protect banks against risks
OSFI says it’s a ‘prudent time ... to build resilience’ amid increased debt levels
Canada’s banking regulator is increasing the amount of capital that the Big Six lenders must carry to protect themselves against risks at home.
The Office of the Superintendent of Financial Institutions said Wednesday that, effective April 30 next year, it will hike its “Domestic Stability Buffer” to 1.75 per cent of a bank’s risk-weighted assets (such as mortgages) from the current level of 1.5 per cent.
“In light of positive credit performance and generally stable economic conditions, now is a prudent time for banks to build resilience against future risks to the Canadian financial system,” said Jamey Hubbs, the assistant superintendent of OSFI’s deposit-taking supervision sector, in a press release.
OSFI first revealed to the public in June that it required Canada’s six biggest banks (dubbed “domestic systemically important banks,” or D - SIBs) to have a capital buffer that was primarily related to domestic risks.
The domestic stability buffer can be set between zero and 2.5 per cent of a bank’s total riskweighted assets, the OSFI has said. Including a surcharge for D - SIBs, a “capital conservation” buffer and another baseline amount of capital, the Big Six will be required to have high-quality capital (such as retained earnings) to match at least 9.75 per cent of their total risk-weighted assets.
“While Canada is currently in the midst of a favourable credit environment with a stable domestic economy, household debt levels continue to be high relative to incomes and uncertainty persists in some housing markets,” OSFI’s press release noted.
“Corporate indebtedness is also growing, representing a potential future risk.”
OSFI has said that it is intending its “increased transparency” to educate people about the domestic stability buffer and, therefore, make it easier for the banks to use it during tough times.
A letter from the regulator to the Big Six, informing them of the buffer move, shed more light on the regulator’s thinking.
“This reflects OSFI’s assessment that, on balance, the identified systemic vulnerabilities remain elevated while economic conditions continue to be accommodative,” the letter said. “Specific vulnerabilities covered by the buffer continue to include: (i) Canadian consumer indebtedness; (ii) asset imbalances in the Canadian market; and (iii) Canadian institutional indebtedness.”
OSFI says it bases its decisions on adjusting the domestic buffer on its own judgment and in consultation with its regulatory partners. The decisions are made on a semi-annual basis, in June and December.
According to the regulator, it will require a remediation plan if a bank breaches the domestic stability buffer, but the lender would not automatically face restrictions on their capital distributions.
Judging by their latest financial results, the Big Six — Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada and TorontoDominion Bank — currently have more than enough capital on hand to keep up with OSFI’s increase.
The average common equity tier 1 capital ratio for the six banks as of their fourth-quarter financials, which were for the period ended Oct. 31, was 11.5 per cent, “a new high,” according to CIBC Capital Markets analyst Robert Sedran. The CET1 ratio also acts as a measure of a bank’s financial strength.