Capital buffer for big banks raised to 3% as household debt risks rise
The Office of the Superintendent of Financial Institutions raised the capital buffer financial institutions must hold to three per cent, citing increased risked from high household indebtedness and the rapid rise in interest rates.
The financial watchdog also increased the capital buffer's range, or the policy tool to keep the country's financial stability in check, to between zero and four per cent starting February 2023, rising from the previous range of zero to 2.5 per cent.
“This new level reflects our observations and high levels of systemic vulnerabilities have persisted and, in some cases, increased in recent quarters,” said OSFI assistant superintendent Angie Radiskovic during a Thursday press conference. “Canadian household debt levels relative to income are approaching record highs, exacerbated by sharply rising debt servicing costs as interest rates have increased. While house prices have begun to decline, they remain elevated after factoring in higher mortgage rates.”
Radiskovic added that highly indebted corporations are more vulnerable to economic shocks in a rising rate environment and sovereign debt levels are elevated worldwide compared to pre-pandemic levels.
“Finally, geopolitical uncertainty remains high, increasing the chance of a global slowdown that spills over into Canada,” Radiskovic said.
Also factored into OSFI'S decision is stress testing various scenarios and taking into account the high-profile acquisitions some of Canada's Big Six banks have made this year. Radiskovic said banks are required to address all operations and cover all of the risks they're exposed to, which would include forward-looking statements and contingency plans in their capital planning strategy.
Since the buffer was created in 2018, it has been OSFI'S tool to provide a capital reserve range that applies to Canada's largest banks. During economic boom times, the reserve is built upon. When the economy hits a period that strains financial institutions, it can be drawn upon to provide support. The buffer comes on top of normal capital ratio requirements that force the banks to keep capital in reserve.
The buffer is baked into the common equity tier 1 ratio (or the CET 1 ratio) that compares a bank's capital against its risk-weighted assets to measure its resilience in a market downturn.