OSFI forcing banks to maintain capital buffer for contingency

Canada’s banking regulator is pulling back the curtain somewhat on capital the country’s largest lenders must have on hand in case of a rainy day — which is also apparently more than had previously been made public.

“Not only will this give more insight into the overall amount of capital being set aside by the banks, it will contribute to broader financial stability by providing information on the key domestic risks to which Canada’s largest banks are exposed,” said a newsletter published Wednesday by the Office of the Superintendent of Financial Institutions.

The six largest banks in Canada — dubbed domestic systemically important banks (or D-SIBs) — have to hold a certain level of highquality capital, known as Common Equity Tier 1 (CET 1), such as retained earnings. OSFI had publicly expressed the CET 1 level for a domestic systemically important bank in Canada as 8 per cent of a lender’s risk-weighted assets, which include, for example, mortgages.

On Wednesday, however, OSFI said it also requires banks to set aside capital worth another 1.5 per cent of assets for an adjustable “domestic stability buffer,” the first time that number had been disclosed. The buffer, similar to additional layers of capital that have been put in place by regulators abroad, would push the regulator’s capital requirement for the banks to 9.5 per cent, and would chiefly be used to guard against “domestic risks.”

A spokesperson for the regulator said the banks had always been required to hold extra capital, but that those expectations “have been communicated privately to banks.”

“Amounts held in the domestic stability buffer are increased when OSFI is of the view that it would be prudent for the banks to hold additional capital to protect against growing risks,” said the OSFI newsletter. “The buffer amount can also be decreased when OSFI is of the view that D-SIBs’ exposures to the vulnerabilities have diminished.”

OSFI did not say what changes might have been made in the past to the domestic buffer — with a spokesperson saying it constituted “supervisory information,” on which the regulator was legally prohibited from providing details — but also said that it would start reporting the capital requirements for the domestic stability buffer and the related risks every June and December on its website.

“Examples of risks that the domestic stability buffer is intended to protect against could include Canadian consumer and institutional indebtedness, or any other risks that could have a system-wide impact,” the newsletter said.

While the announcement comes as Canadians have racked up a relatively high amount of debt, OSFI’s move looks unlikely to have any immediate effect on Canadian banks. For instance, Royal Bank of Canada, the country’s largest lender, reported nearly $490 billion in risk-weighted assets as of April 30, and about $53.3 billion in CET 1, or 10.9 per cent of the assets (also known as the CET 1 ratio).

Gabriel Dechaine, analyst at National Bank Financial, noted that the Big Six lenders reported an average CET 1 ratio of 11.3 per cent for the second quarter.

“While OSFI’s announcement is important, it does not introduce any material concerns at this time,” he wrote.

In announcing the decision, OSFI noted that the global financial crisis caused confidence in some banks to tumble, despite the lenders reporting solid capital.

“This made clear the importance of banks not only holding adequate capital against their risks, but also providing information to the market on what risks capital buffers are protecting against,” the newsletter said.