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Bank headquarters buildings in downtown Toronto. Though it’s hard to calculate Canadian banks’ specific ratio under the Basel model, analysts agreed it misses the mark.Kevin Van Paassen/The Globe and Mail

Long admired for their soundness and stability, Canada's banks are at risk of falling behind their global peers that are racing to better their standards.

After surviving the dark days of the global financial crisis without a single bailout, Canadian banks earned bonus points for beefing up their capital reserves during the recovery. While other country's banks kicked and screamed, the Big Six diligently raised the money they needed and stored it away, giving them added capacity to absorb losses in the event of a future crisis. But now the conversation is evolving, and there are questions as to whether Canada's banks are too tied to the past.

For the past few years, the Basel Committee on Banking Supervision, the global banking regulator, has focused on what is known as the Tier 1 capital ratio, which dictates banks must assign risk weightings to different assets, and hold more cash against the riskiest ones. Canada's banks led the way on this front.

Now a simpler formula, known as the leverage ratio, is getting loads of attention from regulators. Instead of weighting assets by their risk levels, this ratio treats all assets the same – triple-A-rated government debt is deemed just as risky as a subprime mortgage – and requires banks to hold a cash cushion against this overall figure.

Although the Basel Committee will require all banks to meet a leverage ratio of 3 per cent by 2018, meaning they must have cash reserves of at least 3 per cent of their total assets, other countries are starting to propose going above and beyond.

On Tuesday, the U.S. Federal Deposit Insurance Corp. put forward a proposal to force the country's biggest banks to meet a leverage ratio of 6 per cent – twice the global minimum.

In its proposal, the U.S. regulator noted that roughly half of the U.S. banks met Basel's new minimum 3-per-cent leverage ratio in 2006, and the other half were "quite close" to the minimum, yet many still failed. "This suggests that the minimum requirement would not have placed a significant constraint on the precrisis buildup of leverage at the largest institutions," the report said.

In Canada, leverage ratios are rarely discussed. "There's a very good reason for that," said CIBC World Markets analyst Rob Sedran. "We just don't look as good on leverage as we do on capital ratios."

The Office of the Superintendent of Financial Institutions, Canada's banking watchdog, has for years required the banks to meet an assets-to-capital multiple of 20 to 1, meaning assets cannot be more than 20 times their capital reserves. By flipping the equation, that equates to a leverage ratio of 5 per cent, which sounds close to what the U.S. regulator is proposing.

Yet the way OSFI calculates this figure differs from the coming global requirements, in large part because the Basel proposal includes what are known as off-balance-sheet items such as derivatives, those securities that caused so much grief during the financial crisis. Though it is hard to calculate each Canadian bank's specific ratio under the Basel model because off-balance-sheet items are tough to track, several analysts agreed that Canada is nowhere near the 5-per-cent implied figure.

Still, there are questions as to whether the leverage ratio is the best yardstick to judge banks' soundness across borders. In Canada, for instance, residential mortgages are often the biggest assets on a bank's balance sheet, yet many are insured by Canada Mortgage and Housing Corp. – meaning they are effectively backstopped by the federal government.

Under the current Tier 1 capital ratios, these insured assets aren't deemed to be risky, but under the leverage ratio they could require substantial cash cushions.

Mr. Sedran at CIBC said that, for this reason, the leverage ratio isn't the best way to compare across jurisdictions. "The beauty of the leverage ratio is that it's simpler," he added, but "to me it's more a complement to the capital ratio."

OSFI itself also seems to be weighing these country-by-country differences. A spokesman said in an e-mail that the regulator "has been pursuing a reasonable and considered approach to implementing international reforms within the Canadian context."

But even if leverage ratios get more credit, Macquarie Securities analyst Sumit Malhotra said he isn't worried about the Canadian banks, noting that OSFI recently gave them the green light to pay dividends and buy back shares. "I don't think capital is a concern for this sector."

(Tim Kiladze is a Globe and Mail banking reporter.)

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 28/03/24 4:00pm EDT.

SymbolName% changeLast
CM-N
Canadian Imperial Bank of Commerce
+1.3%50.72
CM-T
Canadian Imperial Bank of Commerce
+1.13%68.67
FISI-Q
Financial Institut
+0.97%18.82

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