Banking regulator to shift focus to technology, climate risks

Canada’s banking regulator is ready to “draw a line in the sand” on a decade of drawn-out reforms to make the global banking sector more resilient and devote more energy to emerging risks from climate change and technology, says the head of its regulation arm.

As the Office of the Superintendent of Financial Institutions, or OSFI, prepares to help guide banks through a recovery from the coronavirus pandemic after a year of jarring uncertainty, it is still juggling the last of a sweeping package of changes to rules governing banks’ capital, leverage and liquidity spurred by the financial crisis of 2008-09.

Those regulations, collectively known as the Basel III reforms, set minimum international standards that compel banks to hold more capital to absorb losses, maintain greater liquidity to meet their obligations to depositors and other financial institutions, and to measure the riskiness of assets in a more consistent way. The reforms are widely credited with making the global financial system more stable, but they have been hugely time-consuming and have made complying with regulations more complicated for banks.

“We do need to be able to move forward,” said Ben Gully, assistant superintendent in charge of OSFI’s regulation sector, in an interview after giving a speech to the Toronto-based Global Risk Institute on Tuesday. “Not that financial reform isn’t critical, it is. It’s table stakes. But we’ve done enough of that and I think what’s key for us right now is to say, ‘Well, actually we have to think about the pandemic, we have to think about these other families of risks.’”

New threats that increasingly keep banking regulators up at night present a fresh set of challenges because they fall outside the traditional boundaries of financial risk management. They include global threats such as climate change, fast-moving innovations in technology and cybersecurity and the emergence of new asset classes such as crypto assets – an uncharted and largely unregulated area for financial institutions that is “growing in importance,” Mr. Gully said.

OSFI launched consultations on technology risk and digital resilience last September and on climate-related risks in January. The regulator has also teamed up with the Bank of Canada, banks and insurance companies on a pilot project to build climate change scenarios that could help assess potential effects for financial institutions.

Those discussions are still in their early stages, but likely to grow in importance over the coming year because non-financial risks, if left unchecked, “have the potential to disrupt reputation and, in turn, potentially pose a material financial risk to [financial] institutions,” Mr. Gully said in his speech on Tuesday.

The pandemic has also put a spotlight on how vital it is that banks are not only financially sound, but also have resilient operations in a crisis. One major test came last March when banks had to set up tens of thousands of employees for remote work in the span of a few weeks without disrupting their core businesses. But another lesson has been that “people resilience” matters just as much, Mr. Gully said.

“I think what we’re realizing through the pandemic is this is a marathon, and the sort of wear and tear on our people and the implications for organizational performance is something we are also looking at very closely,” he said.

Turning the page on more than a decade of financial reform will not be simple. The final parts of Basel III are designed to fine-tune the way banks model risks, making those calculations and the implications for capital levels more consistent. With feedback from banks, OSFI is adjusting those standards to fit Canada’s needs, but the last changes won’t be fully in force until 2023 and 2024.

“If we spend so much time fine-tuning and finessing, we’ll never get to put a line in the sand,” Mr. Gully said.

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