Canada’s banking regulator could free up cash for the country’s large banks to lend out by reducing requirements for capital reserves as the falling price of oil and worsening business climate increase the risk of a credit crunch, analysts say.
Governments and central banks around the world are looking to stimulate demand for credit by cutting interest rates, and to shore up banks’ lending capacity through an injection of cash into the financial system. The Bank of Canada, the U.S. Federal Reserve and European Central Bank all announced liquidity programs on Thursday, with the Fed promising $1.5-trillion worth "to address highly unusual disruptions in Treasury financing markets.”
The Bank of Canada said on Thursday afternoon that it would “support the continuous functioning of financial markets through the provision of liquidity,” by expanding its bond buyback program and introducing new “repo operations,” in which it buys securities from Canada’s large banks on a short-term basis to increase cash in the financial system.
Bank of Nova Scotia analyst Sumit Malhotra suggested on Thursday that Canadian bank regulators could also help bolster credit supply by trimming capital requirements known as the “domestic stability buffer."
The Office of the Superintendent of Financial Institutions requires large Canadian banks to hold additional capital “to cover a range of systemic vulnerabilities." Introduced in 2018, the idea is to encourage banks to build up reserves during periods of economic strength that can be reduced in a downturn to encourage the banks to keep lending.
The current buffer is 2.25 per cent of a bank’s risk-weighted assets, which is on top of other regulatory capital requirements.
“With both earnings power and capital for the banking sector being threatened by the combination of direct (interest rates, oil prices, market conditions) and uncertain (aggregate economic fallout from COVID-19) factors, a measure of relief on the [domestic stability buffer] would clearly provide the industry with some capital ‘breathing room,’” Mr. Malhotra wrote in a note to clients.
Britain’s Financial Policy Committee took this step on Wednesday, cutting its buffer from 1 per cent to zero, as part of suite of fiscal and monetary policy measures aimed at shoring up the country’s economy.
“The release of the countercyclical capital buffer will support up to £190-billion [about $332-million] of bank lending to businesses. That is equivalent to 13 times banks’ net lending to businesses in 2019,” the Bank of England said in a news release.
OSFI did not respond to questions about whether it was considering reducing the security buffer or taking other measures to free up capital. Royal Bank of Canada, Bank of Nova Scotia, National Bank and the Canadian Imperial Bank of Commerce declined to comment on whether they are seeking changes. Bank of Montreal and Toronto Dominion Bank did not respond to requests for comment.
The Canadian Bankers Association also declined to comment.
Mr. Malhotra said he expects banks to record “a sharp uptick" in provisions for credit losses in the coming quarters as businesses in hard-hit sectors such as energy and travel struggle with loan payments. That could affect their willingness and ability to keep lending to troubled sectors.
“I could see OSFI potentially looking to lower [the stability buffer], and having discussions with the banks to say they need to keep the lending taps open," said Rob Colangelo, senior vice-president of the global financial institution group at ratings agency DBRS Morningstar.
"But that’s the supply side; the demand side needs to be there as well. ... We’ve seen oil companies say they’re slashing their capital spending budgets, so I think a lot of businesses might take that wait-and-see approach [to borrowing],” Mr. Colangelo said.
OSFI usually meets twice a year to assess the stability buffer, with the next meeting planned in June. It can cut the buffer at other times, but Mr. Colangelo expects it to wait until June.
Bank of America Merrill Lynch analyst Ebrahim Poonawala was skeptical that short-term moves by OSFI would affect the broader Canadian economy.
“This is not really a liquidity crisis for the banks, or the banks having a capital adequacy shortage, even in the U.S.,” Mr. Poonawala said, adding that changing the buffer would mainly be symbolic.
Editor’s note: An earlier version of this article incorrectly named the domestic stability buffer.
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Mark Rendell