Canada’s banking regulator plans more active role among financial institutions

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Canada’s banking regulator is gearing up to take a more active role among the country’s largest financial institutions, signalling that it could continue to boost the amount of money lenders must hold as a buffer against economic risks.

Peter Routledge, who heads the Office of the Superintendent of Financial Institutions (OSFI), said at a Monday conference held by Royal Bank of Canada RY-T that the regulator will “adapt or change course more readily and more frequently than in the past.”

The message was delivered one month after the regulator adjusted the range of the capital level it could force the banks to maintain, sparking concerns over whether it would hike requirements just as some of Canada’s largest banks are working on closing large takeovers.

“It’s a message that we will change it in response to our risk environment,” Mr. Routledge said. “If vulnerabilities build further, such that we think we need to add to the buffer, we’ll do that.”

On the other hand, in the case of a worse-than-expected recession, OSFI would lower the domestic stability buffer (DSB) – a reserve of capital that banks could later release during tougher economic times – to give banks flexibility to weather an economic downturn, he added.

Mr. Routledge struck the assertive tone in his first public remarks since OSFI raised the DSB and ignored calls to relax the mortgage stress test in December, indicating that volatility and heightened economic risks could force the regulator to more frequently course correct how financial institutions prepare for potential downturns.

OSFI head says financial institutions can expect more oversight as Canada enters into period of increasing risk

Mr. Routledge, who took the helm of OSFI in June, 2021, pointed to a suite of unforeseen issues that have posed risks to the country’s largest lenders during his tenure, including market volatility wrought by Russia’s war in Ukraine, as well as the cryptocurrency asset bubble burst. With climate change and the digitization of financial services putting pressure on how banks do business, OSFI is working on ways that lenders can hedge against anticipated – and unforeseen – issues that could put stress on Canada’s financial system.

“How must OSFI adapt to a perilous risk environment, one in which the visible risks are quite daunting and the unseen risks over the horizon could yet swamp those visible risks?” Mr. Routledge said. “We would rather err on the side of acting too early than be criticized for acting too late.”

In December, OSFI raised the DSB and also expanded the potential maximum range of the buffer to 4 per cent from 2.5 per cent, giving the regulator the capacity to raise minimum capital levels even higher. That means that the common equity tier (CET1) ratio – a measure of a bank’s ability to absorb loans that turn sour – could rise as high as 12 per cent from the current 11 per cent, requiring the banks to hold onto billions of dollars in additional capital.

While the DSB provides banks with a buffer to manage risks, each increase to the buffer increases the capital burden on banks by restricting the amount of money that they can reinvest in their businesses or pay out to shareholders.

OSFI’s recent move prompted Bank of Montreal BMO-T to issue a share sale, raising $3.35-billion to boost its capital level as it works toward closing its deal to take over California-based Bank of the West. While all Big Six banks exceed the regulator’s capital requirements, that could change if OSFI raises the level further or if costly expenses such as acquisitions or lawsuits arise.

With Royal Bank of Canada in its initial stages of its takeover of HSBC Canada, RBC’s chief executive officer, Dave McKay, said that the lender’s capital level will rest at about 12 per cent once the deal closes – well above the current requirement, he told the conference Monday.

“Irrespective of what happens with the DSB range, we’re going to close – subject to approval – HSBC well above the current minimums,” Mr. McKay said. “It gives us enormous ability to absorb an acquisition and to grow and not need an equity raise.”

Toronto-Dominion Bank has the highest CET1 ratio at 16.2 per cent as it works on closing its acquisition of U.S. bank First Horizon Corp. Bank of Nova Scotia and Canadian Imperial Bank of Commerce carry the lowest capital levels of the group, prompting speculation from analysts that they may be next to take to public markets to raise equity.

Scotiabank president Scott Thomson, who takes on the role of CEO in February, said at the conference that the lender expects to build its capital level to 12 per cent from 11.5 per cent by the end of the year by slowing risk-weighted assets growth and generating capital internally, avoiding the need to issue shares.

Meanwhile, CIBC expects to take a billion-dollar charge in its fiscal first quarter earnings for a U.S. court decision that found the bank liable for losses incurred by a New York hedge fund. The bank is appealing the ruling.

The charge could push CIBC’s CET1 ratio down to 11.4 per cent, RBC analyst Darko Mihelic said in a note on Thursday. But CIBC CEO Victor Dodig said Monday that even if OSFI raises the buffer, the bank’s capital level will rise throughout the year and that it also has other resources that it can use if it needs to boost its capital level.

“We don’t foresee any equities raises based on everything that we know today,” Mr. Dodig said.