Bank towers are seen from Bay Street in Toronto's financial district in this file photo.Adrien Veczan/The Canadian Press
Canada’s banking regulator maintained the capital cushion that the biggest banks must hold, bucking analyst and investor expectations after it hiked the buffer twice in the past year, forcing lenders to hold onto billions in excess cash.
The Office of the Superintendent of Financial Institutions (OSFI) said Friday that it will not change the domestic stability buffer (DSB) – a capital reserve that banks build to soften the blow of an economic downturn – holding it at 3.5 per cent of a bank’s risk-weighted assets. Since last December, the banking watchdog has boosted the requirements twice, raising it from 2.5 per cent.
By abstaining from another hike, OSFI is signalling that it believes the country’s largest banks have enough cash to weather an economic downturn.
Superintendent Peter Routledge said the regulator considered three main factors when choosing not to increase the buffer. He said that risks to the financial system remain elevated but have not worsened, the current buffer provides adequate “insurance” against possible economic deterioration, and the six largest lenders have all proactively boosted their excess capital to levels well beyond OSFI’s minimum requirement.
“Since the June, 2023, DSB announcement, household debt levels and interest rates have remained elevated,” Mr. Routledge told reporters during a conference call Friday morning. “At the same time, there are some positive signs including an improvement in the household debt to income ratio and in the falling rate of inflation.”
OSFI last announced an increase to the buffer in June, raising it to 3.5 per cent. It previously raised the requirement to 3 per cent last December, while also increasing the potential range of the buffer in December to between zero and 4 per cent of a bank’s risk-weighted assets, up from a prior maximum of 2.5 per cent. The boost to the range signalled that OSFI could ask the banks to hold onto more cash, which also takes a chunk out of profits.
The regulator can change the DSB any time, but it announces a decision to change or hold the level twice each year. The buffer applies to financial institutions that are considered systemically important, including Royal Bank of Canada RY-T, Toronto-Dominion Bank TD-T, Bank of Nova Scotia BNS-T, Bank of Montreal BMO-T, Canadian Imperial Bank of Commerce CM-T and National Bank of Canada. NA_T
An adjustment to the DSB also prompts a change to the minimum capital levels that a bank is expected to hold. The common equity tier 1 (CET1) ratio – a measure of a lender’s ability to absorb losses – will remain at 11.5 per cent.
All six banks currently exceed the minimum threshold by a wide margin, which OSFI factored into its decision. RBC holds the most excess capital, with 14.5 per cent, and CIBC has reserved the least, with 12.4 per cent.
“The reason behind the decision appears to be more bullish than expected,” Scotiabank analyst Meny Grauman said in a note to clients. “This is because it appears that OSFI did not base today’s decision on deteriorating economic data but rather on good bank behaviour.”
When the economy is strong and loan losses are lower, banks are expected to build capital reserves. If the economy weakens, the regulator can lower the requirement to allow banks to release capital to help them absorb losses.
Industry pressure to avoid another hike has mounted amid concerns that the economy is deteriorating. The DSB Council, a group of former bank and regulatory executives created by the C.D. Howe Institute, said in a report last month that OSFI should avoid another increase as economic turmoil is already putting greater pressure on banks facing squeezed profits.
Mr. Routledge said that OSFI considers similar data to that cited in such reports.
“Steel sharpens steel and we appreciate the constructive challenge and the proactive interjection and points of view,” Mr. Routledge said. “We pay attention to everything and everyone and we try to come to the best decision independently on what the right level of the systemic buffer should be in our banking system.”
The largest lenders reported fourth-quarter earnings in late November, signalling expectations for a weak economy as they set aside more money for provisions for sour loans and cut jobs to rein in mounting expenses.
In the first quarter of 2024, new capital requirements expected to take effect that are tied to reform measures known as Basel III Endgame – a global overhaul launched more than a decade ago after the financial crisis. This pressure is building as RBC plans to close its $13.5-billion acquisition of British-based HSBC Holdings PLC’s Canadian subsidiary, and TD awaits a monetary penalty from U.S. regulatory and legal authorities related to issues with its anti-money laundering procedures.
However, the changes are expected to have more muted ripple effects compared with those in the U.S., where regulators are also eyeing higher capital requirements for banks.
The updated rules would force big banks to bolster their capital levels by almost 20 per cent. The Federal Reserve and other regulators say that it could help lenders survive another crisis and help mitigate issues such as the failure of regional banks earlier this year.
During a Senate meeting on Wednesday, the CEOs of major U.S. banks – including JPMorgan, Bank of America, Citigroup and Goldman Sachs – argued that the stricter requirements would harm the economy and increase the cost of borrowing.
Stefanie Marotta