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Canada’s banking regulator is rolling back two emergency initiatives introduced early in the pandemic, including a crucial measure that made it easier for banks to allow clients to defer loan payments.

The initiatives were part of a payment holiday of up to six months orchestrated by banks, regulators and the federal government in March to prevent a sudden spike in defaults that would have squeezed borrowers and lenders alike.

Now, that deferral program is winding down. The Office of the Superintendent of Financial Institutions (OSFI) announced on Monday it has begun removing a temporary change to its regulations that let banks and insurance companies treat deferred loans as if the payments were still being made for the purpose of calculating how much capital they have to set aside to cover potential losses.

This rule change gave financial institutions the flexibility to offer payment deferrals on mortgages, credit cards, premiums and business loans to hundreds of thousands of clients who have been financially affected by the pandemic.

As of July 30, outstanding residential mortgage deferrals in Canada totalled about $170-billion. More than 760,000 Canadians – holding about 16 per cent of the number of mortgages in bank portfolios – had deferred or skipped a mortgage payment by June 30, according to the Canadian Bankers Association.

Banks are required to maintain more capital against loans that are non-performing – meaning payments are overdue – to protect against potential losses. Because banks were temporarily allowed to treat deferred loans as performing loans for the sake of calculating their capital adequacy, they could be more generous with deferrals. With the rules returning to normal, banks will be more sparing in letting clients delay payments.

“While the special capital treatment and regulatory flexibility related to payment deferrals was warranted at the onset of COVID-19, as both lenders and borrowers adapted to the extraordinary circumstances and unprecedented disruptions related to the pandemic, banks are now in a better position to employ their business-as-usual alternatives to support troubled borrowers,” OSFI said in a statement.

The return to normal will be staggered. If a bank granted a payment deferral before Aug. 31, the loan will be treated as performing for the duration of the deferral up to six months. If a bank offers a new payment deferral before the end of September, the loan will be treated as performing for the duration of the deferral up to three months. As of October, new payment deferrals will be accounted for using OSFI’s normal rules.

“Mortgage and loan deferral were an extremely important part of the relief effort; with [the Canadian Emergency Response Benefit], they were unquestionably the most critical two programs,” said Ron Butler, founder and broker at Butler Mortgage Inc.

“But now that the country is out of full lockdown, it is important to find out who has a profound problem in being able to pay their mortgages and those who simply chose not to pay,” he said.

The announcement from OSFI comes a week after Canada’s large banks reported third-quarter financial results. Quarterly profits rebounded faster than many analysts had anticipated, but the Big Six banks again set aside billions of dollars to absorb future losses on loans.

The key question for bankers is what will happen as the remaining loan deferrals expire. Most struck a cautiously optimistic note last week. At Bank of Nova Scotia and Bank of Montreal, at least 90 per cent of clients whose deferrals expired are making normal payments again. BMO’s chief risk officer, Pat Cronin, estimates that only 1 per cent to 5 per cent of deferred loans may become delinquent as grace periods expire.

Among loan deferrals already ended at Royal Bank of Canada, normal payments resumed on 80 per cent, deferrals were extended on 19 per cent and 1 per cent are delinquent.

OSFI also announced that it is phasing out special treatment for loan and premium payment deferrals by insurance companies. While the impact is not has large as in the banking industry, Canadian insurance companies offered rebates on just more than $1-billion in personal and commercial insurance premiums, according to a recent survey by the Insurance Bureau of Canada.

Last April, after regulators gave the green light for insurers to provide rebates for up to 12 months – several major property and casualty insurers began to offer payment deferrals and monthly premium rebates as it became clear there was a reduction in risk – specifically for auto insurers with fewer cars on the road.

Between March 1 and June 30, Canada’s insurers deferred nearly $200-million in premiums for personal and commercial customers, IBC says.

“We anticipate that these figures will increase significantly over the upcoming months, as insurers continue to support Canadians through this challenging period,” IBC spokesperson Steve Kee said.

Alongside the change to the capital treatment rules, OSFI also walked back restrictions that it had placed on private pension plans in March. In a move to ensure pension plans remained solvent amid the market turmoil earlier this year, OSFI froze portability transfers. That meant participants could not move money out of a defined-benefit plan into another plan or use the money to buy annuities.

“We have observed that while market volatility remains elevated, the recovery of the market lows of mid-March has generally been well sustained and [pension-plan] solvency ratios have improved since then,” OSFI said in a statement. It said that it has introduced additional conditions to mitigate the risk that transfers pose to remaining plan members.

“As a result, the superintendent is no longer of the opinion that all portability transfers or annuity purchases will impair the solvency of the pension fund.”

In addition to the temporary freeze on portability transfers, the Canadian government also provided funding relief to pension plan sponsors whose plans have a solvency deficiency.

Last spring, then-finance minister Bill Morneau announced under new regulations that all federally regulated defined-benefit pension plans were no longer required to make monthly solvency payments until December, 2020.

Michael Powell, president of the Canadian Federation of Pensioners, told The Globe and Mail it is concerning that Monday’s announcement by OSFI does not include a pullback on the “funding holiday” for the 2020 solvency payments.

“If things are so good that the government can start rolling back these measures that were put in place to ensure there were no problems, then why not roll back the temporary solvency relief,” Mr. Powell said.

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