Canada’s banking regulator is keeping its threshold for large banks’ capital levels unchanged, suggesting that major lenders have adequate reserves for now but also warning of continuing risks as the economy enters an uncertain recovery.
The Office of the Superintendent of Financial Institutions (OSFI) made no change to its domestic stability buffer, a capital cushion designed to help absorb the shock of an economic downturn, in a regularly scheduled update on Tuesday.
The regulator compels Canada’s six largest banks to build up the domestic stability buffer gradually in good economic times, and releases some of that capital in times of financial stress. Banks can use that extra capital to absorb losses from defaulting loans and to continue lending when businesses and households need credit most.
The decision not to reduce the buffer sends a signal to markets that the regulator is comfortable with the banks’ positions as it continues to gauge the impact of the coronavirus pandemic. But it also ensures banks still have a reserve of capital that they could deploy later if governments reintroduce lockdowns or the economic rebound falters.
On Tuesday, OSFI said it will keep the buffer at 1 per cent of risk-weighted assets – a measure of the riskiness of loans – for now, and that the buffer appears to be working as banks to continue to lend. But the regulator also reiterated a prior promise to reduce the remaining buffer and free up more capital for banks if conditions get worse.
“The timing and size of any further release will depend on the duration and depth of our economic slowdown, and also how it may be reflected in banks’ capital ratios and financial results,” said Jamey Hubbs, OSFI’s assistant superintendent overseeing deposit-taking institutions, speaking to reporters. “The outlook remains highly uncertain, though we are encouraged by progress in reopening economies and more stable funding markets.”
OSFI warned on Tuesday that vulnerabilities in the financial system “remain elevated,” including high debt loads carried by households and businesses, and that the speed of an economic recovery is hard to predict. And the regulator is watching closely for signs of economic stress in international markets that could spill over into Canada, as all large Canadian banks have foreign operations.
Starting in 2018, OSFI increased the buffer twice each year until banks had set aside capital equal to 2.25 per cent of risk-weighted assets. But on March 13, as Canada locked down parts of the economy to help curb the spread of the coronavirus pandemic, OSFI allowed the release of some of that capital by reducing the domestic stability buffer to 1 per cent.
At the time, the regulator estimated that would free up $300-billion of capital that could act as a shock absorber and keep credit from drying up. In March and April, banks increased credit by about $170-billion, or 6 per cent, according to Mr. Hubbs, but he said that spike in lending is still “well within the estimated increased capacity” provided by OSFI’s last reduction to the buffer.
OSFI gives updates on the domestic stability buffer at least twice a year, in June and December, but can change its level any time. If the regulator reduces the buffer again, it could free up tens or hundreds of billions of dollars in capital to support the banks.
When the banks’ last fiscal quarter ended on April 30, all six major lenders had capital levels comfortably above the minimum threshold set by OSFI, even after earmarking $11-billion to cover potential loan losses.
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