Canada’s banking regulator will require large banks to hold more capital to guard against looming risks to the economy, including high levels of household and corporate debt.
The Office of the Superintendent of Financial Institutions (OSFI) said on Wednesday it is raising the so-called “domestic stability buffer,” an added cushion that Canada’s six largest banks are required to build into their core capital reserves to help them cope in an economic downturn. Starting April 30, 2019, the buffer will rise to 1.75 per cent of a bank’s risk-weighted assets, up from the current 1.5 per cent.
The existence of the buffer was disclosed for the first time earlier this year and the decision to raise it sends a signal that regulators are on guard for early signs of strain in the robust economic backdrop that has fuelled banks’ strong earnings of late. In a letter to banks outlining the change, OSFI highlighted “systemic vulnerabilities” that it tracks closely, including high household debt relative to incomes and uncertainty about housing markets. Thanks in part to low interest rates, “corporate indebtedness is also growing, representing a potential future risk,” the regulator said in a news release.
“In our view, the main issue with OSFI’s announcement is one of signalling,” said Gabriel Dechaine, an analyst at National Bank Financial Inc. “This move could create expectations that capital requirements will be nudged higher over time, especially with the Canadian economic outlook not as constructive as it was a year ago.”
All of Canada’s major banks have strong capital reserves that exceed the new minimum set by OSFI and should have no difficulty adapting to the change, which comes into effect on April 30. So far, the banks have brushed off concerns that the country’s economy may be entering the late stages of an economic cycle, reporting a collective $45-billion in profit in fiscal 2018 along with relatively low loan losses.
But rather than wait for clear signs of trouble, OSFI appears to be taking cues from the Financial Stability Board, an international body that monitors the global financial system, which recently urged national regulators to “consider using the current window of opportunity to build resilience, particularly macroprudential buffers where appropriate.”
Some other countries that have experienced a sharp escalation in housing prices, such as Australia, have also been forcing banks to add to their capital cushions, which help protect depositors and creditors in the event the banks suffer large losses in a future downturn. The financial crisis of 2007-08 had a number of causes, but one was a lack of sufficient capital reserves by large financial institutions, especially in the United States and Europe.
“In light of positive credit performance and generally stable economic conditions, now is a prudent time for banks to build resilience against future risks to the Canadian financial system,” OSFI assistant superintendent Jamey Hubbs said in a statement.
A spokesperson for Royal Bank of Canada said the bank’s capital-management practices are “unchanged” and RBC remains “comfortable with our portfolio and our prudent underwriting practices.”
Spokespeople for Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank of Canada declined to comment.
Currently, Canada’s Big Six banks must maintain a common equity Tier 1 (CET1) capital ratio – a key measure of a bank’s resilience – at or above 9.5 per cent. That consists of a base-level requirement of 4.5 per cent, a 2.5-per-cent “capital conservation buffer,” an extra 1-per-cent surcharge because of their size, plus the newly disclosed Domestic Stability Buffer. After April 30, the minimum will be 9.75 per cent.
But banks typically hold extra capital to stay well above those minimums. As of Oct. 31, the CET1 ratios maintained by Canada’s six largest banks ranged from 11.1 per cent at Scotiabank, which has recently completed a string of acquisitions, to 12 per cent at TD.
“Canadian banks are among the strongest and best-capitalized in the world," a spokesman for the Canadian Bankers Association said. “They already exceed OSFI’s revised requirements and are in a position of continued capital and risk management strength going into 2019."