During a bank CEO conference in early January, Canada’s banking regulator pledged to be more transparent about its work.
Assistant superintendent Jamey Hubbs said the Office of the Superintendent of Financial Institutions wants to build trust with Canadians. While he cautioned that OSFI has no plans to share top-secret information, he conceded that the regulator must do a better job of keeping regular folks informed.
“We recognize that old patterns of saying very little about our concerns and our work is not a way to maintain that trust,” Mr. Hubbs said. “We need to be more transparent about our work if we want to contribute to the public confidence in the Canadian financial system.”
Months later, OSFI is facing its first test of that promise. Canadians, already battered by economic fallout from the growing novel coronavirus pandemic, are heavily exposed to our banks through direct stock ownership, mutual funds and pension plans.
Consequently, as regulators around the world free up hundreds of billions of dollars in capital reserves, and in some cases restrict banks from paying dividends, OSFI owes it to Canadians to be frank about how our banks compare with their international peers. That means providing clear answers about whether our banks are capitalized differently than those abroad, and whether it’s realistic to believe that dividends will remain sacrosanct throughout this crisis without a complete explanation about why regulators are sure lenders won’t need that money down the road.
The days of blind faith are over. The S&P/TSX Banks Index remains down about 22 per cent from its peak on Feb. 21. Although it has recovered some lost ground, it’s unclear how long this economic crisis will last and how banks will fare.
Although investor protection falls outside of OSFI’s mandate, depositors, creditors and shareholders are often the same people. Moreover, OSFI’s role includes promoting public confidence in the financial system and ensuring banks provide proper public disclosures about risks.
It’s easy to see why Canadians, especially retirees who rely on dividend income, feel uneasy. Regulators in Britain, Europe and New Zealand have ordered banks to stop paying dividends to conserve capital. Australia’s regulator, meanwhile, urged banks to “seriously consider” deferring paying dividends “until the outlook is clearer.”
So far, OSFI has instructed Canadian banks not to increase dividends or buy back shares. That means lenders can continue paying dividends, but aren’t allowed to boost those payouts. (Dividend increases that were approved before March 13, the date OSFI issued its guidance, are allowed to proceed.)
When asked during a recent technical briefing with media why Canadian banks were not ordered to suspend dividends, an official explained that OSFI’s approach requires banks to build capital buffers so they can use them in a downturn rather than reducing dividends or cutting back on lending. That’s all well and good, but OSFI can’t affirm whether Canadian banks are capitalized differently than those in other developed countries. The Globe cannot name the official because of the rules of the technical briefing.
However, spokesman Michael Toope later wrote in an e-mail: “Given the breadth and depth of the requirements that are applicable within each country, it is difficult to provide a succinct yet complete overview of how OSFI’s capital requirements differ with those in various jurisdictions.”
So why is OSFI confident that Canadian banks can afford to keep paying dividends when banks in other countries have been ordered to stop? The public deserves proper answers, especially since OSFI participated in the development of international standards.
In fact, part of the rationale for those rules, known as Basel III, was to improve the comparability of banks’ capital ratios across jurisdictions. Simply telling Canadians that banks maintain strong capital ratios isn’t enough.
Here’s why. Some banks have more latitude on how they meet capital requirements. The Big Six, for instance, use what’s known in industry parlance as the “advanced internal ratings-based approach” to calculate credit risk, which means they determine “all variables" for calculating risk weights. Risk-weighted assets are used to determine how much capital banks must set aside.
“The accuracy of measures of risk-weighted assets is a key concern especially for large banks in high-income OECD countries,” the World Bank Group stated in a 2019 policy research working paper.
Risk-weighted assets are a worry for two reasons. During the Great Financial Crisis, those measures didn’t accurately reflect risks. More than 10 years later, there’s concern that while overall capital levels have increased, definitions of what constitutes capital have become “less stringent,” the study added. That means large banks in particular could be underestimating risks on their balance sheets.
OSFI needs to assure us that this trend isn’t playing out in Canada. We do know that our banks still include some hybrid debt capital instruments, which are complex securities, in their Tier 1 capital, a key measure of financial strength. Big banks are phasing out these instruments as part of Tier 1 capital, but that process won’t conclude until Oct. 31, 2021.
Additionally, other lower-quality securities, such as subordinated debt, can still qualify as additional Tier 1 capital, depending on their fine print, of course. It would be useful to know how those various instruments are faring these days.
Although no Canadian bank cut dividends during the Great Financial Crisis, we cannot afford to be smug. Canada no longer has the world’s soundest banking system. In fact, Canada currently ranks sixth on the World Economic Forum’s scorecard. Australia, which has taken a stronger position on dividends, is ahead of us in fifth place.
The global shock caused by COVID-19 has affected every sector of the economy in a matter of weeks. Lockdowns in China and India have disrupted global supply chains. Small businesses are struggling.
High consumer debt loads have become a powder keg as many Canadians lose their jobs. The oil-price collapse, meanwhile, is aggravating Alberta’s pain. And when it comes right down to it, no one really knows how long this pandemic will last.
Prior to the coronavirus crisis, eliminating dividends was one of the worst-case stress-testing scenarios for Canadian banks, according to a source. (The Globe and Mail is not identifying the source because they are not authorized to speak publicly about the matter.)
It’s incumbent on OSFI and banks to explain whether their black-swan stress-testing scenarios are based on assumptions that mirror the conditions of this crisis.
Bay Street analysts say many levers can be pulled before dividends are cut, but they’re in the business of selling stock. Maintaining public confidence in Canada’s financial system requires clear answers from regulators, not a request for the unquestioning belief of the masses.
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