Canada’s banking regulator has let it be known that the country’s largest banks must hold more capital on hand than had been disclosed – but the banks already knew that.
To others who track the industry, it was news when the Office of the Superintendent of Financial Institutions (OSFI) revealed in its quarterly newsletter last week that Canada’s largest banks must hold an extra cushion to bolster their core capital reserves, currently set at 1.5 per cent over and above the supposed minimum.
OSFI’s disclosure of an added buffer, to be held in good times and spent to help stabilize banks in a downturn or crisis, is new information. But while National Bank Financial Inc. analyst Gabriel Dechaine wrote last week that the regulator had announced “a new buffer requirement,” it isn’t new at all. And OSFI’s announcement appears to have caused some confusion.
The added capital requirement, known as the “domestic stability buffer” or DSB, was conceived as part of the so-called Basel II reforms − a set of recommended regulations introduced to govern global banks’ conduct around the time of the 2008 financial crisis.
Practically speaking, the official floor for a large bank’s common equity tier 1 (CET1) capital ratio – a key measure of a bank’s health, watched closely by regulators – is now 9.5 per cent. Prior to last week, it was publicly stated as 8 per cent, but that wasn’t strictly true.
Analysts who cover the Big Six banks believe the lenders have unofficially been managing their capital to maintain higher levels for years. OSFI confirmed that banks have already had to meet this higher threshold, but declined to specify for how long. Until now, the DSB requirement was only communicated to banks in private.
From now on, it will be disclosed publicly, usually in June and December – “a departure from OSFI’s notoriously private communications,” Mr. Dechaine said.
“Not only will this provide more insight and transparency into the overall amount of capital being set aside by the banks, it will also contribute to broader financial stability by providing additional information on the key domestic risks to which Canada’s largest banks are exposed,” OSFI spokesperson Annik Faucher said in an e-mailed statement.
The previously advertised 8-per-cent minimum CET1 level for Canada’s six largest banks consisted of three components: a 4.5-per-cent base-level requirement, a 2.5-per-cent “capital conservation buffer” and an extra 1-per-cent surcharge because of their size. All of Canada’s six big banks comfortably exceeded that as of April 30, with CET1 ratios ranging from 10.9 per cent at Royal Bank of Canada to 12 per cent at Bank of Nova Scotia − though Scotiabank will spend some of that excess capital on pending acquisitions set to close later this year.
In a letter released Monday by OSFI, assistant superintendent Carolyn Rogers stresses the need for “increased transparency” to help markets understand the buffer and how banks should use it to cover “a range of systemic vulnerabilities,” including high consumer indebtedness and asset imbalances in Canada.
The DSB applies only to banks OSFI deems systemically important, and can be changed any time within a range from zero to 2.5 per cent.
While OSFI’s decision to disclose the buffer “was technically new information, in our view it is of little surprise or impact to the market,” said Sumit Malhotra, an analyst at Scotia Capital Inc., in a research note. “We continue to believe that 10.5 [per cent] is the CET1 ratio level above which capital deployment becomes an option for the ‘Big Six,’ and each of them meet this criteria.”