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Bank towers in Toronto's financial district seen on Oct. 1, 2018.

Fred Lum

Canada’s banking regulator is proposing tougher rules governing deposits sourced online or from third-party brokers, in a move that would make banks more stable in times of stress but could also put some smaller lenders at a competitive disadvantage.

The draft changes put forward by the Office of the Superintendent of Financial Institutions (OSFI) have not yet been made public. If approved, banks would be required to hold 20 per cent to 40 per cent of deposits gathered from unaffiliated brokers or internet-based accounts as a buffer against sudden withdrawals that could put a lender at risk.

But banks are voicing concerns about some aspects of OSFI’s proposals, fearing they could disproportionately handcuff smaller financial institutions, hampering efforts to encourage greater competition with Canada’s biggest banks. As a result, the proposed rules could also indirectly influence the interest rates and terms consumers are offered on deposits.

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Although all banks would be affected, the impact could be felt most acutely by institutions such as Home Capital, Equitable Bank and Manulife Bank of Canada, depending on each institution’s funding strategies. Low-cost online banks Tangerine and Simplii Financial, which are owned by Bank of Nova Scotia and Canadian Imperial Bank of Commerce respectively, may also be more exposed.

The new rules are being considered less than two years after alternative mortgage provider Home Capital Group Inc. was pushed to the brink of insolvency when clients lost confidence in the lender over allegations it had failed to disclose fraud in its business. Unnerved customers withdrew large volumes of deposits, creating a liquidity crisis. The company later settled the allegations with securities regulators.

In a confidential letter to OSFI, obtained by The Globe and Mail, the Canadian Bankers Association argued some of the categories OSFI has outlined are overly broad – especially the treatment of deposits sourced through the internet – ignoring important factors that make them less prone to sudden or frequent withdrawals.

“If we do not consider the stabilizing characteristics of the deposits … we may apply an excessively blunt instrument when assessing the riskiness of these deposits,” the CBA wrote in its letter to OSFI, dated Jan. 10. A CBA spokesperson declined to comment.

As part of global efforts to make banks more resilient after the financial crisis of 2008, regulators around the world have added new measures to promote liquidity. But OSFI’s experience with Home Capital’s crisis appears to be a key driver behind the regulator’s eagerness to update its Liquidity Adequacy Requirements (LAR) Guideline.

Home Capital’s near-death experience “somewhat unnerved the regulator and depositors," said David Taylor, president and chief executive of VersaBank, based in London, Ont. “So I think that was the trigger in Canada to have a real hard look at the liquidity situation of the [financial institutions].”

OSFI spokesperson Annik Faucher confirmed continuing discussions with banks, and said the regulator expects to issue its proposals for public consultation soon. “We would be pleased to comment at that time,” she said.

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Under current rules, a bank must typically hold on hand 3 per cent to 5 per cent of deposits that are deemed more stable, taking into account factors such as whether clients have established relationships with the bank through other products and whether they are protected by federal deposit insurance.

This run-off rate, as it is known, is based on the estimated rate of withdrawal and renewal for each category of deposits. For less stable varieties – funds sourced from a broker whose client has no other ties to the bank, for instance – 10 per cent of funds must be set aside. For every $1 in deposits collected, therefore, banks can potentially lend or invest anywhere from 90 to 97 cents.

But OSFI’s draft rule changes would raise the run-off rate for less-stable deposits to 40 per cent, and create a new category for internet-sourced deposits with a 20-per-cent set-aside. The regulator appears especially keen to police deposits for which a high interest rate is the main selling point, which attract clients who shop around for the best rates.

Internet-sourced deposits are increasingly common, however, and the CBA fears they will be painted with an overly broad brush. The proposed 20-per-cent threshold does not differentiate on factors such as the depth of the client relationship, whether deposits are insured and other issues related to stability.

“We are concerned that the proposed changes could have the undesired effect of penalizing all digital banking activities,” the association’s letter says. “The industry recommends not creating this new category at this time.”

Mr. Taylor declined to discuss OSFI’s specific proposals, but said as technology reshapes banking, “it’s important for OSFI to stay in step with the times and revisit the liquidity requirements.” Yet, he worries the playing field could end up further tilted in the largest banks’ favour.

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“These types of proposals will definitely impact the smaller [financial institutions] that rely on internet deposits and broker deposits," he said. "There’s no doubt about that.”

The new rules could force banks to rely more on longer-term deposits, which are more costly to attract. And by forcing them to keep more cash on hand, “it could also be punitive toward some of their lending,” said Robert Colangelo, a senior vice-president at credit rating agency DRBS Ltd., “and therefore lower their profitability.”

While OSFI is charged with safeguarding the stability of Canada’s financial system, the federal government has publicly stated its desire to make the country’s banking sector more competitive, in part by encouraging smaller lenders that interact with clients mostly online.

“I suspect that it’s a bit of a tightrope that OSFI needs to follow,” Mr. Colangelo said.

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