Canada’s regulator ups buffer

Canada’s major banks will be required to allocate additional funds to cover potential losses as the country’s banking regulator expresses growing concerns about a possible economic downturn. The Office of the Superintendent of Financial Institutions (OSFI), responsible for overseeing Canada’s largest lenders, announced on Tuesday that it will raise the domestic stability buffer (DSB) from 3.0 per cent to 3.5 per cent, effective November 1, 2023.

The DSB determines the proportion of a bank’s reserve funds that must be set aside to mitigate potential losses, with OSFI describing it as a “rainy-day fund” on its website. The requirement applies to the six largest banks in Canada. Speaking at a press conference, Peter Routledge, the head of OSFI, stated that “financial system vulnerabilities remain elevated and, in some cases, have continued to increase.” He emphasised that OSFI is taking steps to enhance financial stability.

The DSB increase forms part of the overall capital requirement that large banks must maintain at all times. With this adjustment, banks will be required to hold a minimum of 11.5 per cent of their total assets in reserve. OSFI’s data as of April 30 indicates that banks currently maintain reserves at a level of 13.1 per cent.

In anticipation of potential economic turbulence, Canada’s major banks have been uniformly increasing their loan loss provisions in recent quarters. OSFI’s decision to raise the key buffer follows a 50 basis point increase announced in December 2022. The regulator highlighted several risks to the financial system, including a deteriorating economic outlook and the impact of higher interest rates set by the Bank of Canada. Given elevated levels of household and business debt, both sectors are considered susceptible to economic shocks.

Routledge noted that the Canadian economy’s relative strength, coupled with robust bank earnings and signs of a housing market recovery, present an “opportune time” to raise capital requirements for the country’s largest banks. He emphasised that the banking industry is profitable and sound, generating sufficient capital through earnings. Thus, he believes that the cost of acquiring additional insurance against a more severe downturn is relatively inexpensive.

OSFI assesses the DSB rate semi-annually in June and December but retains the authority to adjust the buffer as necessary throughout the year. Factors such as loan delinquencies, the broader economic outlook, and consultations with lenders themselves will inform OSFI’s decision-making regarding future adjustments to the DSB. Additionally, if significant risks materialise, OSFI stands ready to promptly reduce the DSB, allowing banks to deploy the released capital to uphold financial stability.

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