Canada’s banking regulator is forcing major banks to hold more capital because of “elevated” risks, including high levels of household and corporate debt.
For the second time in six months, the Office of the Superintendent of Financial Institutions (OSFI) will raise the “Domestic Stability Buffer” held by banks, citing “key vulnerabilities” to the banking system. The buffer is designed to help lenders cushion the impact of future economic shocks.
Starting Oct. 31, it will be set at 2 per cent of a bank’s risk-weighted assets, up from the current 1.75 per cent.
The buffer is meant to be built up in strong economic times, bolstering banks’ core capital reserves when credit is healthy. The regulator can then reduce the required buffer in the event of a downturn or recession, freeing up capital that banks can use to continue lending. But the immediate impact on banks is likely to be modest.
All of Canada’s six biggest banks currently have capital levels well in excess of the new minimum threshold OSFI is setting. But in the short term, the added burden of a higher buffer could mean banks have less flexibility about how they spend excess capital, including to make acquisitions or return capital to shareholders through buybacks for dividends.
Rob Colangelo, an analyst at DBRS Inc., called the increase to the buffer “a prudent step by OSFI."
“We’re late in the credit cycle, and the expectation is that something’s going to turn, and that’s when the banks will need to have that [higher level of capital]," he said.
The change isn’t expected to hamper banks’ profits or lending practices, but it could subtly alter the math for acquisitions or share buybacks. “It probably means the banks can’t be as flexible in terms of returning capital to shareholders," Mr. Colangelo said.
In a research note, CIBC World Markets Inc. analyst Robert Sedran called the change “an incremental negative that removes a little more flexibility and optionality from the banks’ strong balance sheets.”
Spokespeople for Canada’s five largest banks declined to comment.
Regulators around the world have been tightening capital requirements ever since the financial crisis of 2008-2009 exposed the weakness in banks’ reserves. When OSFI suggests that Canada’s banks should take advantage of a steady economic backdrop as “a window of opportunity” to make themselves more resilient, it is echoing guidance from the Financial Stability Board, an international body that monitors the global financial system.
In Canada, OSFI first disclosed the existence of the Domestic Stability Buffer last year, promising to update its status at least twice a year. At the first opportunity last December, OSFI announced it would hike the buffer from 1.5 per cent to 1.75 per cent starting April 30, citing “systemic vulnerabilities” that included high household indebtedness, uncertainty in housing markets and rising corporate debt.
Those same risks persist today, according to OSFI, which again cited household debt, as well as "asset imbalances and institutional indebtedness” as factors in increasing the buffer.
The higher threshold applies only to Canada’s six largest banks: Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank of Canada. Currently, they must maintain a common equity Tier 1 (CET1) capital ratio of at least 9.75 per cent, including the Domestic Stability Buffer. After Oct. 31, the minimum will be 10 per cent.
As of April 30, the banks’ CET1 ratios ranged from 11.1 per cent at Scotiabank to 12 per cent at TD.
At an industry conference in January, the chief executives of Canada’s largest banks shrugged off OSFI’s December decision to raise the buffer, saying it wouldn’t alter their capital plans. “It doesn’t change anything,” TD CEO Bharat Masrani said at the time.
James Bradshaw