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Regulator tells banks: Be cautious on capital

Canada's banking regulator is signalling that it's too early for financial institutions to start releasing some of the capital they've hoarded to get through the recession.

The financial crisis prompted banks and insurers to sock away more capital than they held two years ago, with the goal of protecting balance sheets from any further unexpected shocks by building up very large financial cushions.

In order to preserve their capital, most institutions have stopped buying back their shares or increasing their dividends, two moves that would effectively transfer some of their capital to their shareholders. But now that an economic recovery appears to be under way and the financial markets are healthier, some banks and insurers are looking to resume those activities. Royal Bank of Canada last week said it will seek permission to repurchase up to 20 million shares.

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An official with the Office of the Superintendent of Financial Institutions (OSFI), which regulates banks and insurers, declined to say whether RBC would be granted the right to do so, but stressed that banks should remain cautious with capital.

"Generally speaking, shares are not currently being repurchased by Canadian financial institutions," said Rod Giles, an OSFI spokesman. "OSFI is of the view that the current environment calls for increased conservatism in capital management. I would also note that capital conservation is important as capital requirements are under review by [international standard setters]"

Last month, Group of 20 leaders said they will take measures designed to curb risks in the banking system, including boosting capital requirements by the year 2013.

RBC is looking to renew its so-called "normal course issuer bid," which expires at the end of the month. It would give the bank the ability, but not the obligation, to buy back up to 20 million shares, or 1.4 per cent of its total shares outstanding. The move is largely routine, and does not necessarily imply that RBC intends to buy back shares.

The bank now has a very large amount of excess capital. The key measure of a bank's capital level is its Tier 1 ratio, a comparison of the amount of capital a bank holds to the risks in its loans, and OSFI requires that it remain above 7 per cent. RBC's is now a whopping 12.9 per cent.

RBC chief executive officer, Gordon Nixon has said he thinks the bank is significantly over-capitalized but that it's prudent to be so in this environment. The bank said in a press release Friday it would only start buying shares with permission from OSFI. Prior to the crisis, financial institutions did not necessarily check with the regulator before buying back shares, but OSFI has requested that they do so and is now saying that it's too early to abandon the practice.

"We expect that Canadian financial institutions will utilize prudent capital management practices at all times," Mr. Giles said. "As such, we expect those financial institutions who have normal course issuer bids in place should not be repurchasing shares pursuant to those bids without first consulting OSFI."

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With a capital level among the highest in the world, Mr. Nixon is now hoping new global capital standards will improve the competitive position of RBC and its Canadian peers. As banks in Europe and the U.S. are forced to jack up capital levels, they may have to pare back on lending or shy away from big deals.

Besides having to bring up their overall level of capital, it's likely that many global banks will have to improve the so-called quality of their capital, by increasing the proportion of capital that's made up of common equity. Canadian banks already get a large proportion of their capital from common equity.

Canadian banks' capital levels have also been getting a boost from an unlikely source: the strengthening loonie. It lowers the value of U.S. loans on their books. Since their U.S. loans are in most instances their riskiest, that decreases the amount of capital that they have to set aside for risks.

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