Big Banks’ fears over capital rules are overblown, OSFI says #CanadaFinance

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Canada’s chief banking regulator says fears about lopsided implementation of post-financial-crisis capital rules and dire warnings about curtailed lending and hits to the Canadian economy are overblown.

In a speech at a conference Wednesday in Toronto, Peter Routledge, head of the Office of the Superintendent of Financial Institutions, said that contrary to the prognostications, new capital floor rules are not expected to have a material impact on capital at the country’s largest six banks.

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“Based on our estimates, the implementation of the 2017 Basel III reforms in Canada is expected to be capital neutral,” Routledge, OSFI’s superintendent, told the audience at the Global Risk Institute’s Summit 2024.

He said the final Basel capital rules, sometimes referred to as Basel Endgame, are attracting unusual attention, both at home at in other countries, some of which are either delaying implementation or watering down provisions agreed to eight years ago.

As a result of the uncertainty, OSFI announced it would delay by one year its final implementation of the capital floor rules, which are aimed at ensuring internal risk models at the banks don’t stray too far from a standardized approach.

“We were not alone in attracting this attention,” Routledge said. “In a neighbouring country, earlier this year one could find a great deal of public attention on the 2017 Basel III reforms, most peculiarly on television advertisements and airport billboards.”

A flurry of lobbying in the United States appeared to pay off for banks there, with the United States Federal Reserve signalling last month that it is considering cutting previously announced increases for bank capital cushions in half.

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Still, Routledge noted in his speech, a number of regulators in the 20 participating countries, have “re-affirmed their intent to fully meet their commitments to the 2017 Basel III reforms,” albeit with timelines that now extend to the later years of this decade and the early years of the next.

He said OSFI will probably not have more to say on the timeline for Canada’s big banks to adhere to the capital floor until next summer but pledged not to extend Canada’s lead on the implementing rules further in a way that would lead to inconsistency in the application of rules meant to improve stability of the global financial system following the 2008 crisis.

Routledge said OSFI welcomes challenges to ensure well-intentioned efforts to enhance the resilience of the Canadian banking sector does not lead to unintended consequences, but he rejected the argument that the final Basel rules will cause a dramatic increase in capital requirements, slow lending and have a negative impact on the Canadian economy.

To bolster his contention, he said the regulator crunched the numbers including information disclosed by Canada’s six largest banks in the second quarter and publicly available regulatory data, which slows the estimated increase in risk-weighted assets due to fully phased-in capital floor rules to be about $85 billion. Using this figure, the impact on the banks’ capital ratios would range from zero to 86 basis points.

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“In other words, the capital floor impact … is many multiples lower than some estimates and is negligible on a net basis,” Routledge said.

He defended the emphasis on banks holding excess capital to ensure their stability to withstand economic shocks. But he said the idea is to find an “optimum” level — “one that lessens the likelihood that a financial shock damages the economy but avoids the ‘stability of the graveyard’ in which economic growth is unnecessarily slowed by an excessive aversion to financial system risk.”

Routledge stood by the intention of the Basel capital floor rules, saying they will cause banks to “more regularly investigate, challenge, and improve the assumptions in their internal models” and reduce differences in capital requirements for banks using internal models and those using standardized approaches to risk-weighting.

“This will tend to add competitive balance, all else equal, which will ultimately benefit Canadian businesses and households looking to finance their futures,” he said.

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After his speech, Routledge addressed OSFI’s recent decision that will relax stress testing by allowing homeowners renewing uninsured mortgages to switch financial institutions without facing a new stress test, something they wouldn’t need if they stayed with their bank.

He said 95 of Canadians don’t switch their bank on mortgage renewal, so the change isn’t likely to shake the stability of the system. Moreover, he said, requiring the new financial institution to stress test a borrower who had already been stress tested left some Canadians — particularly those with variable rate, fixed payment mortgages — feeling like they would be barred from getting a mortgage.

“That did make a difference in our decision making, even though it was only going to be a limited number of Canadians. I don’t think that that’s OSFI’s role,” Routledge said, noting that the agency regulates financial institutions, not individuals, and must be cautious not stray outside its mandate.

Many market players including the federal Competition Bureau had called on OSFI to make the change. The regulator initially pushed back, suggesting the new financial institution should not rely on the underwriting of the previous one when taking on the mortgage loan.

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