OSFI keeps big banks' stability buffer unchanged as risks remain 'elevated but stable'

Mortgage renewals at higher rates and commercial real estate continue to be concerns

Get the latest from Barbara Shecter straight to your inbox

Article content

Canada’s top banking regulator held the domestic stability buffer at 3.5 per cent Tuesday following a semi-annual review of the ‘rainy day’ funds the country’s largest banks must set aside to help absorb losses and to keep loans flowing in the event of financial shocks or uncertainties.

Since 2022, the buffer could be ratcheted up to as much as four per cent and the Office of the Superintendent of Financial Institutions (OSFI) has said the aim is to build up a larger cushion in good times to help protect the banks and economy in times of uncertainty.

Advertisement 2

Article content

“Holding the DSB at its current level reflects OSFI’s assessment that vulnerabilities, such as high household debt, remain elevated but stable, while near-term risks continue to be low despite some recent increase,” the regulator said in a statement Tuesday. “Future mortgage renewals at higher interest rates remain a concern, while commercial real estate lending and geopolitical conflicts continue to contribute to economic uncertainty.”

OSFI introduced the added cushion in June 2018 for banks deemed domestically systematically important and it is a component of their closely watched common equity Tier 1 (CET1) capital requirements. It is intended to help keep Canada’s economy running in times of stress and to ensure large Canadian banks don’t fall into financial distress or failure, which could have an impact on the global financial system.

Last December, OSFI held the buffer at 3.5 per cent, surprising analysts who had expected a 50 basis point increase to the top of the range. But OSFI superintendent Peter Routledge said at the time that there was enough insurance built up within the nation’s banking system to handle a severe yet plausible downside scenario.

Article content

Advertisement 3

Article content

In June of 2023, OSFI had raised the buffer to 3.5 per cent from three per cent, citing risks including high household and corporate debt levels, the rising cost of debt and increased global uncertainty around fiscal and monetary policy. The regulator determines the buffer based on financial trends, risks and key vulnerabilities, including potential for recession, a decline in house prices and geopolitical unrest.

Recommended from Editorial

Among the factors OSFI considered when determining whether to raise, lower or maintain the domestic stability buffer this month was Canada’s heavily indebted households and how they are adjusting to a period of elevated interest rates. 

During a media briefing Tuesday morning, Routledge said that with about half of residential mortgages coming up for renewal in a higher interest rate environment, there is reason to maintain the domestic stability buffer where it is to ensure the big banks and economy keep running smoothly if there is an uptick in highly indebted households having difficulty meeting monthly payment obligations.

Advertisement 4

Article content

Before the key overnight interest rate was cut from five per cent to 4.75 per cent earlier this month, the Bank of Canada said some borrowers were facing up to a 60 per cent increase in their monthly mortgage payments on renewals over the next couple of years.

“Falling rates — 25 basis points on the overnight rate — although constructive, is not a game changer in terms of overall systemic stability,” Routledge said. 

Near-term risks have increased, but they are still considered low overall, he said, adding that banks continue to hold more capital than required by regulators and are performing solidly despite a challenging operating environment.

As a result, he said OSFI has determined that there is no need to push the domestic stability buffer to the top end of range.

“I don’t know if we’re holding back an extra 50 basis points just in case, it’s more like we judge the vulnerabilities, get a certain level, (and) we think three and a half percent plus discipline is sufficient resilience for a potential downturn,” he said.

Conditions under which the buffer could be reduced would include a sudden shock to the system, as was the case when COVID-19 was declared a global pandemic in 2020, he said. Another buffer-lowering scenario would occur if overall vulnerabilities in the system diminished, such as a material drop in household indebtedness, which would produce lower stress losses in OSFI’s analysis. Routledge said there was no indication of such a scenario unfolding at the moment.

Advertisement 5

Article content

OSFI doesn’t have to wait for the twice-yearly review to adjust the domestic stability buffer. When COVID-19 was declared a global pandemic in March 2020, OSFI reduced the buffer to one per cent from 2.25 per cent.

Canada’s banks have traditionally held more capital than required by the regulator. For instance, late last year when the total CET1 requirement, including the 3.5 per cent domestic stability buffer, was 11.5 per cent, the big banks’ ratios were higher than 13 per cent.

OSFI said Tuesday that all six of the large banks subject to the domestic stability buffer still have CET1 ratios exceeding 12 per cent. The Common Equity Tier 1 ratio is a measurement of a bank’s equity compared with its total exposures weighted by risk.

Some in the financial sector argue that high capital requirements and the tendency of banks to exceed regulatory floors slows lending and hinders investment, but Routledge said Tuesday that he sees it as a strength of Canada’s financial system.

“In terms of the behavior of bank boards and senior managers, I think it is an advantage in Canada that we set, in a principals-based fashion, the buffer floor and that boards and senior managers operate at above that floor as an additional measure,” he said.

Advertisement 6

Article content

Robert Colangelo, a vice-president at Moody’s Ratings, said he expects that the banks will continue to maintain capital buffers above the regulatory minimum given rising risks that include higher household indebtedness and weaker commercial real estate demand.

“The impact of payment shocks on household debt serviceability with a significant number of mortgages coming up for renewal remains uncertain,” he said, but he added that the recent Bank of Canada rate cut will provide some relief to borrowers and should help slow the credit-quality deterioration experienced by Canada’s largest banks over the past year.

• Email: [email protected]

Bookmark our website and support our journalism: Don’t miss the business news you need to know — add financialpost.com to your bookmarks and sign up for our newsletters here.

Article content