Canada’s banking regulator has raised the ceiling on a capital buffer that it requires the country’s largest banks to hold, citing risks from inflation, rising interest rates and household debt as reasons for caution.
The Office of the Superintendent of Financial Institutions (OSFI) announced a change Thursday that will increase the maximum level of the Domestic Stability Buffer, or DSB. The buffer, which is a store of capital built up in good times that can be used to soften the blow from economic shocks, will now have a range of 0 to 4 per cent of a bank’s risk-weighted assets.
OSFI also announced Thursday that the buffer’s level will be increased to 3 per cent as of Feb. 1, 2023. That is an increase of 0.5 per cent from the current level of 2.5 per cent, which had been the maximum level until now. OSFI updates the DSB level at least twice annually, but can change it any time to respond to the economic environment.
The new, higher DSB level means banks must maintain common equity Tier 1 (CET1) ratios of at least 11 per cent – a key measure of a lender’s ability to absorb losses – though most banks choose to hold extra capital above the regulatory minimum. And that could climb higher if the regulator chooses to push the DSB closer to the new 4-per-cent maximum threshold.
By increasing the top end of the buffer range, the regulator is raising the burden on banks to set aside significant capital to guard against losses or economic upheaval. That can affect decisions by bank executives about how much to lend, to invest in their businesses, and the amount of capital they return to shareholders through dividends and stock buybacks.
The change “reflects OSFI’s assessment that systemic vulnerabilities remain elevated – with some, namely Canadian household indebtedness and asset imbalances, edging upwards – as well as the results of recent stress tests,” the regulator said in a news release. “Globally, persistent inflation and rising interest rates, along with geopolitical tensions, have exacerbated vulnerabilities and led to increased economic uncertainty.”
A year ago, OSFI said it would review the DSB’s design and range to make sure it continues to work as intended. That review concluded that, “on the whole, the DSB continues to serve as a key tool aimed at ensuring both systemic stability and the resiliency of” Canada’s six largest banks, said Angie Radiskovic, OSFI’s chief risk and strategy officer, in a statement on Thursday.
The DSB only applies to the six domestic banks that are labelled as systemically important to Canada’s banking system, known in industry jargon as D-SIBs: Royal Bank of Canada RY-T, Toronto-Dominion Bank TD-T, Bank of Nova Scotia BNS-T, Bank of Montreal BMO-T, Canadian Imperial Bank of Commerce and National Bank of Canada. CM-T
All six banks currently have capital levels that exceed the new minimum level, though three of them – RBC, TD and BMO – are awaiting regulatory approvals for major acquisitions of rival banks. Should those deals be approved, each bank’s capital levels will decline when they pay the agreed purchase prices, but all three banks have suggested their CET1 ratios will remain above 11 per cent at that time.
In the early days of the COVID-19 pandemic, as large swaths of the economy went into lockdown, OSFI lowered the DSB from 2.25 per cent to 1 per cent. At the time, the regulator said that would free up more than $300-billion of additional capacity to make loans to customers.
As the most acute phase of the pandemic receded, and banks suffered few losses thanks to massive government support and stimulus programs, OSFI raised the buffer back to 2.5 per cent in June, 2021. That compelled banks to rebuild their capital buffers to guard against the next potential shock.
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