OSFI raises capital buffer for banks too big to fail as outlook darkens

Office of the Superintendent of Financial Institutions
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The Office of the Superintendent of Financial Institutions is an independent agency of the Government of Canada reporting to the Minister of Finance created “to contribute to public confidence in the Canadian financial system”. Wikipedia

Concerns about the economic and operating outlook for Canada’s largest banks has prompted the country’s main banking regulator to raise the capital buffer the financial institutions must hold to maintain “resilience to key vulnerabilities and system-wide risks.”

The 25 basis point increase — to two per cent of total risk-weighted assets — will be effective Oct. 31, the Office of the Superintendent of Financial Institutions said Tuesday.

What it does speak to is the regulator’s concern about the economic outlook and operating environment for the banks, which apparently in their view, is weakening 

OSFI established the domestic stability buffer, an added cushion to maintain stability of Canada’s systemically important financial institutions, at 1.5 per cent last June. It is reviewed and set twice a year, based on OSFI’s monitoring and analysis of “a range of vulnerabilities,” and was raised to 1.75 per cent in April.

When making decisions about the stability buffer, the regulator considers consumer and institutional indebtedness, and whether there are asset imbalances in Canadian markets including housing, analysts said.

It “looks like they think the operating environment is more challenging at the margin,” said David Beattie, senior vice president in the financial institutions group of Moody’s Investors Service, on Tuesday.

The change is not expected to have a large impact on capital decisions at the country’s big banks on issues such as share buybacks because their overall capital buffers exceed the levels set by OSFI, analysts said.

“However, what it does speak to is the regulator’s concern about the economic outlook and operating environment for the banks, which apparently in their view, is weakening,” said a Toronto-based analyst who spoke on condition that his name would not be used.

The regulator’s “prudent concern” could be driven by the prospect of a slowing economy in which business spending fails to pick up the slack from a declining consumer spend, he said.

New guidance from OSFI on interest rate risks Improperly managed risks pose a ‘significant threat’ to a bank’s capital base, earnings

This would be against a backdrop of already-stretched household balance sheets, and a possible trade war between the United States and China could add further stress to the economy, the analyst said.

Gabriel Dechaine, an analyst at National Bank of Canada, said OSFI’s decision to raise the capital bar amid recession fears is “a good thing,” particularly since Canadian banks’ total capital buffers are tracking well above OSFI requirements that now set the minimum at 10 per cent.

The average was 11.5 per cent at the end of the recently reported second quarter, with a range of 11 per cent to 12 per cent, he said in a note to clients Tuesday.

“If a downtown actually does materialize, then banks will not only be in a better position to withstand it, they may be able to deploy capital opportunistically (through buybacks or acquisitions) which would be better for investors in the long term,” Dechaine wrote.

He added that increases to the domestic stability buffer in “good times” are phased in, while any reductions in “bad times” would be immediate.

In December, when the first increase to the new domestic stability buffer was announced, TD Securities analyst Mario Mendonca said commercial loan growth and credit losses are likely to capture more focus in 2019 and 2020 than the consumer segment.

“Commercial loan growth, supported in large part by commercial real estate and construction lending, appears to be running above long-term sustainable levels,” Mendonca wrote in a Dec. 12 note, adding that commercial credit losses in 2018 were “well below the long-term average.”

However, he added that he remained positive on the outlook for bank stocks, in part because “the Canadian banks’ business model has proven to be far more resilient than … their global financial services peers” in periods of stress.

Published at Tue, 04 Jun 2019 20:30:52 +0000