Canada’s banking regulator has maintained the capital cushion that the country’s largest banks must hold, signalling that they have enough cash to weather a tougher economy.
The Office of the Superintendent of Financial Institutions (OSFI) said Tuesday that the domestic stability buffer (DSB) – a capital reserve that banks must maintain to soften the blow of an economic downturn – will remain at 3.5 per cent of a bank’s risk-weighted assets.
In recent years, the banking regulator boosted the buffer twice, hiking it from 2.5 per cent. The increase forced lenders to hold onto billions of dollars in excess cash, taking a chunk out of profits. OSFI also previously increased the potential range of the buffer to between 0 and 4 per cent, up from a maximum of 2.5 per cent.
Some analysts and senior bankers have questioned whether higher capital levels are harming the competitiveness of Canada’s banking sector.
Superintendent of Financial Institutions Peter Routledge said Tuesday that any decision to lower the buffer would depend on economic circumstances. OSFI would consider a decrease in the event of a shock to the financial system, he said, as it did during the pandemic, when it lowered the buffer by 125 basis points to free up capital to ensure banks could continue lending. (A basis point is one-100th of a percentage point.)
“As you look forward, there is always uncertainty about what you’re encountering,” Mr. Routledge said in response to a reporter’s question. “It would be our view that in that uncertainty, OSFI would have to be decisive about the DSB and consequential. Think of the actions we would take as meaningful and supportive broadly of public confidence. We would not be incremental.”
While systemic risks to the financial system are stable, they remain elevated, Mr. Routledge said. But OSFI is monitoring continuing threats, including elevated household debt levels, housing and commercial real estate valuations, non-financial corporate debt and geopolitical risks.
Canadian household debt-to-income ratios have declined since the spring, but the debt service ratio – measured as total obligated debt payments as a proportion of disposable income – remains at its historic peak.
Borrowers will also face payment shocks over the next few years as mortgages come up for renewal at higher interest rates. But this trend is “less concerning” now that the Bank of Canada has started lowering the cost of borrowing, Mr. Routledge said.
Even after drops in interest rates, residential and commercial real estate valuations remain uncertain. Credit risk could intensify if valuations continue to decline, he said.
Debt levels at non-financial companies have risen relative to the pace of economic growth.
While uncertainty is stoked by international policies, geopolitical tensions have had limited effects on Canada’s financial system, according to Mr. Routledge. U.S. president-elect Donald Trump has threatened to implement tariffs on Canadian imports, which could dampen activity among the corporate and commercial clients of Canada’s largest banks, as well as the economy as a whole.
“Our view from right now is that because we have built up a domestic stability buffer, the system has the resilience to operate through that uncertainty – and the system has resilience to operate through quite handily,” Mr. Routledge said. “Not with ease. I don’t mean to say we’re not taking this very seriously, but we have confidence in the financial system’s resilience because we built a bunch of buffers, including the domestic stability buffer, into the system.”
While OSFI can change the DSB at any time, the regulator announces a decision to change or hold the level twice a year. The requirement applies to financial institutions that are considered systemically important, including 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 CM-T and National Bank of Canada NA-T.
The DSB also affects the minimum capital levels that a bank is expected to hold. The common equity tier 1 (CET1) ratio – a measure of a lender’s ability to absorb losses – remains at 11.5 per cent.
All of Canada’s six biggest banks exceed the minimum threshold, which OSFI said it factored into its decision to maintain the buffer at its current level.