Office towers are shown in Toronto's financial district on June 27, 2018.Tijana Martin/The Canadian Press
Canada’s banking regulator is keeping a buffer for banks’ capital levels that helps cushion the impact of economic shocks unchanged, but opened the door to future changes to its design.
The Office of the Superintendent of Financial Institutions (OSFI) kept its domestic stability buffer steady on Friday, in a regularly scheduled update. The buffer, or DSB, is a store of capital that banks are required to build up in good times that can be released when they are under financial stress to help absorb losses and allow them to keep lending to clients.
“The buffer is prudent and appropriate to address potential concerns in the near term,” Jamey Hubbs, OSFI’s assistant superintendent, said on a conference call.
Since the end of October, the buffer has been set at its maximum level of 2.5 per cent of risk-weighted assets – a metric that measures the riskiness of different loans.
While OSFI kept the level the same, it announced plans to “review the DSB’s design and range” to ensure it remains effective in the long term.
If the bank regulator changes the range of the DSB – which is currently 0 to 2.5 per cent of risk-weighted assets – it could open the door to a requirement that banks hold more capital.
However, Mr. Hubbs said OSFI was not starting the review “with a pre-determined view of what the appropriate range is.”
He said the regulator would look at the lessons learned during the pandemic. In March of 2020, in the early stages of the COVID-19 pandemic, OSFI reduced the buffer to 1 per cent, freeing up some $300-billion of capital that banks could use as a shock absorber against the crisis. As the economy recovered, government stimulus programs helped drive down banks’ losses on loans, and bank capital reserves increased, the regulator raised the buffer back to its maximum levels earlier this year.
“As we saw during the pandemic it was important to have a buffer of useful capital that could be quickly released to provide ample support to bank’s lending capacity,” he said.
Banks have accumulated tens of billions of dollars of excess capital above regulatory minimums, and are planning to use some of it to buy back shares. All six major banks also recently announced large dividend increases after OSFI lifted temporary restrictions on capital distribution.
In the near term, OSFI said it is monitoring high household indebtedness and “imbalances” in housing markets, but that “near-term risks are moderate.”
Next Friday, Mr. Hubbs said the regulator will announce whether the mortgage stress test, or borrowing qualifications, will remain the same for uninsured mortgages. (Homebuyers do not need mortgage insurance if they make a down payment of 20 per cent of the property’s purchase price.)
Currently, borrowers have to prove they can make mortgage payments at an interest rate of 5.25 per cent. Under OSFI rules, lenders are required to stress test borrowers at the greater of 5.25 per cent or two percentage points above their contracted rate.
Earlier this year, OSFI toughened up the mortgage stress test as a proactive measure and said the housing-market conditions had the potential to put lenders at increased financial risk.
Household debt has rapidly increased over the course of the pandemic with homebuyers taking advantage of low mortgage rates to buy bigger properties. The average selling price of a home across the country is now 40 per cent higher than prior to the start of the pandemic,
Mr. Hubbs did not provide more detail on next Friday’s announcement. But OSFI has promised to communicate the mortgage stress test requirements every December. That is ahead of the spring home selling season, which has historically been the busiest period for real estate transactions.
For the capital buffer, OSFI reviews the level of the DSB every June and December, but can adjust the level of the buffer any time if necessary.
“The economic recovery is progressing and the financial resilience of Canada’s largest banks continues to be robust,” the regulator said in a statement.
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