Canada’s banking regulator is working to change the way it treats some business loans, in an effort to make it more appealing for banks to lend to companies that are key to Ottawa’s plans to reshape the country’s economy.
The head of the Office of the Superintendent of Financial Institutions (OSFI), Peter Routledge, said Wednesday that the regulator is consulting with banks and life insurers “to help them help the country,” at a conference in Toronto held by Bank of Nova Scotia.
The forthcoming changes are intended to “rebalance” a highly technical set of rules by which the regulator assigns different levels of risk – known as “risk weightings” – to different types of bank loans.
Those weightings help determine how much capital a bank has to hold in reserve against its loan portfolio, which in turn shapes decisions about who gets loans and how much banks lend.
In July, OSFI announced lower capital requirements for life insurers making investments in Canadian infrastructure through debt or equity, helping open the door to increased support for projects.
This fall, OSFI is ramping up similar work with major banks, and plans to release documents outlining “significant adjustments” to relative risk weightings for bank loan portfolios.
The work was prompted in part by the dramatic shift in U.S. tariff policy that is already harming businesses in hard-hit industries such as aluminum, steel and automotive manufacturing, and has created widespread uncertainty for business owners.
“It woke us up,” Mr. Routledge said.
So far, the banking and insurance sectors that OSFI regulates have proved to be resilient, and “where we are now is a lot better than we thought and a lot better than we feared,” he said.
But as Canada’s economy adapts to massive change, and as Ottawa seeks to make major investments in infrastructure, energy and defence, Mr. Routledge said OSFI is concerned about a long-term shift that has led banks to lend less in relative terms to businesses.
Whereas commercial lending accounted for about 60 per cent of banks’ loan portfolios in 1982, it now makes up about 25 per cent of current loan books, he said. That is partly because risk weightings on business loans are often three to four times higher than loans to households, such as a mortgage, which skews their relative profitability.
The result has been that banks in Canada and abroad have pulled back on some types of lending to small and medium-sized businesses, as well as large corporations. In the U.S., a booming private credit sector has seen investors raise vast pools of capital to make direct loans to private companies, often at higher interest rates. But in Canada, banks are still the main source of capital for many businesses.
If the trend away from business lending continues, it could constrain new economic investment and growth. OSFI’s initiative to tweak risk weightings seeks to help rebalance the mix of bank loans.
“Maybe a bit more commercial exposure would be good not only for the banks, but good for the country as we adapt our economic model,” Mr. Routledge said.
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Banks’ lending to the defence sector, in particular, “is arguably a little low,” but in recent decades that has been more because of modest Canadian investment in defence, rather than regulatory constraints, Mr. Routledge said.
OSFI would at least consider adjusting risk weightings for defence lending – especially if new public-private partnerships are created – to encourage lenders to support Canada’s loftier spending targets for national security, he said.
“Until I see a proposal I can’t really say, but we are open for business on considering that,” he said.
Last week, the chief executive officers of some of Canada’s largest banks said they are encouraged by the federal government’s commitment to getting major projects off the ground and diversifying the country’s exports.
“We stand ready to meet that moment and work with governments and private sectors,” Toronto-Dominion Bank CEO Raymond Chun said on a conference call with investors.
Most of that economic planning is still in its early stages, “but at least we’re talking about it,” National Bank of Canada CEO Laurent Ferreira said in an Aug. 28 interview.
“I get a sense that everyone is on board. It’s not just the federal government, but it’s also the provinces and it’s the business community. And this sense of urgency is unprecedented,” he said.
“I think everyone in this country knows that we need to get our act together and get back on a prosperous path.”
Mr. Routledge warned that OSFI is not “the secret sauce or the magic thing” that will suddenly unlock much greater lending to businesses among banks, or investment by large insurers. “We’re not the critical success factor but we’re an enabler to drive that.”
The changes also won’t happen overnight, and OSFI will be wary of undoing too many of the increased capital requirements that have helped shore up the banking system against unexpected shocks since the 2008 financial crisis.
“Can we do anything, without costing ourselves too much resilience, to stay out of the way of that shift in relative capital allocation?” Mr. Routledge said. “That’s the question.”