Canada’s enthusiasm for Basel III threatens to do harm

Article content

Following the 2007-2008 financial crisis, central banks from 28 countries and bank regulators devised an international regulatory accord called Basel III. Published in 2010, it promised common standards for measuring, reporting and managing financial risk across all 28 jurisdictions by imposing new, higher capital charges — the money a bank holds in reserve to cover bad loans and losses from trading stocks, bonds, derivatives and other financial products.

Article content

Basel III’s complex methodology is the stuff tech geeks dream of. Small armies of PhDs in mathematics and physics, consultants, project managers, business analysts and change managers were hired by banks around the world at a cost of hundreds of millions of dollars to assess and implement it. Basel III is full of terms ordinary people have never heard of — risk-weighted assets, fundamental review of the trading book, output floors — the kind of technical jargon that in plain speak means more constraints on bank lending and trading.

Canada was an enthusiastic voice for global change and a respected one. Canadian banks were a model of financial stability when 25 banks in the United States failed in 2008, and almost 400 more failed in the following three years. In 2010, devising very conservative rules in Basel III for banks to guard against losses was understandable in the U.S., European Union and United Kingdom.

But given the performance of the Canadian banking system throughout and after the financial crisis of 2007-2008, Canada is the last jurisdiction that needed to adopt Basel III.

Article content

Article content

In 2010, the Basel III plan was for the 28 countries to implement the change between 2013 and 2015. Yet, implementation was repeatedly delayed for various reasons. It was too complex (true), it could further hobble banks that were already weakened by the financial crisis (also true) and the economic impact would reduce economic growth (fact).

The one lesson the banking history of Canada and abroad teaches us is that regulatory reforms born of crises are less likely to be implemented as time passes and the cool light of day focuses attention on the economic costs.

Fifteen years later, Canada’s enthusiasm continues while it has ebbed in other jurisdictions. That enthusiasm for Basel III threatens to do more harm than good to the Canadian banking system and those it serves. Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), is front-running Basel III, requiring implementation by the middle of 2026.

The U.S. Federal Reserve has publicly indicated it will not impose the Basel III rules as written, and will, if it implements them at all, deliver a U.S.-friendly version of the regulation. Full implementation in the U.K. isn’t likely until 2030. The EU is looking at 2032. What is certainly possible is that neither the U.K. nor the EU will implement Basel III if the U.S. doesn’t.

Article content

On June 19, the Financial Post’s Barbara Shecter reported that National Bank of Canada financial analyst Gabriel Dechaine had run the numbers on Basel III’s impact on Canadian banks and found they would undermine “individual bank earnings potential,” restrict “lending to certain segments” and reduce competition.

Over at the Bank of Nova Scotia, economist Jean-Francois Perrault is also ringing the alarm bells. He makes it clear why the average Canadian should be concerned: “Implementation may require banks to shed up to $270 billion in risk-weighted assets to meet the output floor by mid-2026. This would reduce lending to firms and households, including mortgage credit, by about nine per cent of current nominal GDP at a time of elevated financial needs.”

The shedding is already taking place, according to Dechaine. He said Scotiabank’s domestic mortgage book has declined five per cent (or $15 billion) since the first quarter of 2023 and that its corporate loan book has declined 13 per cent (or $17 billion) between the second quarter of 2023 and 2024.

With Canada Mortgage and Housing Corp. reporting that 2.2 million mortgages are up for renewal in 2024 and 2025, shrinking access to bank mortgages in the run-up to Basel III going live in 2026 will directly impact the average Canadian.

Article content

Perrault plainly states that “government-mandated requirements to shed assets (or raise capital) run counter to efforts to raise investment and improve access to the housing market for Canadians. This seems to be another instance of policy inconsistency in the Canadian policymaking landscape.”

In April, Royal Bank of Canada chief executive Dave McKay pointed to the danger of OSFI pushing too hard to implement Basel III at the expense of Canada’s competitive position, saying “we cannot get out of sync with our two major competitive markets, Europe and America.”

Undermining the competitiveness of Canadian banks has a domino effect. For consumers and businesses, it means higher banking costs compared to the U.S. Larger Canadian businesses that have U.S. connections are more likely to take their business to a U.S. bank, which can provide more credit at lower prices. This costs jobs for Canadians who work at banks.

Getting “out of sync” may also push foreign banks supervised by OSFI out of Canada, rather than operate under a higher-cost, higher-capital regulatory regime. Did that play a part in HSBC Holdings PLC selling its Canadian arm to RBC?

Article content

The Canadian banking system proved its mettle in the financial crisis of 2007-2008 without Basel III. The not-so-secret sauce to Canadian banking success over its history is that stability is more than good prudential regulation. It is also the product of well-managed, profitable, globally competitive banks that can serve the needs of Canadian businesses and consumers and, in the process, grow the Canadian economy.

OSFI and the federal government would do Canadians a favour by remembering this reality and putting the full implementation of Basel III permanently on hold, or at least until such time as the U.S., U.K. and EU implement it themselves.

John Turley-Ewart is a regulatory risk management consultant and Canadian banking historian.

Article content