Canadian Bank Watchdog Delays Plans to Hike Capital Requirement

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(Bloomberg) — Canada’s financial regulator is giving the country’s banks more time before they’re forced to change how they calculate lending risks, rules that some have warned could prompt banks to reduce lending. 

The Office of the Superintendent of Financial Institutions said Friday that it will delay regulations on “capital floor levels” that would require Canadian banks to calculate more of the risks in their loan books using a standardized model, in lieu of internal methods, by a year.

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The planned changes, which would phase in over several years, are part of the global Basel III accords, meant to limit financial contagion in the event of a crisis. They reflect concerns that some banks’ internal assessments don’t adequately capture risk.

Canada is still ahead on implementing many of the Basel III reforms, but Friday’s extension on the capital floor rules will give the regulator the chance to consider the pace of implementation in the US and other countries — and give Canadian banks more time to get their books in order. 

“With respect to the final leg of the changes we’re making, which is known as the ‘standardized floor’ — which is very complex, but is basically a check on the models banks use to allocate capital — we are well ahead of our peers,” Peter Routledge, superintendent of financial institutions, told Canadian lawmakers during a parliamentary committee hearing last month. He said OSFI was consulting with industry on the “right schedule” for the rising floor.  

New bank capital rules proposed in the US last summer have faced fierce opposition from lenders, with lobbyists arguing the plan would dent competition in the industry and make home and business loans less affordable.

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US officials haven’t reached an agreement yet, but there have been signs the proposal will be scaled back or changed significantly. That debate south of the border has highlighted how far ahead Canada has been on implementing the changes.

Delaying the capital floor changes also removes a potential economic headwind as some analysts have warned that the rules could further stifle loan growth when Canadian households are contending with rising unemployment and higher-for-longer borrowing costs.

In a report to investors, Bank of Nova Scotia Chief Economist Jean-Francois Perrault warned that the original plan for implementation of the new rules had the potential to reduce lending to households and firms by about 9% of nominal GDP “at a time of elevated financing needs.”

“Risk-weighted assets are overwhelmingly in corporate and retail lending,” he said, adding that “any asset shedding would likely be concentrated in these areas and would see banks lend less than would otherwise be the case to companies and individuals to meet these objectives.”

Cost of Capital Rules

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National Bank of Canada analysts led by Gabriel Dechaine warned last month that while the intent of the capital-floor rules in Canada is to ensure banks properly reflect the risk inherent in their loan books, “conservative capitalization has a cost.”

In a report to clients on June 18, they modeled the impact of applying the full output floor to the Canadian banks’ most recent quarterly balance sheets and estimated that an additional C$80 billion ($59 billion) in risk-weighted assets “would hit the sector.”

To keep capital ratios in line with regulatory minimums, most of the country’s banks would have to either increase their common equity tier 1 capital or cut some of their lending.

In preparation for changing capital rules, the analysts noted, some banks have already been employing a range of strategies, including Bank of Montreal’s use of synthetic risk transfers and its decision to exit indirect auto lending the Canada and the US, as well as Scotiabank’s deliberate curbing of its mortgage book.

“The CBA and its members acknowledge OSFI’s pause to Basel III Output Floor phase-in to review other jurisdictions’ implementation plans,” the Canadian Bankers Association, a lobby group for the industry, said in an emailed statement. “We will look forward to further information from OSFI on their review.”

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