The Office of the Superintendent of Financial Institutions said Tuesday that it will increase the buffer – a capital reserve that banks build to soften the blow of an economic downturn – on Nov. 1, hiking it to 3.5 per cent from 3 per cent of a bank’s risk-weighted assets. The move is the second increase in the past six months as OSFI ramps up “insurance” against mounting risks to the financial sector.from 0 to 4 per cent of a bank’s risk-weighted assets.
“Today’s decision reflects our assessment that financial system vulnerabilities remain elevated and, in some cases, have continued to increase,” said OSFI superintendent Peter Routledge told reporters Tuesday. “We are in a period of rising interest rates and home prices have begun to climb again. Households and corporates remain highly leveraged, making them more vulnerable to economic shocks.”
A change in the DSB also prompts an adjustment in the minimum capital levels that a bank is expected to hold. The common equity tier 1 ratio – a measure of a lender’s ability of absorb losses – will increase to 11.5 per cent from 11 per cent. The hike means that the banks will have to hold billions of dollars in excess capital. All six banks currently exceed the minimum threshold.
When the economy is strong and loan losses are lower, banks are expected to build capital reserves. The regulator can later release it to help banks absorb losses if the economy sours. But by tasking the lenders with holding onto money, they have less capital to invest in growth opportunities or to give back to shareholders through dividend increases or share buybacks.
While OSFI can change the DSB any time, it announces a decision to change or hold the level twice each year. The buffer applies only to the institutions that are considered systemically important, including Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank of Canada.