Canada’s bank regulator is quietly asking the country’s largest banks to put aside a lot more rainy day cash. OSFI, Canada’s bank regulator, increased the domestic stability buffer (DSB) on Thursday. The move would see its Big Six financial institutions set aside significantly more capital for a risk-related event. The move will lower the need for taxpayer bailouts, but it will reduce credit availability.
Domestic Stability Buffer
Domestic stability buffers (DSBs) are a capital cushion that major banks have to set aside. The capital is then used as a tool to manage liquidity without the need to resort to a taxpayer bailout. If a risk event hits and reduces credit availability, the regulator authorizes a reduction of the DSB. This helps to facilitate more loans, and at a more cost effective interest rate.
Similarly, before an expected risk event OSFI might increase the DSBs to ensure sufficient capital is present. This throttles credit for a short period, but fills the coffers with emergency capital that can be deployed later on.
All domestically systemically important banks (D-SIBs) are subject to meeting the DSB. For those not in banking, a D-SIB is a bank that’s vital to the operation of a country, and therefore needs to have more safety measures in place. In Canada, those are better known as the Big Six banks. The requirement is in addition to their capital conservation buffer, surcharge, and minimal capital requirements.
Canada’s Big Six Will Have To Set Aside An Extra 3% Capital Buffer
Canada’s bank regulator raised the DSB yesterday, giving banks until February 2023 to put aside 3% of RWAs. It’s an increase of 0.5 points from the current rate, increasing the share by nearly a fifth. In 2020, it had been cut to just 1%, so we’re seeing that share nearly triple over the course of two years.
What does that mean in practical terms? It depends on other factors, but generally this is a reduction in credit liquidity. The intended impact is tighter lending, which can mean higher rates, higher qualifying levels, and/or reduced liquidity. This also means in the event of recession, the Big Six won’t be as dependent on taxpayer bailouts. They’ll probably still get a bailout in a crisis, but they won’t technically need one.
Canada’s Bank Regulator Is Warning Banks They’ll Need To Set Aside More Capital Than Previously Thought
A small detail many might miss is that the 3% DSB will be higher than the regulatory maximum. That’s because OSFI also increased the maximum DSB from 2.5% to 4.0% as well. Remember, the DSB is in addition to other capital buffers banks are required to hold. Reading between the lines, this can be indicative of a regulator that sees the potential for risk and volatility to be much higher than previously expected.
The prudential changes are just one of the big changes to address the mess we just witnessed. Early this year, OSFI also confirmed financial institutions will begin to assign higher risk weights to investor mortgages by next year. The BASEL III-driven change will lower investor activity, throttling even more credit to the segment. This will help prevent re-inflation when the impact of DSBs and higher interest rates begin to wear. This is a global change, so simply switching governments won’t just stop the move.