Canada’s bank regulator is growing increasingly concerned about a risk event. This morning the Office of The Superintendent of Financial Institutions (OSFI) raised the Domestic stability buffer (DSB) target 50 basis points (bps) to 3.5% of risk weighted assets (RWA). Banks subject to the buffer will have until November 1, 2023 to get it done. This comes after a similar-sized increase this past February, which saw the DSB hit 3x 2020-levels. Not only is the regulator increasingly worried about a risk event, but this is going to throttle credit and make borrowing more expensive.
Domestic Stability Buffer
The Domestic Stability Buffer (DSB) is money that major banks have to set aside for a rainy day. In the event a bank needs emergency cash, the regulator can authorize the use of the DSB, avoiding the need for a taxpayer bailout. Great, so why not raise it to 50%, and have taxpayers never hear the word “bailout” again?
The impact of higher DSBs can cost you a lot more. As a risk event approaches, the DSB rate rises, meaning banks are setting aside more cash. This reduces credit liquidity, which means borrowers will have to compete for what’s left. Less credit liquidity results in more expensive credit, less credit, and/or harder qualifications.
When the risk event passes, the DSBs are typically lowered to release the cash back into the system. This helps increase credit liquidity, and delivers more cheap credit to help with a recovery.
DSBs are in addition to other regulatory capital buffers, and only apply to domestic systematically important banks (D-SIBs). D-SIBs is the technical term for a bank that’s vital for the operation of a country, and are better known in Canada as the Big Six.
Canada’s Bank Regulator Will Significantly Decrease Loans
The increase is one of the biggest signs that the age of low rates is over. At the end of 2022, OSFI raised the maximum DSB from 2.5% to 4.0%, to accommodate the current level. Prior to that, 2.5% was seen as the most extreme amount they may need to put aside. With the most recent announcement, these banks will have to put a share of capital aside that’s 40% larger than the max possible less than a year ago.
It’s hard to nail down exactly how much the move will reduce the credit supply. Back in 2020, the DSB was cut from 2.25% to 1.00% of RWA, and generated $300 billion in additional lending capacity. This helped to drive the record low rates seen, in addition to the Bank of Canada (BoC) rate cuts. Now imagine a similar concept but in reverse, and banks have seen the value of their RWA surge, so the share is even bigger in dollar terms.
Canada’s Overleveraged Households & Rising Delinquencies Contributed To The Decision
The regulator cited both domestic and global concerns as the reason behind the change. “Current vulnerabilities, including high household and corporate debt levels, the rising cost of debt, and increased global uncertainty around fiscal and monetary policy, coupled with Canada’s financial sector showing strength throughout the winter and spring has presented the opportunity for OSFI to build more resiliency in the system,” read the regulatory announcement.
Though, the change comes at the same time that Canada’s D-SIBs are extending mortgage repayment terms for much longer than typically allowed. Arguing that failing to extend the mortgages on overleveraged borrowers would result in a hardship, tying the regulators hands since they aren’t interested in forcing delinquencies.
By increasing the DSBs, OSFI will be forcing the banks to become more conservative with their lending. It’s a total G move, reigning in reckless lenders leaning on their “too big to fail” status.
Its just getting started….the recession is here and it will get much, much worse….get out of debt, do not buy a house….deals are coming….patience, patience….big deals on the way….
Deals are coming if you happen to be an investor with millions of dollars ready to deploy.
Otherwise, be ready to face the reality of reduced affordability thanks to tighter credit conditons
Looks like you smoked enough weed today, Govt is slowing the fast paced expansion of economy.
What happens when these bad mortgages hit the 105% loan to value wall? Any slight dip in valuation can start a cascade.
Thanks again Stephen. insightful with a doll up of sarcasm. Just how I like it!
In a hopeless situation, the Government doesn’t have any clarity & resolution.
“Arguing that failing to extend the mortgages on overleveraged borrowers would result in a hardship, tying the regulators hands since they aren’t interested in forcing delinquencies. ”
So, what they are saying is that there is no market economy anymore ? Are not those who are supposed to pay for bad decisions never have to? Looks like banks are not willing to pay for their bad decisions either. To me it increasingly looks like very large criminal case involving not just banks but those in the government who abated this sort of behaviour.
I’m not clear as to why raising the DSB restricts credit availability? Even if the banks have to ‘hold onto’ more cash, isn’t the issuance of credit in Canada simply done out of thin air? I mean, money is created when a bank issues a loan – it’s just an entry on a spreadsheet – they don’t actually loan you cash they have on hand, right?
My understanding is that’s how fractional reserve banking works – the (legal) ability to issue loans that are several multiples of what you actually have on hand. It would seem to me that raising the DSB would actually help in terms of being able to issue credit moving forward.
I think the more important effect of raising the DSB is that it sends a ‘signal’ to the banking sector that the government (i.e. OSFI) believes that moving forward, the public will have a harder time making payments on their debts, for whatever reason. Hence the reaction of the banking sector is to simply look more carefully at the issuance of loans.