Canada

Canadian Bank Regulator Tightens Credit, As The Household Debt Risk Emerges Again

Despite rainbows and unicorns, Canadian household debt problems didn’t just disappear. In fact, they got worse in many cases, and the economy is finally strong enough to start thinking about them. The Office of the Superintendent of Financial Institutions (OSFI), the country’s bank regulator, announced the domestic stability buffer (DSB) will rise in October. 

The buffer had been lowered at the start of the pandemic, to allow banks to lend more freely. This flooded the economy with hundreds of billions in additional lending capacity. Now that the economy is recovering faster than expected, OSFI is raising the buffer again. Concerns of debt vulnerability returned so fast, they raised the DSB to the highest level. Yes, even higher than it was before the pandemic.

Domestic Stability Buffer (DSB)

The domestic stability buffer (DSB) is an additional capital buffer to protect banks. All banks are required to set aside capital, those essential to the country need to put aside a little more. These banks are called Domestic Systemically Important Banks (D-SIBs), and Canada has six. The additional capital they have to put aside is the DSB. The regulator lets these banks tap the resource before touching an essential buffer. Kind of like defensive driving can let you avoid having to use your airbags.

When things are bad, the regulator lowers the DSBs so banks have more capital to lend. If the economy is weak, lenders tend to avoid as much risk as possible. This can mean tighter credit, more selective lending, and/or rising interest costs. If that happens, consumption can slow, making a downturn worse, or dampening a recovery. By lowering the DSB, even if bank revenues fall, they have a lot more capital to lend. Even if they don’t touch any of it, it being readily accessible helps to free up credit.

If the economy is doing well, the regulator increases the DSB, leaving the banks with less capital to lend. Banks aren’t as risk-averse, and are more willing to lend when incomes or revenues are flowing. Increasing the DSB tightens capital available to lend, while credit is growing. By throttling credit growth, they help to prevent too much risk to credit exposure. Less capital can mean an adjustment period or higher rates for some products.

Canadian Bank Regulators Asks Banks To Increase Buffer By 150%

The Canadian bank regulator is raising the domestic stability buffer — by a lot. The DSB will be rising to 2.5% according to this morning’s announcement. Banks have until October 2021 to set aside the additional capital. It’s always nice to get a few months notice when you’re asked to put aside billions of dollars.  

Pandemic Had Cut The Buffers, Flooding The Market With $300B More In Lending Capacity

Last year when the news of a pandemic first broke, OSFI lowered the DSBs. The buffer was cut to 1.0% in March 2020, down from 2.25% pre-pandemic. At the time they said this would free up $300 billion in additional lending capacity.

The idea is to make sure there is plenty of liquidity to keep the pipes of the financial system flowing. It may have worked a little too well though, with those pipes flooding the market. The regulator is now setting the DSB higher than pre-pandemic levels, to the highest rate allowed.

If that sounds like they’re trying to choke a little bit of credit growth, that’s because they are. Households and businesses have seen brisk credit growth. Despite this, little of that credit is turning into productive investments, like machinery. In the release, they said it was due to “key vulnerabilities such as household and corporate debt.” 

What does it mean for households? It depends on how the rest of the credit market responds, but this is credit tightening. Credit tightening generally brings higher rates and more difficult borrowing conditions. This is kind of the point — lenders don’t need additional incentive to lend in this environment.

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12 Comments

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  • Omar 3 months ago

    Wouldn’t this be the capital people thought would be going to dividends? Because that’s funny.

  • David Reiss 3 months ago

    Oh look, banks need more protection as people resume having to pay their bills. I’m confused because Stats Can made it seem like the economy has never been better with whole industries shut down, and wages soaring. I was hoping for a lockdown every couple years, whenever systemic household risk comes up. eye_roll.gif

    • Tom Wolfe 3 months ago

      Well Jesus, someone is finally saying what I have been saying since the rail closures before the pandemic. We have been f*cked for a long time now.

  • Party on 3 months ago

    The following numbers are from the Bank for International Settlements (BIS)

    Total credit to the non-financial sector (core debt), % of GDP (as of the end of the 4th quarter, 2020)

    Greece – 345.6
    Canada – 359.7

    https://stats.bis.org/statx/srs/table/f1.1

    The following BIS chart shows Canada’s total credit to its non-financial sector (core debt), as a percentage of its GDP from 1990 to the end of the 4th quarter of 2020:

    (At the end of 2006 it was 219)

    https://stats.bis.org/statx/srs/tseries/CRE/Q.CA.C.A.M.770.A?t=f1.1&c=&p=20204&i=6.10

    • Paul 3 months ago

      Thank you for posting this. If you google the same “type” of stat mostly you come up with a number hovering around 100% which we all know is impossible.

  • Matt 3 months ago

    Why 2.5% instead of 2.25%? It seems almost trivial when discussing numbers this large. Can they raise the ratio again if they need to?

  • Sam 3 months ago

    Let me get this straight. BOC lowers DSB so Banks can lend to bolster the economy to get through the pandemic. Money was supposed to finance manufacturing, start-ups etc….things that would allow companies and organizations to innovate and grow providing good jobs and good taxable economic activity during what would otherwise have been a stultifying downturn.

    Instead, the banks capitalized on the insatiable housing hunger brought on by the BOC’s other initiative, dangerously low interest rates. The Banks made large…better than even before the Pandemic while household debt skyrocketed, even more than before the pandemic. Other than real estate, no other industry really felt the benefit of this activity.

    Is this a better outcome than if the BOC kept the interest rate around 2.5% – 3% and didn’t lower the DSB? Just asking.

  • Ashley 3 months ago

    Very soon someone from one of the banks will come up with a story how debt is not that bad, things are totally under control and people should buy up condos as people are dying to return back to office and will scoop up every unit available.
    The other days an economist from CIBC was suggesting people should have atleast 4 real estate assets: a family house, a condo close to work, a cottage for family trips and an investment property.
    Why would debt be a bad thing 🙂

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