Summer 2013

Global Finance: Reflections and Considerations

Excerpt from remarks by Superintendent Julie Dickson to the 2013 Bloomberg Canada Economic Summit – Toronto, ON – May 21, 2013

Global Economy a Concern

Let me start at the broadest possible level – the global economy. The IMF talks about a three-speed global economy: countries doing well (these tend to be emerging market economies and developing economies such as Asia, which account for about three-quarters of global economic growth); countries on the mend (that is, the U.S.); and countries that continue to have major problems; Europe, the U.K., Japan are examples. While the IMF did not reference Canada in its three-speed global economy survey, the Bank of Canada continues to project slow economic growth in the coming years.

The aggressive response by central banks to the global financial crisis, as well as the weak global economy, has manifested itself in very low interest rates. Sustained low interest rates are a major area of focus for OSFI. When low interest rates first appeared, OSFI saw that the impact was most noticeable on pension plans and insurance companies. But a sustained low interest rate environment, especially combined with a flat yield curve, affects the banking sector as well, largely through squeezing net interest margins, which negatively affects revenues.

This environment can provide incentives for banks to grow their earnings asset base by trying to gain market share (a zero sum game), increase fee income activities, reduce expenses, enter new markets, and by increasing the proportion of higher-yielding assets. Of more concern, products and businesses that are over-reliant on low financing costs tend to grow and borrowers are strongly incented to increase leverage.

The impact of low interest rates can clearly be seen in the Canadian real estate market. Consequently, the real estate lending market has been a significant area of focus for OSFI, because of the significant incentives for consumers to borrow and for banks to maintain revenues, the size of mortgage lending portfolios, the concerns about some markets being overvalued, and the possibility that customers’ debt serviceability could be masked by low interest rates.

Thus, for some time, OSFI has been conducting major reviews of bank mortgage lending portfolios. We have issued a guideline that includes a set of best practices for prudent residential mortgage lending. Further, the Minister of Finance has taken steps to place restrictions on mortgage insurance. All of these measures have led to some welcome changes in the market, slower growth in household credit, and a more balanced picture overall.

The Importance of Implementing Basel III

Since the global financial crisis began, there has been tremendous focus on prudential regulation of banks, as we have seen that failing banking systems wreak havoc on economies and governments. The crisis demonstrated the importance of the safety and soundness of banks, especially those that are systemically important.

Canada’s banking system fared reasonably well through the financial crisis. Because of this, I am often asked why OSFI is in such a rush to implement Basel III. I would like to take this opportunity to highlight a few of the reasons why OSFI required immediate implementation of Basel III beginning in 2013, and also why the surcharge on the big six banks will apply as of 2016, and will not be phased in.

First, as noted earlier, the current global economic environment is not comforting. When in uncharted waters, you do not want to test whether the boat is sound enough. We need to be prepared in the event of serious downside risks materializing.

Second, while the European Union and the U.S. have not yet adopted Basel III and only recently released their respective guidance for Basel III, other countries such as Australia, Singapore, Switzerland and China, have – in some cases with higher requirements than Basel III dictates. Even the U.S., has required its banks to consider Basel III capital levels as part of supervisory control of dividends and share buy-backs. Consequently, there has been a doubling in the last four years of the capital in the largest U.S. banks. In addition, U.S. supervisors are openly discussing whether Basel III should be revised in the future to make the capital and liquidity requirements even more onerous on large banks.

Third, Canada’s banks have been rated the strongest in the world, in part due to our strong standards. The International Monetary Fund (IMF) has noted that, “Canada’s banking system is well capitalized, has posted another year of strong profits, and continues to show low non-performing loans, also owing to high prudential standards and rigorous supervision.” More recently, Bloomberg included four Canadian Banks in its list of the top ten strongest banks in the world.

These references to high prudential standards do not come free of charge. They require that supervisors be vigilant, and that financial institutions implement internationally agreed upon standards. Strong regulation and supervision can be reflected in better ratings, and better ratings can allow for cheaper funding. From this perspective, strong supervision impacts the bottom line of a financial institution in a positive way. It does not limit opportunities; it expands them.

We, at OSFI, need to continue to assess vulnerabilities and our responses to them. As some have noted, “OSFI is a dark place” because of our focus on all the things that can go wrong. But it is a focus that has proven to be valuable. And this gives me comfort that Canada will continue to enjoy a safe and sound financial system.

Click here to view the full text of the Superintendent’s remarks.

Let There be Light: Transparency and the Financial System

Excerpt from remarks by Assistant Superintendent Mark Zelmer to the BMO First Annual Reserve Management Conference – Toronto, ON – May 7, 2013

There has been a fair amount of concern expressed about the way in which banks compute the risk-weighted assets denominator in their regulatory capital ratios. Some observers claim that allowing banks to use their own internal risk models to measure risk results in asset risk weights that are too complex and difficult to understand. Others argue that this also provides too much flexibility to banks and their supervisors on how risk should be measured, making it difficult to compare risk management practices and reported capital ratios across banks.

OSFI believes Canadian D-SIBs should have public information disclosure practices covering their financial condition and risk management activities that are among the best of their international peers. That is why we announced in our recent D-SIB Advisory that the six major Canadian banks are expected to adopt the recommendations of the Financial Stability Board’s Enhanced Disclosure Task Force (EDTF).

Many of the recommendations are already in place here in Canada, given the strong disclosure practices of the six major Canadian banks. And, I am pleased to report that they have agreed to implement the remainder over the course of this year and next. 

In the case of risk-weighted assets, the major banks will be enhancing their disclosures to help users understand how bank risk models are influenced by data inputs, modelling assumptions, mathematical formulations, manual overrides and point-in-time versus through-the-cycle assumptions. We should also see more explanations as to how banks assess model performance, including how credit risk models perform relative to actual default and loss experience.

We also recognize that some investors would welcome more information on the funding and liquidity profiles of the six major Canadian banks. Therefore, and consistent with EDTF recommendations, the six major banks started producing a contractual maturity table of their financial assets and liabilities, including off-balance-sheet items, when they reported their first quarter results. Later this year, this will be expanded to include more granular details on items with a less than one-year maturity, as well as more details on where liquid assets are held within the banking group and on how encumbered assets impact the pool of liquid assets. You can also expect to see more information emerge over time on bank funding sources and how they are evolving over time.

These address only a few of the recommendations. Overall, OSFI believes these new disclosures will be useful in assessing Canadian banks and their risk and liquidity management practices. Indeed, we hope it will help to underscore further the strength and stability of the major Canadian banks.

Click here to view the full text of the Assistant Superintendent’s remarks.

OCA Releases Business Plan for the 2013-2016 Planning Period

The mission and mandate of the Office of the Chief Actuary (OCA) are central to its contribution to Canadians and Canada’s retirement income system. The OCA strives to provide actuarial advice and contributes to enhancing public confidence in the retirement income system, the federal public sector retirement system and other social security programs in which the Canadian taxpayer is a stakeholder.

The OCA monitors and communicates future demographic and economic risks by submitting regular statutory actuarial reports. These reports are designed to inform Members of Parliament, representatives of client departments and decision-makers, thereby contributing to greater public confidence in the management of the programs.

The Office of the Chief Actuary tabled its 2013-2016 Business Plan before Parliament on May 31, 2013. It outlines key challenges and risks and describes the OCA’s priorities for the planning period.

Click here to view the OCA business plan.

OSFI Survey: Financial Institutions Survey Findings

In the fall of 2012, OSFI commissioned The Strategic Counsel, an independent research firm, to conduct a confidential survey with executives of the financial institutions that OSFI regulates. The primary objective was to assess OSFI’s performance as a prudential regulator and supervisor.

The questionnaire was administered primarily via an on-line survey, and through some in-person interviews. All active financial institutions regulated by OSFI were invited to participate. The report presents the responses in summary form; OSFI does not know how specific institutions responded.

Overall impressions of OSFI as a regulator and supervisor are positive in nearly all areas. Most of the results from the 2012-13 survey are consistent with those conducted in 2007-08 and in 2010-11. The most positive ratings in 2012-13 pertain to the issue of contributing to public confidence, consistent with previous survey results.

OSFI appreciates the feedback provided through this consultation. Based on the results, no areas have been identified as requiring immediate improvement. However, OSFI will continue undertaking in-depth, industry sector consultations to monitor our performance and implement improvements, as required.

Click here to view the survey results.

Minimum Capital Test Discussion Paper and Quantitative Impact Study

The Office of the Superintendent of Financial Institutions is performing an in-depth review of the regulatory capital framework for federally regulated property and casualty (P&C) insurers in order to ensure that capital requirements are more closely correlated with the evolving risks and risk management techniques in the P&C industry.

Some of the key proposed changes to the P&C insurance capital framework are to :

• Revise the composition of regulatory capital, qualifying criteria for eligible capital instruments, and applicable limits and to clarify and amend regulatory adjustments to capital;
• Revise the risk factors for insurance premiums and claims liabilities, with the recognition of an implicit diversification credit within the insurance risk factors;
• Review all credit risk factors for balance sheet assets and make adjustments where deemed necessary;
• Revise the risk factors for structured settlements, derivatives and other exposures with more granular risk factors based on a credit rating and term to maturity of an exposure.

P&C insurers were invited to provide comments on the proposed changes to the regulatory capital tests. Moreover, to estimate the capital impact of the proposed changes, all P&C insurers were requested to participate in a quantitative impact study (QIS) so that OSFI can assess the appropriateness of the new framework and ensure that it is more risk based as compared to the current MCT.

OSFI will consider the industry’s comments on the proposed changes to the regulatory capital framework, as well as the QIS results, in the preparation of the draft MCT Guideline, which will be issued for public consultation before the end of 2013. The final MCT Guideline is expected to be issued in the summer of 2014 and will take effect on January 1, 2015.

Click here to view related documents and more proposed changes.

Recent Postings

Basel Pillar 3 Capital Disclosure Requirements

On July 2, 2013, OSFI posted an advisory that builds on OSFI’s November 2007 Advisory on Pillar 3 Disclosure Requirements, by providing clarification on the implementation of the Basel Disclosure Rules for all institutions subject to Pillar 3 disclosure requirements.

Click here for the advisory and related documents and more details.

Revisions to Incorporation Guides and Transaction Instructions

A number of Guides and Transaction Instructions have been updated to make OSFI’s expectations for incorporation more transparent. The revisions reflect OSFI’s expectations and practices as at December 31, 2012. As these expectations and practices continue to evolve, the Guides and Transaction Instructions will be updated as needed.

Click here to view the updated guides and transactions.

Update on Regulatory Reporting System (RRS)

As part of an ongoing project to modernize filing of corporate and financial returns, the RRS will be used to gather and process financial and corporate returns collected by OSFI, the Canada Deposit Insurance Corporation, and the Bank of Canada. The new RRS is scheduled to be implemented for Deposit-taking institutions in September 2013.

Click here for more details on the update.

InfoPensions – Issue 9 – May 2013

On May 21, 2013, OSFI’s Private Pension Plans Division released InfoPensions Issue 9, which included announcements and reminders on issues relevant to federally regulated private pension plans as well as descriptions of how OSFI applies selected provisions of the Pension Benefits Standards Act, 1985 (PBSA), its regulations, directives and OSFI guidance.

Click here to read InfoPensions.