OSFI Actions to Address Operational Issues Stemming from COVID-19

Document Properties

• Type of Publication: Letter
• Date: March 27, 2020
• To: Federally Regulated Deposit Taking Institutions (DTIs)

OSFI continues to actively monitor the evolving situation with COVID-19 and has been in frequent contact with institutions to assess their operational capacity and plans to address developing situations in the current economic environment.

As a result of these ongoing discussions OSFI is taking a number of steps to reprioritize its work and requirements to allow institutions to focus on their resilience efforts and their contributions to financial stability.

In its March 13 press release, OSFI communicated that it is suspending all of its consultations and policy development on new or revised guidance until conditions stabilize. Further, OSFI has adjusted a number of regulatory reporting requirements, and has encouraged institutions to use their capital and liquidity buffers as appropriate.

OSFI is today announcing a comprehensive suite of adjustments to existing capital and liquidity requirements that are not appropriate in the current extraordinary circumstances. All of the measures noted below are being introduced to afford institutions further flexibility in addressing current conditions while promoting financial resilience and stability. Over the coming weeks, OSFI will provide additional details on the implementation and disclosure issues associated with these changes. In addition, for those items that are temporary in nature OSFI will also provide guidance on the unwinding of the accommodations at the appropriate time.

OSFI will continue to engage DTIs on further developments and potential changes over the coming weeks. Institutions should be proactive in informing their OSFI Lead Supervisor of any financial or operational challenges they encounter as a result of COVID-19. Where further clarifications to supervisory or regulatory expectations are required, institutions and other stakeholders will be notified in a timely manner. When conditions return to normal, we will review the full suite of measures listed below for relevance at that time.

Loans subject to payment deferrals will not be considered past due

In situations where mortgage payment deferrals are granted by DTIs, these loans will continue to be treated as performing loans under the Capital Adequacy Requirements (CAR) Guideline. This means that these loans will not be subject to a different risk weight under the Standardized Approach to credit risk and will not be considered delinquent when determining the probability of default under the Internal Ratings Based Approach as a result of these payment deferrals. DTIs should continue to assess the credit quality of these borrowers and follow sound credit risk management practices.

If other types of loans (e.g. small business loans, retail loans (including credit cards) and mid-market commercial loans) are granted similar payment deferrals by DTIs, these loans will be afforded the same capital treatment as described above.

This temporary capital treatment will remain in place for the duration of the payment deferral, up to a maximum of 6 months. This treatment will be revisited in the future as needed. Institutions granting payment deferrals will be subject to additional reporting requirements surrounding these loans. Additional details on these reporting requirements will be communicated to DTIs in the coming weeks.

Transitional arrangements for capital treatment of expected loss provisioning

In line with other jurisdictions, OSFI will introduce transitional arrangements for expected credit loss provisioning that are available under the Basel Framework. This will result in a portion of allowances that would otherwise be included in Tier 2 capital to instead be included in Common Equity Tier 1 (CET1) capital.

The adjustment to CET1 capital will be dynamically measured each quarter as the increase in Stage 1 and Stage 2 allowances relative to the baseline level. The baseline level is the amount of Stage 1 and Stage 2 allowances as at the quarter ending December 31, 2019 (for December year-end DTIs) or January 31, 2020 (for October year-end DTIs). This increased amount is adjusted for tax effects and subject to a scaling factor that will decrease over time. The scaling factor will be set at 70% in fiscal 2020, 50% in fiscal 2021 and 25% in fiscal 2022. Allowances allocated to portfolios treated under the Internal Ratings Based Approach that are in an Expected Loss (EL) shortfall position during the transition period will not be eligible for the transition.

Covered bond limit temporarily increased to enable greater access to Bank of Canada facilities

Currently, total assets pledged by a DTI for covered bonds must not, at any time, represent more than 5.5% of the issuer’s on-balance sheet assets as specified in OSFI’s letter of May 2019 on the revised covered bond limit calculation (link). Due to the current exceptional circumstances, OSFI will permit DTIs to temporarily exceed this limit in order to allow these institutions to pledge covered bonds as collateral to the Bank of Canada. During this time, total assets pledged for covered bonds must not exceed 10% of a DTI’s total assets, including instruments issued to the market and those pledged to the Bank of Canada. The maximum amount of pool assets relating to market instruments remains limited to 5.5%. This temporary relief will be provided for at least a year and could be extended beyond this, if needed. Institutions which exceed the 5.5% limit will be expected to return below this threshold as soon as market funding conditions permit, and provide a plan to OSFI outlining their proposed approach and timing to return below the required threshold.

DTIs are encouraged to use Leverage Ratio buffers

Similar to the risk-based capital ratios, DTIs are expected to hold operating buffers above the regulatory minimum leverage ratio. These buffers are held in normal times to help ensure that an institution has additional flexibility in times of stress. OSFI is encouraging institutions to use operating buffers that are held above the authorized leverage ratio of the institution.

Institutions’ liquid asset pools are designed to be used

Under OSFI’s Liquidity Adequacy Requirements (LAR) Guideline, OSFI expects that an institution will use the stock of unencumbered high quality liquid assets (HQLA) it holds within the Liquidity Coverage Ratio (LCR) as a defense both against the potential onset of liquidity stress and during a period of liquidity stress. OSFI emphasizes that current guidance states that: “during a period of financial stress, institutions may use their stock of HQLA, thereby falling below 100%, as maintaining the LCR at 100% under such circumstances could produce undue negative effects on the institution and other market participants.”

Adjustments to OSFI’s liquidity requirements

OSFI is providing the following guidance to institutions related to the LCR minimum standard:

• No LCR outflow for secured funding transactions with the domestic central bank – OSFI confirms that, in line with the current provisions in OSFI’s LAR Guideline, Chapter 2, paragraphs 93-94, no LCR outflow is assumed to occur for secured funding transactions with an institution’s domestic central bank, regardless of the type of collateral utilized in the transaction.
• No LCR outflow for bankers’ acceptances (BAs) sold to the Bank of Canada under the BA Purchase Facility (BAPF) – Institutions do not need to recognize an outflow (i.e., 0% outflow rate) for BAs sold to the Bank of Canada under the BAPF. All other stamped BA liabilities issued by the institution that mature within 30 days should continue to be included at a 100% outflow rate per LAR Guideline, Chapter 2, paragraph 90.
• Expansion of the LCR treatment of term deposits for retail and small business under hardship situations – Institutions are permitted to extend the definition of ‘hardship’ to include situations borne out of current circumstances, which align with the spirit of what is currently included in the existing definition (e.g., reduced income for a depositor). Institutions should document these additional situations and track the amount of deposits that are provided under this extended treatment.

In addition, OSFI is providing flexibility within the Net Stable Funding Ratio (NSFR) treatment for assets encumbered as part of central bank liquidity operations during stress periods. Specifically, under paragraph 31 of the NSFR, assets pledged for exceptional central bank liquidity operations (i.e. those considered to be non-standard, temporary operations conducted by a central bank in order to achieve its mandate in a period of market-wide financial stress and/or exceptional macroeconomic challenges, per footnote 19 of OSFI’s NSFR rules) are permitted to receive the same Required Stable Funding (RSF) factor that is applied to an equivalent asset that is unencumbered, regardless of the remaining term of encumbrance. On a temporary basis, institutions are permitted to utilize this treatment up to a maximum RSF factor of 50% for any eligible asset pledged to the Bank of Canada to secure funding.

Applying IFRS 9 in extraordinary circumstances

IFRS 9 is principles-based and requires the use of experienced credit judgement. Consistent with OSFI’s IFRS 9 Financial Instruments and Disclosures guideline^{Footnote 1}, OSFI is providing guidance on three specific aspects of the accounting for Expected Credit Losses (ECLs) due to the exceptional circumstances arising from COVID-19. OSFI believes this guidance will allow DTIs to remain compliant with IFRS as issued by the International Accounting Standards Board. DTIs should also consider any additional guidance provided by the International Accounting Standards Board on the application of IFRS 9 in relation to COVID-19.

Significant Increase in Credit Risk

Under the IFRS 9 ECL accounting framework, DTIs should consider both quantitative and qualitative information, including experienced credit judgment, in assessing for significant increase in credit risk. In OSFI’s view, the utilization of a payment deferral program should not result in an automatic trigger, all things being equal, for significant increase in credit risk.

Forward-looking information

IFRS 9 requires the consideration of past performance, current conditions and reasonable and supportable forward-looking information over the life of the exposure to measure ECL. In determining the economic impacts of COVID-19, DTIs are encouraged to consider the exceptional circumstances, significant government support, the high degree of uncertainty and established long-term economic trends evidenced by past experience in determining reasonable and supportable forward-looking information.

Disclosure

Due to the exceptional and sudden change in economic conditions, OSFI expects DTIs to provide sufficient and timely disclosures to allow users to understand assumptions and judgements made by management during the period to address the COVID-19 outbreak. Disclosures should include transparency on the nature and uptake of payment deferral programs and significant changes made to forward-looking information and economic forecasts compared to the prior reporting period.

Implementation of Basel III reforms is delayed

On March 27, 2020, the Group of Governors and Heads of Supervision (GHOS), the Basel Committee on Banking Supervision’s (BCBS) oversight body, announced a delay in the international implementation of the Basel III reform package^{Footnote 2}. This measure was introduced to provide additional operational capacity for banks and supervisors to respond to the immediate financial stability priorities resulting from COVID-19 on the global banking system.

In line with that extension, OSFI is deferring the following implementation dates of the Basel III reform package:

• OSFI’s implementation date for the final set of Basel III reforms published by the BCBS in December 2017 is being delayed to Q1 2023^{Footnote 3}. This includes revisions to the Standardized Approach and Internal Ratings Based Approach to credit risk, the operational risk framework, and the leverage ratio framework, as well as the introduction of a more risk sensitive capital floor.
• OSFI’s implementation date of the revised Pillar 3 disclosure requirements finalised by the BCBS in December 2018 will be delayed until Q1 2023 at the earliest.

In addition, OSFI’s implementation date of the final set of revisions to the BCBS market risk framework (known as the “fundamental review of the trading book” or FRTB) published in January 2019 is being delayed until Q1 2024^{Footnote 4}. This extended timeline recognizes the complexity of the FRTB framework and the required infrastructure enhancements needed to adhere to it. OSFI’s implementation date of revised credit valuation adjustment risk framework is also being delayed to Q1 2024.

OSFI’s Proportionality Initiative for Small and Medium Sized Banks is deferred

OSFI is delaying the timing for the implementation of the Small and Medium Sized Banks (SMSB) Capital and Liquidity framework to the beginning of Q1 2023 in line with the above noted delay in the domestic implementation of Basel III. OSFI will also delay the consultation work on Pillar 2 and Pillar 3 capital and liquidity requirements for SMSBs.

Additional adjustments to OSFI requirements and timelines