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Thank you for that introduction, Senator Gerstein. I am happy to be here with you and members of the Senate Standing Committee on Banking, Trade and Commerce. I look forward to talking with you about the Office of the Superintendent of Financial Institutions and my new role as its Superintendent. I will begin with some background on OSFI’s work as the prudential regulator and supervisor of federal financial institutions.
The role of the prudential regulator; market conduct
A key feature of financial regulation in Canada is the separation of prudential regulation from market conduct regulation. This is called the ‘twin peaks’ model, which has been adopted in other countries, notably the U.K. and Australia.
OSFI is Canada’s prudential regulator, promoting financial stability by keeping a close eye on the solvency, liquidity, safety and soundness of federally regulated financial entities. OSFI’s work covers about 400 financial institutions – mainly banks, insurance and trust companies – and over 1200 private pension plans.
In regulating and supervising financial institutions, we constantly ask ourselves these three questions:
- Are the institutions measuring, monitoring and managing their risks prudently?
- Do they have enough capital, that is to say, enough capacity to absorb severe but plausible losses and still serve their clients?
- Do they have enough liquidity – that is to say, cash, and assets that are easily converted into cash – to pay their liabilities as they come due, even when under stress?
The regime governing the relationship between financial institutions and their customers, which is known as ‘market conduct’, differs from prudential oversight in many respects. The Financial Consumer Agency of Canada – FCAC – oversees the market conduct of banks. For example, FCAC watches over rules governing disclosure to customers before they enter into mortgages, and rules governing how credit limits are set for credit card holders.
OSFI works in close collaboration with the other members of the federal Financial Institutions Supervisory Committee, or FISC, which I have the privilege to chair. The five FISC members are:
- OSFI which, as mentioned, focuses on prudential regulation of federal financial institutions;
- the Department of Finance, which develops federal legislation, budgets and other aspects of financial policy and management;
- the Bank of Canada, whose main focus is monetary policy; it also has some financial sector responsibility, particularly for the payments system as well as supporting the liquidity of the financial system as a whole;
- the Canada Deposit Insurance Corporation, which insures deposits at federal financial institutions, and
- the Financial Consumer Agency of Canada, which, as mentioned, administers market conduct regulation of banks. It also leads the Government of Canada’s efforts to promote financial literacy.
The mandates of the various FISC members complement each other. There is little or no overlap in those responsibilities, by design. Together, they compose an interlocking federal oversight framework for promoting public confidence in a strong, stable, and competitive financial system. The FISC meets regularly to share information, coordinate actions and advise the federal government on financial system issues.
How OSFI works
Now I would like to take you inside OSFI and describe how we work.
It is important to understand that OSFI’s job is not to stamp out risk taking by financial institutions. Risk taking is inherent in the provision of financial services. And the efficient and uninterrupted provision of financial services is essential in keeping the economy growing.
However, we saw in the recent financial crisis that excessive risk taking by financial institutions, unimpeded by sound risk management and lacking sufficient capital and liquidity, is a recipe for disaster.
The ongoing balancing act for all regulators is to restrain excessive risk taking, while allowing financial institutions to take reasonable risks and compete effectively at home and abroad.
There are two principal facets to OSFI’s work. First, we issue guidance to financial institutions. This provides them with a clear indication of what we expect of them in terms of capital, liquidity and risk management more generally.
Second, we closely monitor how individual financial institutions adhere to our guidance; this is our supervisory work.
To the extent possible, we stay away from detailed, prescriptive rules. Rather, we prefer to rely on high-level, broadly stated principles. These allow financial institutions the flexibility they need to act on their responsibility to take reasonable risks and to manage those risks. Indeed, much of our guidance requires institutions to undertake risk management activities, and to report on them.
Let me give you some examples of OSFI guidance, to illustrate our work:
- We’ve issued a guideline on corporate governance. Among other things, it asks institutions to ensure their boards include members with financial services industry experience. They must also have board members who can promote sound corporate governance, particularly in overseeing risk management.
- We’ve also issued guidance on the capital base necessary to accommodate any major losses an institution might incur. The capital base serves as a cushion, making it possible for the institution to absorb major losses and continue to serve its customers.
Since the financial crisis, OSFI has significantly increased capital requirements for banks, in line with the new international standards established in the wake of the crisis. Moreover, the capital requirement for banks that we judge to be important to the Canadian financial system as a whole is higher than that for other banks.
In simple language this means that in Canada, there’s extra padding in the capital cushion needed to absorb big losses when a bank gets into trouble.
Canada and global reform
Now, I’d like to turn to global financial reform.
Canada has been, and will continue to be, a strong supporter of international standards in financial sector regulation, led by the Financial Stability Board, or FSB.
International agreements on minimum norms are the best way for us to be able to impose prudent standards on our globally active financial institutions, without impeding their ability to compete with foreign institutions. That alone is a strong argument in favour of adhering to these agreements, and being seen to do so.
As you know, the FSB is a G-20 body coordinating post-crisis financial reforms globally. The FSB’s role is to identify key weaknesses underlying financial turmoil, and to recommend actions to improve market and institutional resilience.
At the heart of global reform is the development of international minimum standards for financial institutions. Thanks to our reputation for financial stability, Canada has had considerable influence in the development of these standards, which govern risk capital, leverage ratios, operational risk and other matters.
That said, we calibrate our implementation of global requirements, to reflect the Canadian situation.
Our progress report
OSFI remains focused on the priority areas detailed in our 2013-2014 Annual Report, which was tabled in Parliament in early October. These are:
- responding to risks emanating from the economy,
- responding to risks emanating from regulatory reform,
- a high-performing and effective workforce, and
- an enhanced corporate structure.
We will continue to deliver on these priorities while exercising the expenditure restraint expected of all branches of the federal government.
For reasons of brevity and to highlight our work in risk management, I’ll focus on the first two of those priorities in these remarks.
We have taken a number of steps to address risks emanating from the economy:
- We have responded to concerns about low interest rates and high household indebtedness via enhanced monitoring, retail lending reviews and stress testing of the institutions we regulate.
- We have conducted significant reviews in other areas as well, including:
- cyber security and operational risk,
- corporate governance, and
- catastrophic risk such as earthquakes and flooding.
- We have issued guidance on many aspects of risk management, including:
- residential mortgage underwriting,
- insurance companies’ own risk and solvency assessments,
- liquidity adequacy requirements, and
- regulatory capital requirements, as I noted earlier.
OSFI also participated in the International Monetary Fund’s Financial Sector Assessment Program. The IMF report was very favourable about the effectiveness of the FISC partners’ oversight of Canada’s financial system.
I’d quickly like to list some of the work we have undertaken to address our second priority – risks emanating from regulatory reform.
- We work with banks and insurance companies to gather data and to assess the impact on these companies of the new capital requirements imposed as a result of the global financial crisis.
- We have also worked with banks on new liquidity requirements, and
- We have monitored, and made representations regarding the evolution of international accounting standards and how they will impact the capital frameworks of Canada’s bank and insurance companies.
Much reform to date, globally and within Canada, has focused on the really big players in financial services. These are the financial institutions whose failure could threaten economic stability. In Canada, six institutions have been identified as domestic systemically important banks, or D-SIBs as we call them. OSFI has placed higher capital and reporting requirements on the D-SIBs, and they are also subject to more intense supervision.
At the same time, we recognize that, in some instances, we may need to establish different expectations for Canada’s smaller financial institutions, whose failure would not threaten financial stability and whose resources are not as plentiful as those of the D-SIBs. It is important for these institutions to manage their risks appropriately but we recognize that a one-size-fits-all approach could inhibit their ability to compete and grow.
As a consequence, OSFI is considering how best to apply our regulatory and supervisory approach to smaller institutions so that our expectations are not an unnecessary burden to their ability to thrive, while still respecting prudent standards in risk management and capital ratios.
In closing, I’d just like to point out that it’s been just over six years since Lehman Brothers, the fourth-largest investment bank in the U.S., filed for bankruptcy. That failure ushered in the global financial crisis. It also ushered in huge improvements in prudential regulation and supervision.
Canada’s financial system and economy got through the crisis in relatively good health, because of sound management of its financial institutions, along with diligent regulation and supervision.
OSFI has increased the quantity and quality of capital, increased liquidity, and raised our expectations about risk measurement and risk management in many areas. At the same time, the Canadian financial services industry has continued to enjoy strong results.
Looking ahead, we will continue to focus on the four priorities set out in our annual report, and to strengthen the Canadian approach to prudential supervision and regulation.
So, thank you for having allowed me to provide you with a quick overview of the work of my office and our current focus. I look forward to responding to your questions.