Perspectives on the Industry from the New Superintendent

Remarks by Superintendent Peter Routledge, OSFI Risk Management Webcast for Deposit-Taking Institutions

Thursday December 9, 2021

CHECK AGAINST DELIVERY

Thank you Jamey for that introduction. Welcome everyone to our OSFI Risk Management Webcast for Deposit-Taking Institutions. For those I haven’t met yet—probably very few of you—I’m Peter Routledge, Superintendent of Financial Institutions.

Before I go any further, I would like to acknowledge that I am speaking from the traditional unceded territory of the Anishnaabeg nation. I am grateful to have the opportunity to be present in this territory. I recognize that those joining us today may work in different traditional Indigenous territory.

Recognition of our shared history is a crucial prerequisite for building trust and reconciliation with our compatriots of Indigenous descent. I urge you to read the Final Report of the Truth and Reconciliation Commission of Canada.

The Risk-Return Balance: Getting It Right

While I am of course no stranger to the issues facing Canada’s deposit-taking institutions, this is the first of these webcasts for me since I took on the role of Superintendent of Financial Institutions in June 2021.

The subject at hand today is a very important and topical one. Risk management, of course, has long been a cornerstone of our organization. It’s right there in our mandate: “OSFI advances a regulatory framework designed to manage risk.”

We also say we protect the rights of depositors, policyholders, creditors and others, while allowing “financial institutions to compete effectively and take reasonable risks.”

There is obviously a delicate balance to be struck here, and it’s important to get it right. While senior management and boards of directors are ultimately responsible for their decisions, failure of a financial institution may have a cascading impact that threatens other institutions as well as the larger system and consumer confidence in it.

That is why we hold these webinars.

As the risks increase in scope, practical and well-practiced risk management can only grow in importance. Our commitment to understanding and managing risk must evolve, to match the evolution of the risk environment within which federally regulated financial institutions–FRFIs–and especially deposit-taking institutions operate.

Risk Management in Action: the DSB and Dividends

I am pleased to say that one relatively new piece of the risk management framework for Canada’s largest deposit-taking institutions has performed flawlessly. I am of course referring to the Domestic Stability Buffer, or DSB, which was instituted in 2018.

The DSB—which applies to Canada’s domestic systemically important banks—proved its worth when COVID-19 began to make headlines, bringing volatility and economic uncertainty in its wake.

On March 13, 2020, when COVID-19 struck in earnest, OSFI decided to lower the Domestic Stability Buffer to 1.00% of risk-weighted assets, a “release” of 1.25%. This release provided Canada’s six systemically important banks with ample loss-absorbing capacity, while at the same time freeing up about $300 billion in lending capacity. This DSB release supported ongoing lending through the pandemic and banks did not breach their capital requirements, exactly as intended.

When we lowered the DSB last year, OSFI also took the prudent step of communicating our expectation that all FRFIs would halt increases to regular dividends and executive compensation as well as pause common share repurchases.

I am delighted to note this expectation was lifted on November 4, after which date financial institutions could once again increase regular dividends and executive compensation. Additionally, subject to the existing requirement for Superintendent approval, they could once again repurchase common shares.

In doing so, responsibility for decision-making was returned to boards of directors and senior management, where it belongs.

The track record shows that the leadership of Canada’s financial institutions have, for the most part, made modest, humble, and responsible decisions regarding the strategic direction of their institutions and their capital distributions.

As I said on November 4, we at OSFI expect them to continuously re-affirm this tendency and expand their definition of sound business and financial management, as do a growing number of business executives, entrepreneurs, investors and international and multilateral organizations.

History will undoubtedly show that COVID-19 was an extraordinary outlier event that tested the resilience of our economic and social compact. Canada’s financial institutions fared quite well during this period. However, many Canadians bore the brunt of the pandemic’s financial costs out of proportion to their ability to weather the consequences.

Given this, I believe the boards of directors and senior management of Canada’s FRFIs will take account of their complex environments—and relative good fortune—in making these decisions regarding capital distributions. They will recognize the special burden and responsibility that flows from their success and from the expanded environmental, social, and governance expectations of their investors. And they will make capital distribution decisions that demonstrate humility, enhance their institutions’ reputations and fulfill OSFI’s expectations regarding sound risk management.

The Financial Services Environment in Flux

So, if we’ve fared so well in the past, why now has risk management taken on a more urgent tone? What’s changed?

Well, the heightened uncertainty we’ve seen the past decade or two does not begin and end with the COVID-19 pandemic. There’s the immense growth of digital transactions, the rise of cryptocurrency and other technological advances that have both led to the development of new business models and the disruption of traditional ones.

We now get the sense that every day we are on the cusp of a major leap into the future. This unprecedented pace of change brings great opportunity, naturally, but also risks that have the potential to manifest themselves in unprecedented ways.

Our Changing Climate Poses New Risks

Climate risk is one such major development and is linked to the incredible economic progress we’ve seen over the past two-and-a-half centuries. It’s incontrovertible that our global climate is changing, and the prudential risks associated with this change are numerous.

Climate change posts risks to deposit-taking institutions like yours—and indeed the broader financial system and economy as a whole.

There are the physical risks it brings, such as damage to valuable assets as a result of severe weather events influenced by climate change.

Then, there are the liability risks, such as legal and reputation risk flowing from a financial institution’s support for fossil fuel projects and other initiatives that are seen to contribute to climate change.

Of course, climate risk is also somewhat unique compared to its peers, in that it encompasses transition risk as well.

Now, I’m not suggesting that risks caused by flux states in economic and business cycles are new—of course they are not.

However, since the first Industrial Revolution we have heated our homes and powered our machines with fossil fuels. Today, 250 years later, the energy source driving our economy—and underpinning our society and way of life—is about to change. It must change.

That change, that transition to an economy that runs on cleaner and greener sources of energy, will result in upheaval—to what extent exactly is yet unclear. But, a recent pilot project led by OSFI and the Bank of Canada gives us some indication.

A year ago, we teamed up with the Bank and six financial institutions on a pilot project to model various transition scenarios. The final report will be published early next year, but I can tell you the analysis contained in it yielded some fascinating—if sobering—results.

For example, it showed that while every sector of the economy will contribute to this transition, some will be affected negatively while others may benefit. The analysis also showed that for a commodities-exporting country like Canada, there could be significant macroeconomic impacts due to price movement on global markets for these commodities.

With the aid of Stephane Tardif, this afternoon we’ll discuss our policy approach and strategy to ensure OSFI’s response aligns with the scale and urgency of climate risks.

I would be remiss, though, if I didn’t pause here to speak about another risk: the risk of doing nothing, or being too slow or not determined enough.

Last month, we published comments received as part of the consultation on climate risk OSFI held in the first half of 2021.

We heard that FRFIs are at varying levels of maturity when it comes to both risk appetite and mitigating the risks associated with climate change. Many FRFIs reported being in the early stages of looking at how best to address the issue.

And in that climate change pilot project with the Bank of Canada, our scenario analysis showed that delaying action on climate policies will heighten the impact on the overall economy, and increase risks to financial system stability.

I can tell you that as the regulator overseeing Canada’s federally regulated financial institutions and private pension plans, we are very much interested in climate change and investing in managing the risks associated with it. We expect action from you as well.

Technology Brings Radical Change—and Risk

Of course, here in the 2020s we now talk of more than one Industrial Revolution. It’s now commonly accepted that, with the levels of technological and digital advancements, we’re on the Fourth Industrial Revolution.

The economic and social gains afforded by digital technology have created great wealth and boosted productivity and efficiency across nearly every industry and sector of the economy.

But as Mohamad Al-Bustami will make clear in the next session, this progress inevitably brings risks with it.

Like climate risk, technology risk can be organized into subcategories of risk. We define technology risk as “the risk arising from the inadequacy, disruption, failure, loss or malicious use of information technology systems, infrastructure, people or processes that enable and support business needs and can result in financial loss.”

This implies risks “within the walls,” as it were: an unsuccessful implementation of a digital strategy that results in lost productivity and business, for example.

This is classic operational risk and, for the most part, financial institutions can manage these.

Then, there are risks outside the walls: a global scale cloud outage that makes it impossible for customers and clients to do business with you.

Or, even worse, a nation-state sponsored destructive cyber attack that damages your reputation and exposes you to litigation as a result.

These can be more difficult to guard against, but we must find ways to do so. Such as, collaboratively enabling and fostering timely actionable sharing of information, intelligence and threat data.

Of course, all the while we are contending with these emerging categories of risk, the familiar ones such as operational risk and credit risk remain with us. Although we have managed these “core” financial and non-financial risks since virtually the inception of the financial system, they too are changing and we must continue to pay attention to them.

As you’ll hear from Elspeth Bowler and Robert Dougall today, OSFI will continue to address these established risks with an eye on how both these risks and the management of them will evolve, as well as how they’ll interact with emerging risk categories over the coming years.

The Three Ps: a Risk Management Mindset

Now, you’re likely thinking there is a lot to unpack here. Indeed, there is ample food for thought across today’s agenda.

Perhaps the best starting point is to ask: what kind of mindset should a modern agile regulator aim to foster, to help ensure both current and emerging risks are given due consideration?

Quite simply, the mindset we aim to foster is one based on Preparedness, Partnership and Prudence. We expect you to demonstrate this mindset, and we expect OSFI staff will demonstrate it as well.

Let’s start with Preparedness. We’ve already addressed it, at least in part: while the spread of COVID-19 might not have predictable—or preventable—the early responses were effective because of our collective preparation.

While OSFI was prepared to release the Domestic Stability Buffer to provide lending capacity, your institutions were prepared too. Many of you worked with the Canada Mortgage and Housing Corporation to offer mortgage deferrals to vulnerable households. You reduced interest rates for consumer lending products such as credit cards and lines of credit. And you waived personal banking fees for many Canadians.

We, collectively, were able to take these actions because we were prepared. We had set up a system, in advance, that gave us the capital levels we required to quickly respond to this global pandemic and the economic instability that ensued.

Next, Partnership. With apologies to the 15th-century English poet John Donne, “no organization is an island.” We are all in this together, and we must work together for the greater good.

You are indeed our partners in the prudential regulation of Canada’s financial system. You provide us with timely data that drives our modelling, and the co-operation that allows us to quickly and optimally address supervisory matters.

OSFI is also an active partner internationally, with the Basel Committee on Banking Supervision, and here at home with organizations such as the Canadian Bankers’ Association.

With Partnership comes an associated trait, predictability. Our expectations are clear, and yours should be of us as well. That is the foundation of a solid partnership.

Finally, Prudence – perhaps the overarching trait, on which all is built. As a prudential regulatory authority, we are often focused on the formal interpretation: requiring financial institutions to meet capital and liquidity requirements.

But prudence is a more basic human trait that transcends financial regulation. It is a survival mechanism: we weigh the possible benefits of being right against the possible drawbacks of being wrong, and act accordingly.

Prudence has its place, especially when managing large amounts of mostly other people’s money. I refer you back to OSFI’s mandate, and the phrase “take reasonable risks”.

Risk is a constant, but our approach to it is not. As circumstances change, the risks we see—and our tolerance for them—will inevitably change as well. Yesterday’s acceptable level of risk could be unacceptable tomorrow.

Prudence dictates we constantly reassess the risks and reposition ourselves to meet them, all the while applying that test of reasonability.

As I said on November 4 when I announced the end of our temporary expectations regarding capital distributions, we expect that the boards of directors and senior management of financial institutions will continue to follow the responsible, humble and mindful approach that has served them so well to date.

This means giving due consideration to the social, and governance expectations of their investors, and acting in a way that enhances their institutions’ reputations and fulfills OSFI’s expectations regarding sound risk management.

OSFI’s Evolution: New Risks, New Approaches

Now, we at OSFI certainly recognize that in order to innovate, you have to take risks. That’s why our organization has set out on a transformational journey that will prepare us to meet the opportunities and challenges presented to us by our risk environment.

This “Blueprint”, as we call it, will mean thinking differently than we have in the past, which in itself is a form of risk. But it’s my firm belief that OSFI must be ready for recurring bouts of volatility and uncertainty, perhaps more frequent than in the first two decades of this century.

This “new normal” we see on our horizon will require a new approach; we have an urgent imperative to not merely reform OSFI, but transform it.

It means we will reposition the pursuit of our mandate, to make strengthening public confidence in Canada’s financial system the overriding purpose of everything we do at OSFI.

It will also involve refining our culture so that it thrives in uncertainty and in this new complex risk environment. In short, we will be courageous and bold in making decisions that are driven by our risk appetite, and informed by exceptional analysis and insights.

We will also take actions that are timely and well-understood in terms of the risk trade-offs involved.

But at all times, prudence must prevail. And as partners, OSFI and the financial institutions we work with must see things through the same prudential lens, and share the same prudential concerns.

Conclusion

Over the next few hours you’ll hear from OSFI thought leaders on the most topical risks facing Canada’s financial system. We will conclude the day with an excellent panel featuring colleagues from the Financial Institutions Supervisory Committee that will offer a broader perspective on these emerging or “horizon” risks.

I trust you are looking forward to both the rest of today’s sessions, and to working with OSFI in the spirit of preparedness, partnership and prudence for many years to come.

We look forward to working with you to best position our industry to manage through the myriad changes that face us today—and with which we will have to contend tomorrow.

By demonstrating the humility, conscientiousness and capacity to adapt and thrive that have characterized Canada’s financial services industry to date, I have no doubt we will succeed together.

Thank you.