Expectations on the use of Pillar II capital buffers for DTIs using the Standardized Approach to credit risk

Document Properties

  • Type of Publication: Letter
  • Date: May 1, 2020
  • To: Banks, Bank holding companies, Federally regulated trust and loan companies

OSFI continues to actively monitor the COVID-19 pandemic and is providing additional information on expectations surrounding capital management for deposit-taking institutions (DTIs). This includes:

  • an overview of capital expectations for domestic systemically important banks (D-SIBs) and for small and medium-sized banks (SMSBs), together referred to as DTIs
  • use of Pillar II capital buffers by DTIs using the Standardized Approach to credit risk
  • expectations for all DTIs on prudent capital management actions in the current environment

I – Overview of capital expectations for DTIs

Since the global financial crisis, OSFI has raised capital requirements for DTIs and further required DTIs to exceed those requirements under normal conditions by building robust capital buffers.

The current DTIs capital regime is multi-layered and includes minimum capital requirements, Pillar I capital buffers, e.g. a Capital Conservation Buffer (CCB) for all DTIs and an additional surcharge of 1% of risk-weighted assets (RWAs) for D-SIBs, and Pillar II capital buffers, e.g. institution-specific buffers and for D-SIBs, the Domestic Stability Buffer (DSB). The CCB, D-SIB surcharge and DSB are required to be met by common equity tier 1 (CET1) capital. See figure 1.

DTIs Capital Expectation (% of RWA) 
Text version - Figure 1

DTIs Capital Expectations (percentage of risk weight assets)

This figure shows the capital requirements for big banks and small and medium sized banks in two columns. For both big banks, and small and medium sized banks, the minimum total capital requirements are 8% of risk weighted assets and the Pillar 1 buffers are from 8% to 10.5%. Big banks are also required to hold a further 1% in Pillar 1 capital from 10.5% to 11.5 % for the Domestic Systemically Important Bank surcharge. Pillar 2 buffers for big banks include an additional 1% Domestic Stability Buffer (as at May 1, 2020) as well as bank specific buffers in excess of this amount. Pillar 2 buffers for small and medium sized banks are bank specific buffers in excess of 10.5%.

Notes:

  1. The size of DTIs-specific Pillar II buffers will vary by institution
  2. Where applicable, DTIs' Pillar I buffers will also include countercyclical buffer add-ons
  3. The calibration of the Domestic Stability Buffer is reviewed by OSFI semi-annually and is set between 0% and 2.5% RWA
  4. Minimum requirements include minimum CET1 capital of 4.5%, minimum tier 1 capital of 6% and minimum total capital of 8% RWA

II – Use of Pillar II capital buffers by DTIs using the Standardized Approach to credit risk

Pillar II capital buffers include risks that are not sufficiently captured under Pillar I capital requirements taking into account institution-specific factors such as business model, activities, size, risk profile and risk appetite, and stress testing results. DTIs are responsible for developing and implementing internal capital targets and developing strategies to achieve those internal targets. OSFI's approach to assessing the adequacy of Pillar II capital buffers established by DTIs is outlined in guideline E-19 Internal Capital Adequacy Assessment Process and guideline E-18 Stress Testing.

Capital buffers are built-up during normal times to provide an institution with additional flexibility in times of stress. As noted in a statement by the Superintendent on April 3, 2020, regarding measures taken to support the resilience of financial institutions, OSFI considers that measured declines in bank capital ratios are acceptable in the current circumstances and entirely consistent with the functioning of a well-capitalized and prudent institution.

For clarity, the ability to use Pillar II capital buffers in times of stress like the current COVID-19 pandemic applies to all DTIs, including those using the Standardized Approach to credit risk. DTIs that plan to use Pillar II buffers by operating below their internal capital targets should discuss this with their designated Lead Supervisor.

III – Prudent capital management in the current environment

OSFI expects all DTIs, including those using the Standardized Approach to credit risk to consider the appropriateness of their capital management actions in the current environment. This includes the following:

  • In cases where DTIs are using their capital buffers, they should use the capacity prudently and consider appropriate capital conservation actions. An institution should also have a plan for how it expects to manage its risks and restore capital.
  • DTIs should consider stress testing information (including plausible future adverse scenarios) as part of the capital management decision-making process.
  • DTIs must ensure that they undertake prudent capital management actions to protect depositors and other creditors while taking reasonable risks.

OSFI has also posted additional FAQs related to the use of capital buffers and prudent capital management at the following link.

Questions should be directed to your OSFI Lead Supervisor.

Yours sincerely,

Jamey Hubbs
Assistant Superintendent
Deposit-Taking Supervision Sector