Sustaining Canadian Financial System Resilience Through Uncertainty and Volatility

The Office of the Superintendent of Financial Institutions, or OSFI, was born following the failures of Canadian Commercial Bank and Northlands in 1985. The Canadian federal government created OSFI in 1987. In our Act, Parliament gave OSFI its purpose: “ … to ensure that financial institutions and pension plans are regulated by an office of the Government of Canada so as to contribute to public confidence in the Canadian financial system.” We do so by supervising federally-regulated financial institutions and pension plans, informing their boards of directors and plan administrators if the institution is not in sound financial condition, and evaluating system-wide risks that may have a negative impact on the financial system.

Since the start of this century, the global financial system has endured multiple bouts of volatility, including the recession of the early 2000s, the Global Financial Crisis of 2008-9, and the arrival of the COVID-19 pandemic. In Canada, our financial system weathered these volatility storms very well. However, we must keep an eye on the horizon by assuming and planning for more frequent volatility storms, similar to those of the past twenty years.

Indeed, we at OSFI now find ourselves in a risk environment that has fundamentally shifted. The risks we face today are much more unpredictable, complex, interrelated, and existential than they have been in the past. They are challenging our assumptions about the scope of sound prudential oversight and the capabilities required of OSFI to fulfill our obligation to Canadians.

How does OSFI effectively respond to the changing risk environment?

  1. We are transforming ourselves: In order to deliver on our mandate successfully in our current risk environment, OSFI will transform, not reform, itself. We published the Blueprint for our Transformation on our web site in December 2021 and it outlines not only the strategic imperative for our change but the goals we will pursue. At the heart of our transformation are three foundational elements :

    • Mandate – refocus the delivery of our mandate to place greater emphasis on contributing to public confidence in the Canadian financial system
    • Risk Appetite – expand and fortify risk management capabilities and risk appetite to support strategic and operational management
    • Culture – embed our corporate values so that our colleagues bring their true and best selves to work everyday and thrive within a risk environment of great uncertainty

    Fundamentally, we at OSFI have recognized and embraced the same advice we often give to our regulated constituents – those risk management mindsets that enabled success in the past are necessary but not sufficient to enable success in the future. As OSFI’s risk environment shifts, so too must our mindsets. This means we will have to innovate new supervisory practices to ensure OSFI acts early to contribute to public confidence in the Canadian financial system, and we must innovate new regulatory policies to meet our new risk environment.

  2. We are responding to emerging risks like climate and digitalization: We are now building a capacity to understand and assess how climate-related risks affect the Canadian financial system. In partnership with the Bank of Canada, we recently released our Report on Climate related transition risks, and have baseline information on our data gaps, and have identified methodologies to deepen our understanding of climate transition risks against economic portfolios. More importantly, we have deepened our understanding of OSFI’s responsibility in helping financial institutions manage transition risk, or the risks associated with transforming economies to reduce reliance on greenhouse gas emitting energy sources.

    Let me explain. Collectively, the nations of the world will select a pathway towards net zero greenhouse gas emissions by 2050. The world may choose to start now and take a 30-year pathway. Or the world may choose to begin in the 2030s and take a riskier, accelerated pathway. While a longer transition is better for Canada and our financial system, a shorter transition begun in the 2030s is plausible and that pathway brings with it a greater risk of financial volatility. Therefore, we at OSFI must prepare our financial system in the 2020s for a shorter, more volatile transition in the 2030s. We will act this decade to drive mature climate risk management and ensure the capital build-up appropriate to sustain financial system resilience in the 2030s.

    The digitalization of financial services will affect all business models and threaten an unknowable few. We are starting to look at our “regulatory perimeter” and how best to develop a policy approach to deal with the emergence of innovators, many of which have not yet fully entered the regulated financial system. For innovators, we must recognize that our system, as currently constructed, is not easy to enter. We ask for rigorous governance and capital standards; an expectation that stems from our pre-occupation with financial system resilience.

    We won’t change these or any other of the principles that underlie Canada’s excellent track record of financial system resilience. But we do have an opportunity to enable a higher degree of innovation from new entrants.

    Our true north for sustaining systemic resilience as financial services digitalize is to ensure Canadians benefit from financial sector innovation generated by both incumbents and new players. What OSFI will seek to avoid is a two-tiered system, with some participants heavily regulated and supervised and others lightly regulated and supervised.

    Along with other financial regulators, we are watching the continued rise of crypto currencies as well as the broader ecosystem of decentralized finance. All of this comes against the revolutionary backdrop of trends in open banking and the rising use of Application Programming Interface (or API), which may facilitate major changes in retail financial services.

  3. We are not losing sight of ongoing risks: OSFI has always been in the business of risk management, and we will continue our work on existing risks, such as housing. As I mentioned recently at a recent Parliamentary Committee appearance, we have remained intensely focused on the risks in housing finance since the global financial crisis. In that time, OSFI and our federal regulatory partners have consistently taken regulatory actions (at least 25 significant actions by my count) to help address these risks in the financial system.

    Our aim with respect to our activities in the housing market is to foresee housing finance system risks beyond the horizon and adapt early. Our strategy is to ensure the Canadian financial system has sufficient buffers to absorb the uncertainty and volatility one finds in a market such as housing. One example of such a buffer is the minimum qualifying rate (MQR) for uninsured mortgages under Guideline B-20 (Residential Mortgage Underwriting Practices and Procedures), a buffer we introduced in 2018 and refined several times including most recently in June 2021 . This buffer ensures that most Canadian mortgagors today qualify for mortgages at an interest rate of 5.25%, well above prevailing contract rates. This means that those mortgagors have a buffer that will add to their financial resilience in the face of unanticipated events such as the loss of employment, or a house price correction.

As 2022 progresses, I am certain that the volatility we have observed over the past two years, or indeed the past twenty, will recur. To fulfill its mandate, OSFI must therefore be agile and adjust quickly to this new reality. Our transformation is focused on ensuring that our organization has the capability and the tools to succeed in the “new normal” and to ensure that the public’s confidence our financial system remains unwavering.