Office of the Superintendent of Financial Institutions
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Date: June 5, 2023
Good day, everyone. Great to be here. I am speaking to you from my office in Ottawa.
We at OSFI have gone through or continue to go through a transformation of our institution and we are transforming ourselves to be more effective regulators in a very, very challenging risk environment.
One of the strategies we have employed is to be transparent, transparent with the general public and transparent with the federally regulated financial institutions and their industry associations in order to be clear and to remove uncertainty about how we, as a regulator, might act in risk environments that are benign and risk environments that are malignant or risk environments that are, like today, somewhat uncertain.
First, I’d like to thank you all for being with us today. Our intention is to increase the transparency around OSFI regulations for the benefit of financial institutions. We have an excellent agenda for this webcast and hope to explain OSFI's plans for the coming years.
So, before I begin, I thought that for those with visual impairments, I would describe myself. I am a white male. I am five foot nine with short brown hair. My pronouns are he and him. And I am wearing a white shirt, a blue jacket, and a grey tie.
So, I thought I’d just take a few moments to set a context of how or where we’re operating as a regulator and where you all are operating as financial institutions, explain what we’re doing, and where our supervisory focus is. I’d like to take a minute and talk about our Risk Appetite Statement and then we’ll talk about a really exciting initiative we have underway, which is a new supervisory framework that will come into force April 1, 2024. Then I’ll give you a preview of what else is on the agenda.
So, starting with setting the context, well, in the last few months we saw or witnessed the failure of four fairly good-sized US regional banks and the near failure and subsequent acquisition of a globally systemically important bank, the first such resolution, if I can use that word, of a globally systemically important bank, since the great financial crisis of 2008 and 2009.
Naturally, when you get these sorts of events in capital markets it creates uncertainty and fear and it’s natural for observers to wonder a) if the institutions and a particular banking system are sound and b) what the regulator might do to adapt to what could be an emergence of crisis conditions.
Now I’ll talk more about how we’ll react specifically when I talk about our risk appetite, but what I would like to say is overall the Canadian financial system and the players therein have spent the last 15 years really building margins of safety in terms of capital, in terms of liquidity, in terms of their institutions’ security and integrity.
And, while there is a natural uncertainty in respect to what’s going to happen in the economy and how that might affect individual players within the financial system, I do want to communicate a guarded confidence that the institutions in Canada’s financial system have very good buffers or margins of safety that will serve us well as we move through the next one to two years of perhaps greater economic uncertainty.
Yes, inflation that has re-emerged over the last year and a half has been a shock. The interest rates that are necessary to fight that inflation have also presented challenges to our financial system, but so far our system has adapted well to those changes and we think the last year is a good prologue for what will come. We think our financial institutions will manage through this period and Canada’s financial system will demonstrate again a fairly responsible level of resiliency overall.
In order to aid in that resiliency, we endeavoured last year to publish what we call our Annual Risk Outlook or ARO. And in that document we aim to outline the risks we worry about, what we’re doing in response to those risks as supervisors, and what regulatory policies we might amend or put in place to adapt to those risks.
If you just Google OSFI Annual Risk Outlook, you’ll get it. Our top three risks are housing market downturn, liquidity and funding risk, and commercial real estate risk. Now those are the Big Three that we spend a lot of time on. There are six others: transmission risk from the non-bank financial intermediaries, corporate and commercial credit risk, digital innovation risk; climate risk; cyber risk; and third party risk.
We intentionally this year ranked those as a ranked order, so if you’re wondering what we are most worried about, you have our ranked order. And we have supervisory and regulatory plans in place to address them.
We published this document back in April so you all can read it and figure out what we’re thinking about, what we’re doing. We hope that that document is useful and we want to hear how we can make it more useful because it is meant to make life easier for the institutions we regulate.
In terms of our supervisory activities, which I’m sure everyone is interested in, I want to just take a minute and re-emphasize our focus on what we call the 4 C’s: capital, cash, credit, and contingency. These are the basic tenets of a sound financial system.
In terms of capital, we stress the need for federally regulated financial institutions to have ample margins of safety in their capital base in order to manage uncertainty, particularly in times of economic downturn.
Cash, we ask federally regulated financial institutions or I’m going to call them FRFIs from now on, to ensure that they have ample liquidity buffers to manage unforeseen liquidity draws. It could be deposit draws, it could be margin calls or collateral calls. We ask institutions to be a little bit extra careful on that.
Credit, we ask FRFIs to carefully assess their credit risks and maybe even be a little more careful over the next 12 to 18 months to ensure counterparties are ready to fulfill their obligations to them and when not to make sure that their provisions are kept up-to-date with potential losses.
And then contingency, we ask FRFIs to develop contingency plans to deal with not only financial but various non-financial risks, so cyber risk, digital innovation risk, or third party risk.
These are the core best practices and disciplines that FRFIs should continually reinforce at their institutions.
Next topic I’d like to turn to is OSFI’s Risk Appetite Statement, which we recently published in May which we think lays a transparent foundation for clarity in how OSFI will make decisions in periods of uncertainty. I’m going to read the Risk Appetite Statement and then I’ll talk about it.
We at OSFI have a high appetite, a high-risk appetite for early intervention to address risks that could jeopardize the public’s confidence and the soundness of the Canadian financial system. We recognize that it is not cost-effective or realistic for us to intervene on all risks facing regulated institutions and pension plans. As such we’re willing to accept the orderly failure of a regulated institution, but we have a low-risk appetite for a surprise failure.
Most importantly, OSFI is ready to act early and decisively when weaknesses in our financial system emerge and/or when weak players emerge. We would rather be criticized for acting a little too early than have the economy endure the costs of a financial institution supervisor that acts too late. And we think financial system history is replete with examples of supervisors acting a little bit too late and economies bearing higher costs than they otherwise would have.
That will be our True North in terms of how we respond to weaknesses in the financial system and we look forward to doing whatever we can to make that risk appetite as clear and transparent as possible to all of you.
In line with our new risk appetite, we’re building a new supervisory framework with the first serious revision of it since the turn of the century. It represents a comprehensive update. A couple of the highlights will build in greater differentiation in risk rates. So right now, we have stage zero which is sort of the preferred stage meaning we will not intervene. Then we have a series of intervention levels, stage 1, stage 2, stage 3, stage 4 that get progressively more severe.
The problem is the vast majority of our institutions are in stage zero and it’s very difficult right now for institutions to understand where they stand in that category. So we’re going to have a new eight point scale, stage 1, 2, 3 and 4 or grading scale 1, 2, 3 and 4 will be non-intervene levels, one is better than four. 5, 6, 7 and 8 are our successive staging levels.
In addition, we will have an overall risk rating which will replace the composite risk rating. As importantly we’re not stopping at a single overall or composite risk rating – we’re going to disclose ratings on four other categories: business risk, financial resilience, operational resilience, and risk governance.
Later this year you’ll hear a lot more about the framework and we’re making ourselves available to the boards and senior managers of our FRFIs who want to understand more about how this framework works in general and how it might apply to them.
This is a very significant change in how we will supervise. Our opinions and the rationale underlying them will be far more transparent to each of your institutions. And aside from that being a benefit to all of you it will make us more accountable for justifying and explaining our supervisory themes. And because we will feel more accountability for those supervisory themes they will increase in quality as we go forward. And our discussions, our supervisory discussions at all levels will be more rich as a result.
And those are specific outcomes that we intend. We accept more accountability, we want more transparency, we want richer conversations with your institutions. And that’s why we’re developing the framework in this manner.
We also intend for it to be proportional. Not all institutions have the same risk profiles, the same size, the same operational complexity. And this framework is meant to be proportional to that reality.
So for the rest of the day my colleagues are going to discuss several really important topics. Top of the list Bill C-47 of the Budget Implementation Act, which does propose changes to OSFI’s mandate. I would note up front that it has not received royal assent, but we feel like it’s far enough along to explain what the implications would be if it achieves or realizes royal assent. We’ll talk about our policy architecture renewal, which will dovetail nicely with what may be in Bill C-47. We’ll talk about digital innovation and operational resilience, technology and cyber resilience, climate risk and we’ll give some important updates on issues such as capital and credit risk and re-insurance, the International Financial Reporting Standard 17 (IFRS 17) and liquidity.
So, as I hope is clear, OSFI will remain vigilant. We will take swift and decisive action where necessary. We’ll prioritize transparency with all of you and with the general public. And we believe by doing these things well we will contribute to public confidence in the Canadian financial system. We aim to provide clear insights into the risks we see and we aim to listen to feedback when folks don’t agree with our insight into those risks or our view of them.
Thank you for attending today and thanks to everyone on the OSFI team who worked hard to put this webcast together.