Superintendent Routledge participates in a fireside chat with the National Bank of Canada at their 22nd Annual Financial Services Conference

Speech - Montreal -

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1. Let’s talk about the Canadian regulatory environment. Is OSFI becoming more rules based than principles-based?

  • OSFI’s approach to risk is principles-based, so they are practical in a variety of circumstances.
  • This includes how supervisory and regulatory judgement are applied.
  • However, our approach must be proportionate. As risks materialize, we need take quick action and sometimes become more rules based, in order to have an appropriate response to the risk.
  • Housing risk is a case in point. Canadians demanded that we be tougher, and so in B20, the minimum qualifying rate is a rule, although we tried to base it on principle.
  • This approach is also embodied in OSFI’s new Supervision Framework, coming into effect on April 1st, which is a comprehensive update to how we supervise financial institutions. It results in a richer and more practical dialogue between the institution’s Board, senior management and OSFI supervisors.

2. What are the potential unintended consequences of more stringent regulation and how do you manage that risk?  (For example, seeing Canadian banks shed some assets, alter strategies, restrict lending)

  • OSFI’s role is to identify risks and set out appropriate principles for managing them.
  • It is the responsibility of institutions to make business decisions and manage their own risks. Their decisions are based on their own risk appetites, as determined by their senior management, boards of directors and private pension plan administrators.

3. In comparison to foreign jurisdictions, Canada seems to be taking a more conservative approach. For example, we implemented Basel III upgrades quicker. How do we balance conservatism with a level playing field for Canadian financial institutions?

  • Canada considered the Basel III upgrades to be a responsible and prudent update to that capital regime.
  • As a proactive and principles-based regulator, we were able to move quickly to adopt the rules, taking care to ensure they reflect the Canadian context.
  • Other jurisdictions that have taken longer to adopt Basel III, such as the US, tend to have public rules-based processes that take longer to complete.
  • We are monitoring the international implementation of Basel III closely, given our concerns with the ability of Canadian financial institutions to compete effectively and take reasonable risks.

4. Let’s talk about the mortgage market. What do you need to see, as the Superintendent, to alleviate concerns about household indebtedness? Is OSFI urging banks to do more to help their customers manage higher rates? And what is your perspective on accommodations, such as extending amortizations?

  • All products entail a certain amount of risk—some more than others. To manage high household debt risk, mortgage lenders need to be proactive and apply Guideline B-20 expectations, including the “stress test”, before loans are granted. 
  • In response to the heightened risk environment, we recently published a Regulatory Notice to clarify and reinforce our expectations. It emphasizes the need to proactively identify and address vulnerable accounts, portfolio segments and concentrations.
  • It’s important for lenders to have risk management practices throughout the life cycle of the mortgage. The external environment can change rapidly after initial underwriting. As I’ve said, the housing finance system would produce better outcomes for borrowers and lenders alike if Variable Rate Mortgages with fixed payments products were less prevalent.
  • Borrowers can also take early actions to manage their debt loads during periods of high or rising interest rates. Those early actions could include:
    • increasing mortgage payments
    • making lump sum payments
    • renegotiating their mortgages
  • About accommodations – lenders should also adhere to the Financial Consumer Agency of Canada’s Guideline on Existing Consumer Mortgage Loans in Exceptional Circumstances. We also expect lenders to be prudent in any forbearance assessments and seek sustainable debt serviceability.

5. Commercial Real Estate.  Recent events in US, and how those factors play into the domestic landscape.

  • We share many commercial real estate (CRE) concerns with the US as these markets are facing similar headwinds: high rates and falling demand. We’ve publicly identified CRE as a top risk and expect this risk to remain heightened. Notably, the construction market continues to show signs of slowdown. Meanwhile, ongoing office vacancies means these valuations remain under pressure.
  • We’re closely monitoring CRE developments and responding accordingly to make sure the banks are provisioning right.
  • Last September, we published a regulatory notice to reinforce our expectations around governance, underwriting, and account and portfolio management in the CRE space.

6. How do climate risks reflect in the regulatory capital framework?

  • The simple answer is, right now, climate risks are not explicitly reflected in the regulatory capital rules. However, we know climate risks manifest through traditional risk channels, so the current regulatory capital framework likely already captures climate risks to some extent.
  • The challenge we have is the risk capture could be incomplete due to difficulties in estimating climate risks. There is still a lack of forward-looking data and metrics. So, we are taking an evidence-based approach to addressing any climate capital adequacy issues before making any adjustments to the framework.
  • We will collect detailed, quantitative data through our final regulatory return instructions and standardized climate scenario analysis testing. This will support our analytics and help identify any potential capital adequacy issues that may arise due to climate risks.
  • We also set expectations for banks to incorporate climate risks into their internal capital adequacy assessments (the ICAAP process). Our requirements now include a climate risk category, asking for details on how much internal capital is allocated to address physical and transition risk.
  • On March 20th, we released updates to Guideline B-15: Climate Risk Management. The updates ensure that the expectations for federally regulated financial institutions (FRFIs) in the Guideline’s Annex 2-2 align with the International Sustainability Standards Board’s final IFRS S2 Climate-related Disclosures standard. At the same time, we released new Climate Risk Returns that will collect standardized climate-related data on emissions and exposures is also publishing a What We Heard Report with the feedback received.

7. As a regulator, what are your thoughts on Industry feedback to OSFI’s Final Integrity  & Security Guideline? And how prevalent is foreign interference?

  • The financial sector is not immune to foreign interference, whether it be direct interference, through malicious actions, or through undue influence.
  • The industry feedback we received on our draft guideline was extremely useful. Broadly speaking, comments were to make sure our expectations are explicitly risk-based, especially with respect to background checks, physical premises, and reporting. Industry also wants us to use clearer and more consistent terminology and provide clarity around proportionality.
  • The final guideline aims to help financial institutions take proactive measures to become more resilient to threats including undue influence, foreign interference, and malicious activity, all of which can damage the integrity and security of a financial institution.

8. Insurance industry: Are there any risks specific to the P&C industry you would like to highlight?

  • Today’s risk environment is much higher than it was before COVID.  Asset evaluations are shifting. As we see macro changes in climate, credit markets, and geopolitics – P&C insurers are exposed to these risks through the physical risks they underwrite and transition risks with the investments that they undertake, and potentially liability risks. P&C insurers should worry about how those broad transverse risks affect their balance sheets.
  • Because high frequency events are increasing in severity, reinsurance coverage and net retentions of P&C insurers are impacted – this could result in potential earnings or even capital volatility.