Superintendent Routledge - Refining OSFI’s Risk Appetite at Economic Club of Canada

I would like to take a few moments to frame the conversation around an issue of intensifying interest at OSFI and in the broader financial system: that issue is regulatory and supervisory modernization.

Hopefully, I don’t have to make the case that Canada’s financial system has, this century, set an enviable standard for resilience globally. Canada is headquarters to a wide array of sizable financial institutions that are internationally active, profitable, well-capitalized, and resilient.

Canadian financial institutions generate earnings well above their cost of equity, remain well-capitalized and liquid relative to international standards.  So, given this track record, what compels OSFI towards modernizing our regulatory and supervisory approach?

In short, the imperative of adapting our risk appetite to the threats on our horizon. Let me explain.

Our Past Has Shaped Us, and Produced New Risks

The global financial crisis of 2007-2009 (GFC) shaped OSFI’s and our international peers’ approach to financial system regulation. Collectively, global financial system regulators strengthened the regulatory and supervisory guardrails that bind financial institution behaviour. These guardrails are meant to improve the resilience of the financial systems that power economies.

Coming out of 2023, we at OSFI recognized that those guardrails had worked rather well. We endured a once-in-a-century pandemic followed by a related spike in inflation and interest rates – events that could have produced substantial systemic crises but didn’t. Through those shocks, Canada’s financial institutions continued to serve their customers, and Canada’s economy, without disruption.

As 2023 gave way to 2024, we internalized this positive outcome and we also began to grapple with emerging risks on our horizon, such as:

• Shifts in the international environment that made it obvious that Canada’s economy will have to adapt to a new reality. The financial system that OSFI supervises and regulates will have to finance that adaptation.
• Smaller FRFIs justifiably and credibly pointed out how some post-GFC reforms exacerbated their competitive disadvantage – for example in bank funding and capital treatment.
• Innovators who offered new, financial service business models based on new digital technologies were not eager to join the regulated system, an outcome that further called into question competitive balance.

Evaluating OSFI’s Risk Appetite Against a New Reality

Our experience over the past five years has taught us something about our risk appetite. We had a very low tolerance for financial system volatility and instability and a high tolerance for the risks our efforts posed to economic growth and competitive intensity. That is not to say we only cared about financial stability and disregarded growth and competition. But we heavily weighted our activity towards financial stability out of a sincere intent to meet Canadians’ demand that we avoid a calamity like the GFC.

There is a metaphor that I and my global peers have used to describe this outcome: the stability of the graveyard^{Footnote 1}. In OSFI’s case, that refers to a regulatory and supervisory approach in which economic growth and competitive intensity are unnecessarily impaired by an excessive aversion to financial system risk. In short, we at OSFI are shifting our risk appetite so that we avoid the stability of the graveyard without accepting too much financial instability risk.

Now, OSFI’s risk appetite outlines the risks it will accept in pursuit of its mandate. Therefore, OSFI must step back and reconsider its risk appetite, in response to the opportunities and threats on our risk horizon and in the context of fulfilling our mandate.

Historically, OSFI accepted very little risk to financial stability in the federally-regulated financial system. In practice, that meant we endeavoured to prevent institutional failure without much consideration of the costs of that approach – particularly with respect to sustainable economic growth and competition. As I noted earlier, we have been successful in exercising our risk appetite as evidenced by the lack of financial institution failures over the past 30 years and the relative resilience of Canada’s financial system during that same period.

Now we know that Canadians do not want a sudden spike in financial system volatility and disruption but they do want Canada’s financial system to power sustainable economic growth and to harbour greater competitive intensity. And we at OSFI believe we can realize each of those ideals concurrently if we adapt our risk appetite adroitly.

Adapting our Risk Appetite to the World As It is

Accordingly, OSFI is adapting our risk appetite to today’s risk environment. We will not view financial stability as the solitary outcome to be realized without much regard to economic growth and competition. But we will not sacrifice the hard-won advantages of a financial system that can weather extraordinary international volatility without absorbing a disruption of the core services it provides.

We characterize our risk appetite in the following way:

• Financial system resilience will remain OSFI’s primary responsibility
• And we will complement that primary responsibility with an enhanced focus on, and commitment to, two secondary responsibilities
  1. Ensuring our supervision and regulation do not impair Canada’s federally-regulated financial system as it finances sustainable economic adaptation and growth
  2. Promoting a greater degree of competitive intensity with a focus on lowering competitive imbalance throughout the financial system

With OSFI’s matured risk appetite, the financial institutions that OSFI regulates, both incumbent and new entrant, will have new opportunities to compete and contribute to Canada’s economic adaptation. Of course, their boards of directors and Chief Executive Officers own their risk decisions. And OSFI’s supervisory efforts will ensure that Canada’s financial system benefits from institutional risk-taking while remaining resilient to the punches that will also arrive.

So, what does this mean in more practical terms? What will OSFI do in the months and years to come?

Let me give you three avenues of activity:

1. Tailoring capital and liquidity requirements for sustainable economic growth and intensified competition
   • We have already begun this task in our decision to lower the Domestic Stability Buffer’s level and range earlier this year; and in our 2025 decision to delay further increases in the standardized capital floor applied to the capital requirements of systemically important banks
   • This fall, we will announce a number of amendments to our capital requirements that address concerns about sustainable economic growth, competitive intensity, or both
   • And we are already hard-at-work on 2027 amendments that will go further than this year’s
   • You may see initiatives that lower capital intensity for small- and medium-sized deposit-taking institutions and reduced stress-testing burden on the same
   • We are looking at simplifying regulatory capital structure for small- and medium-sized deposit-taking institutions, particularly credit unions
   • We will look at ideas to lessen the cost of funding imbalance between systemically-important and non-systemically important deposit-taking institutions; ideas which could include enhanced capacity for covered bond issuance and other forms of securitization
2. Easing the pathway for entry into the federally-regulated financial system
   • In June, OSFI launched its Streamlined Approvals Framework to give prospective new entrants a quicker, clearer, and more predictable path to becoming a federally regulated financial institution.
   • We’ll get through applications within a year and strive to shorten that as our risk appetite matures.
3. Regulatory burden reduction
   • We will continue work on what we call our ROT initiative. By ROT we mean regulation that is Redundant, Obsolete, or Trivial. Annually, you will see an OSFI focused on eliminating, decommissioning, or shrinking regulatory content that meets one or more of those criteria.

I hasten to add these ideas are a beginning, not an end. OSFI remains open to continuous adaptation as we apply our risk appetite to a new reality.