The Canadian Banking System through the Pandemic: Where We Are and Where We Are Going

Opening remarks by Superintendent Jeremy Rudin prepared for OSFI's 2020 Risk Management Webinar for Deposit-taking Institutions

November 23, 2020


Welcome to our risk management webinar for deposit-taking institutions.

I regret not being with you in person today; it would have been fun to say hello to some familiar faces and to marvel at how many new faces have arrived. That said, the virtual format has its advantages as well: we can accommodate more participants and it is just as accessible to people who live and work outside the Greater Toronto Area.

Today I want to speak with you about the journey of the Canadian banking system through the pandemic: how we got to where we are today, and where we may be going.

Resilience building is paying off

The experience of the last few months has clearly shown that the Canadian banking system was well prepared for this crisis. The system entered the pandemic period with the capital resilience, the liquidity resilience, and the operational resilience that we sorely needed. Our experience also shows that most (although not all) of the things that a prudential regulator and supervisor can do that are useful during a downturn, should be done well before the downturn arrives.

Capital resilience

Let us start by looking at capital. A well capitalized banking system is essential for financial stability, because a strongly capitalized banking system helps to cushion financial shocks while a weakly capitalized banking system will amplify those shocks.

Even though we already had this view in Canada before the global financial crisis, we strengthened our capital requirements in its aftermath, in co-operation with our international partners. We not only raised our minimum standards, we also pushed banks to exceed those standards under normal conditions and so created robust capital buffers for use in times of stress. The clearest example of this approach is the Domestic Stability Buffer, which applies to the systemically-important banks. At the onset of the pandemic, Canada had one of the largest such buffers in the world.

I am pleased to say that all of this worked much as we had hoped. We lowered the DSB at the onset of the pandemic, taking it from 225 basis points of risk-weighted assets down to 100 basis points. As it transpired, the most important impact of that move was to signal clearly to banks and to market participants that a measured decline in capital levels would be an appropriate and prudent response to the deteriorating economy.

In the first quarter that was reported after the onset of the pandemic, we hit what I like to call the “downturn trifecta”: [1] Loan growth rose (supporting the economy). [2] Loan loss provisions went up (because of the downturn). And [3] market participants were unconcerned by the decline in bank capital levels. This was a textbook example of how the capital regime should work during a downturn, one where the banking system is able to absorb shocks rather than forced to amplify them.

In subsequent quarters, capital ratios have trended upwards in Canada. This may be surprising given that the economy remains weak, but it is the result of the confluence of three factors.

[1] Banks took the bulk of new loan loss provisions as soon as the economic outlook changed, which is what the new IFRS 9 accounting standard requires. [2] At the same time, pre-provision net revenue has held up well, and [3] loan demand has been understandably weak.

Liquidity resilience

There is also more to the story than capital resilience. We also substantially strengthened our liquidity requirements for banks after the Global Financial Crisis. Just last year we revisited and strengthened those requirements again based on our post-crisis experience. Just like the case of capital, banks had built substantial buffers above the minimum requirements, partly at our urging.

This too worked well. Banks used part of their liquidity buffers at the onset of the pandemic when financial markets were severely disrupted. Timely central bank intervention then restored market functioning broadly, which allowed banks to retain some of their liquidity buffers, and subsequently to rebuild them. Now that we are several months into the pandemic, liquidity is no longer a pressing concern; many banks are awash in deposits as consumers and firms moderate their spending.

Operational resilience

Banks have also demonstrated their operational resilience during the pandemic. I hope and expect that our work was helpful in this regard, as a few years ago we ramped up our focus on operational risk in general and on business continuity and third parties in particular. Of course, being resilient on the technology/cyber front is a significant component underscoring overall operational resilience and credit has to go to bank IT departments and the people who approved their budgets.

That wraps up my quick tour of how we got to today. Let us now turn our attention to where we are going.

What is next? Planning for a worst-case scenario

I think that we can be confident that we will eventually put the pandemic behind us. The recent news about vaccines is promising, and it is providing a welcome boost to everyone’s spirits.

But as the prudential regulator and supervisor, it is my job to remind you that it could get worse before it gets better. In severe but still plausible scenarios, it could get much worse.

COVID cases are rising in Canada and in many of our trading partners. Winter is coming to our hemisphere with the prospect of even better conditions for the virus to spread indoors than we saw during the troubling days in March and April. And “compliance fatigue” is growing.

Finally, we have to be alive to the possibility that other unwelcome events could impact the economy while it is already weakened. After all, if someone had told me a year ago that we would have a global pandemic and a global oil price war at the same time, I probably would have scoffed. But that is exactly what we experienced last March.

If the economy does take a sharp turn for the worse, the highest profile issue from OSFI’s perspective will be capital. The good news, and its very good news, is that there is plenty of capital for the banking system to be able to continue its shock absorber role. Still, if we find ourselves in another cycle of economic decline, or a W-shaped scenario, I expect that we will have to ramp our communication about how the capital regime works. We will be reminding banks and market participants at every opportunity that OSFI requires banks to build up capital buffers in good times precisely so that will be available for use during periods of stress like the one we are experiencing. We will also have to remind everyone that banks will be given ample time to restore their capital buffers in a transparent and measured way, when it is time to do so.

In this W-shaped scenario we may need to lower the DSB even further. Fortunately, a full 100 basis points of the buffer remains, almost half of the level we had at the onset of the pandemic. We would also have to reconsider the earliest date for contemplating an increase in this buffer, which is currently set at September of next year.

Some of you may have tuned out a bit during this section because you are confident that we will move smoothly towards the post-vaccine recovery. And let us hope you are right.

But I am not ready to take that for granted. For myself, I cannot stop thinking about the summer of 2008.

What about that summer, you ask? You will remember that the financial crisis had kicked off in Canada the previous summer with the disruption of the non-bank Asset Backed Commercial Paper market. Not long thereafter, the Bank of Canada began providing liquidity support to the financial markets, support was quite unprecedented by the standards of the day.

By the following summer, however, the Canadian situation had improved materially. It had improved so much that the Bank of Canada was actually cutting back the size of the support facilities that it had launched in 2007. Down the street at the Department of Finance, the powers that be were confident enough about the future that they decided that they could afford to put a novice in charge of their financial sector policy shop; someone who had never been an Assistant Deputy Minister before and who had no financial sector experience either. (That person was me, by the way).

We all know what happened shortly thereafter, when Lehman Brothers failed.

Of course, we may well escape a W-shaped recovery. But even if we do, the recovery may look very different from the pre-COVID “normal”. As the Governor of the Bank of Canada has reminded us, we could be in for a long, slow and bumpy recovery, which would weigh on credit performance. If we do have a long and slow recovery it will be accompanied by very low interest rates, which would weigh on earnings. Moreover, the pandemic experience may lead to structural changes in the economy, or accelerate changes that were already underway. These changes will create new opportunities for banks, but also new risks.

When the recovery becomes more entrenched, we will look to continue unwinding the extraordinary measures that we took at the onset of the pandemic. As you know, we are phasing out the extraordinary treatment of loan deferrals that we established in March, but there are many other measures still in place. We only brought in those measures that we judged to be credible, consistent, necessary and fit-for-purpose. When a measure no longer meets those tests, we will withdraw it.

Future of dividend increases

Of the extraordinary measures that we implemented in the spring, I am guessing that you are most interested in the future of the bans on dividend increases, on share buybacks and on increasing total executive compensation. Certainly those are extraordinary restrictions, and we do not want them to become a permanent feature of our system. So how will we know when it is time to relax some or all of them?

The most important consideration will be the extent of uncertainty about the economic outlook. This means that there is no set date nor specific economic indicator that will trigger our decision. We’ll begin to relax those restrictions when we get to the point where we think that there are few if any plausible paths that lead to a second pandemic-induced setback for the economy.

In that regard, it is important to understand that, from our perspective, keeping the restrictions on a bit too long is not as serious a mistake as taking them off too soon. If we have the restrictions in place longer than necessary, the capital simply stays in the bank and it will be there to be distributed later when the restrictions come off. If, on the other hand, we take the restrictions off too soon, the capital leaves the bank and it cannot be recaptured when it is needed.

You are probably watching to see what will happen in other countries that also have restrictions on distributions of bank capital. So are we. We are also keeping in mind that the circumstances in Canada differ from those of most of those countries.

In some countries, all dividends are prohibited. When the authorities in those countries lift that restriction, it will have the benefit of showing investors that it makes sense to put capital into banks because there is a reasonable prospect of getting it back out later. In Canada, on the other hand, we have never banned dividends; we have only prohibited dividend increases. Indeed, we are now into the second crisis of this century where Canadian banks have generally continued to pay dividends uninterrupted, which presents a very different picture to investors.

In yet other countries, share buybacks have been the principal means of returning capital to investors; dividend payouts pale in comparison. In Canada, the situation is reversed. Why does that matter? Because share buybacks are easy to start and easy to stop. Dividends are quite another matter.


I am going to complete my overview of our journey through the pandemic with the following observation. None of the issues that we were concerned about before the pandemic have fallen overboard, they have all travelled with us on the journey. That is why we restarted our policy development work and consultations in the fall after having suspended them in the spring.

The first consultation that we launched was about technology risk. That is no accident; rather than slowing the pace of technological change the pandemic has increased it. You will also have seen the recent announcement that we are working with the industry and the Bank of Canada on scenario analysis of the risks arising from the transition to lower greenhouse gas emissions. We will be following up with a broad discussion paper on the prudential approach to climate-related risks early in the new year. We are also determined to complete the work we started on implementing the Basel III end-game in Canada, and on a more proportional approach to capital and liquidity requirements for small and medium-sized banks.

We are looking forward to working with you, and other stakeholders, on these and other important projects. And, like you, we are really looking forward to end of the pandemic.