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As economic risks increase, the Office of the Superintendent of Financial Institutions (OSFI) in Canada has announced that banks will be required to hold a higher amount of capital to safeguard against potential future losses.
Starting from November 1, the Domestic Stability Buffer (DSB) will be raised by 50 basis points to 3.5% of total risk-weighted assets. The OSFI regularly evaluates the DSB level, typically raising it during times of economic stability and releasing capital during periods of economic stress. This buffer is often referred to as a “rainy day fund.”
According to Peter Routledge, the superintendent of OSFI, this decision reflects the assessment that vulnerabilities in the financial system remain elevated and, in some cases, have even increased. Factors such as rising interest rates and increasing home prices, coupled with high levels of household and corporate debt, contribute to the heightened vulnerability to economic shocks.
Routledge also acknowledged the resilience demonstrated by Canada’s financial sector and emphasized that OSFI aims to enhance the resilience of the financial system by taking further action. This marks the second increase in the DSB within a span of six months, following the rise to 3% in December. The buffer range has been expanded to 4%, whereas previously it ranged from 0 to 2.5%.
The DSB serves as an additional reserve of funds beyond the minimum capital banks are required to maintain, known as the common equity tier 1 (CET1) ratio. As a result of this increase, the CET1 ratio will rise from 11% to 11.5%, necessitating banks to hold billions of dollars in excess funds to withstand potential economic downturns.
OSFI has confirmed that all six of Canada’s major banks currently surpass the minimum threshold for capital reserves.
OSFI prepared to lower buffer should risks materialize
Routledge stated that if economic or housing risks materialize, OSFI is prepared to lower the DSB and release funds to banks. Factors such as loan delinquencies, macroeconomic indicators of economic growth and employment are closely monitored. However, despite some early softening, the housing market remains resilient, loan delinquencies remain historically low, and banks have exhibited strong earnings.
He further assured that any future decisions regarding the level of capital reserves will be communicated transparently to avoid surprising financial institutions.
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