Bank Watchdog in Canada Signals Confidence With Capital Lift

A Canadian fifty dollar banknote depicting Former Prime Minister William Lyon Mackenzie King and a Canadian one hundred dollar banknote are arranged for a photograph in Ontario, Canada. (Photographer: Brent Lewin/Bloomberg)

Bank Watchdog in Canada Signals Confidence With Capital Lift

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Canada’s banking regulator raised a key capital requirement for large domestic banks, a signal that it considers the economic risks of the Covid-19 pandemic to have largely subsided.

The country’s bank superintendent said Thursday it will raise the domestic stability buffer to 2.5% from 1%, beginning in October. The regulator lowered the buffer in March 2020, giving banks more room to absorb losses while still lending through the crisis.

The move by the Office of the Superintendent of Financial Institutions suggests the regulator believes the banks are no longer at risk of a wave of defaults and have sufficient capacity to lend, and that credit markets are functioning well.

Excess Capital

Canada’s largest banks can easily meet the new requirements because they are awash in capital. They have about C$80 billion ($64.8 billion) more in common equity tier one capital than is required to meet regulatory minimums, and C$40 billion more than the 11% CET1 ratio they typically target, according to Bloomberg Intelligence.

“I think Osfi probably looked at the current timing and said, ‘Now’s the time, given the banks are so flush, to just nudge up this minimum level or normalize it,’” Rob Wessel, founder of Toronto-based Hamilton Capital Partners, said on BNN Bloomberg Television.

“Probably the biggest impact it will have is, it will limit the amount of cash that banks can use when they make acquisitions -- at least those ones that want to make acquisitions. But it’s not likely to have any impact of dividends at all,” Wessel said.

The S&P/TSX Commercial Banks Index was up 0.1% as of 10:49 a.m in Toronto.

‘Resilient’ Lenders

“The economic and market disruptions stemming from the pandemic have abated and banks’ capital levels have been resilient,” Osfi said in a statement. “These conditions support today’s decision to rebuild the buffer.”

However, some “key vulnerabilities” remain in the economy, including elevated household and corporate debts, the regulator said.

“The two key housing vulnerabilities -- high household indebtedness and imbalances in the housing market -- have intensified over the past year, so higher capital requirements make sense,” Himanshu Bakshi, a credit analyst at Bloomberg Intelligence, said by email.

Osfi is still prohibiting the banks from increasing dividends or buying back shares, another one of its measures to protect the financial system during the crisis. The Federal Reserve has lifted similar restrictions that were placed on U.S. banks near the start of the pandemic.

Time to Adjust

Bloomberg Intelligence has forecast that Canadian banks may get regulatory permission to boost payouts and repurchase shares in the second half of this year.

While the move on the domestic stability buffer and the limits on buybacks and dividend increases are “independent decisions,” the regulator looks at similar factors for both topics, said Jamey Hubbs, assistant superintendent of the deposit-taking supervision sector for Osfi.

“There is some overlap in the vulnerabilities and metrics and indicators that we would look at for both decisions,” Hubbs said in response to reporters’ questions.

The regulator also thought it was important to update banks on its expectations for capital requirements and give them time to adjust ahead of any decision to lift the restrictions on capital returns, he said.

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