Canada’s banking regulator is holding the cash cushion that large lenders must set aside for loan losses and other adverse events steady at 3.5 per cent, noting that vulnerabilities in the financial system remain elevated.
All banks are required to maintain minimum capital levels to ensure they have reserves to absorb such losses, but the Office of the Superintendent of Financial Institutions (OSFI) mandates that banks considered systemically important – that is, all of the Big Six banks – should often hold capital over and above this level.
OSFI raised this buffer twice in 2022 and 2023 but has now held it at 3.5 per cent for two straight decisions, which are usually announced every six months. The last hike was one year ago, when the buffer was raised from 3 per cent of a bank’s risk-weighted assets.
On Tuesday, OSFI said a hike wasn’t necessary this time around because the large banks hold capital reserves above the 3.5-per-cent threshold, meaning they have capital above the combined level of 11.5 per cent of risk-weighted assets. Each Big Six bank is currently above 12 per cent, even after some significant developments, such as Royal Bank of Canada’s acquisition of HSBC Bank Canada and Toronto-Dominion Bank’s recent announcement of a large share buyback program.
The “3.5-per-cent-plus discipline at the Big Six banks is sufficient resilience for a potential downturn,” OSFI superintendent Peter Routledge said on a conference call Tuesday.
Because the banks are well-capitalized, there was a chance OSFI could even lower the buffer in response to economic conditions. The regulator typically requires banks to hold more capital when business is good and credit losses are low, helping them build a surplus that can be released when the economy is under strain. When capital is released, it can be used to fund loans.
Earlier this month, the Bank of Canada cut its benchmark interest rate by a quarter of a percentage point as inflation falls and the economy softens.
However, OSFI noted that Canadian household indebtedness sits near its historical peak and roughly half of Canadian mortgages will renew in the next few years, likely at much higher rates. The regulator is also monitoring commercial real estate, a sector in which many projects and buildings are struggling under higher interest rates, elevated inflation and lower demand.