As economic risks heighten, OSFI raises the amount of capital banks must keep on hand

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Canada’s banking regulator today announced an increase in the amount of capital banks must keep on hand to cover potential future losses.

The Office of the Superintendent of Financial Institutions said it will increase its Domestic Stability Buffer (DSB) by 50 basis points to 3.5% of total risk-weighted assets effective November 1. OSFI regularly assesses the DBS level, typically raising it in times of economic stability and releasing that capital in times of economic stress.

OSFI has previoulsy referred to the DSB as being like a “rainy day fund.”

“Today’s decision reflects our assessment that financial system vulnerabilities remain elevated and in some cases have continued to increase,” said OSFI superintendent Peter Routledge.

“We are in a period of rising interest rates and home prices have begun to rise again. Households and corporates remain highly leveraged, making them more vulnerable to economic shocks.”

However, Routledge added that Canada’s financial sector has “shown resiliency,” and that OSFI is seizing on this current strength to “take further action to bolster the resilience of our financial system.”

This is the second increase to the DSB in six months after it was raised to 3% in December. At that time, OSFI also increased the range of the buffer up to 4%. Previously, the buffer ranged from 0 to 2.5%.

The DSB is a reserve of funds in addition to the minimum capital banks are expected to keep on hand, known as the common equity tier 1 (CET1) ratio. As a result of today’s increase, the CET1 will increase to 11.5% from 11%, requiring banks to hold billions in excess funds to help weather future economic downturns.

OSFI confirmed that all six of Canada’s big banks currently exceed the minimum threshold for capital reserves.

OSFI prepared to lower buffer should risks materialize

In his comments to the media, Routledge said OSFI is prepared to lower the DSB and release funds to banks should economic or housing risks start to materialize.

“We look very closely at delinquencies on loans [and] we look very closely at macroeconomic factors that show economic growth and employment,” Routledge said.

However, Routledge acknowledged that despite some softening early in the year, the housing market remains resilient, loan delinquencies are still near historic lows and bank earnings have been strong.

He said any future decisions related to the level of capital reserves will “follow the principle of no surprises” to the financial institutions.

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