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Zealous approach to regulation pays off for Canada’s banks

Canada’s commitment to a strong banking sector is now world famous. But its banking industry appears to have achieved the best of both worlds, maintaining stability without suffocating innovation or stifling growth. Philip Moore finds out how it has achieved this impressive balance.

“Strong supervision impacts the bottom line of a financial institution in a positive way,” said Canada’s chief regulator, Julie Dickson, in a recent speech. “It does not limit opportunities; it expands them.”

Some would dispute this, with a debate continuing to simmer in the UK, for example, about the impact of regulatory diktat on lending volumes and broader economic activity. 

But Canada’s banking industry appears to have achieved the best of both worlds, maintaining stability without suffocating innovation or stifling growth. “With no bank failures since 1985, Canada has an enviable recent regulatory track record,” says Standard & Poor’s in its most recent banking industry country risk assessment for Canada. That is a view that nobody would seriously contest.

Since its creation in 1987, that track record has been jealously guarded by the Office of the Superintendent of Financial Institutions (OSFI), Canada’s chief regulator and supervisor, which is an independent agency of the government and reports to the Ministry of Finance.

Since the global financial crisis, which was navigated with fewer alarms in Canada than in most developed economies, the vigilance with which OSFI supervises domestic banking has been intensified.

It has required that Basel III be fully implemented in 2013, rather than phased in by 2019, as some other jurisdictions have done. It has slapped a 1% capital surcharge on the so-called Big Six which are deemed to be Domestic Systemically Important Banks (D-SIBs), which will apply from 2016. This will lift the minimum common equity tier one requirement to 8%. 

Dickson makes no apology for the zealousness with which OSFI has applied the Basel standards well in advance of other jurisdictions. She has a simple enough answer to those who ask why OSFI has been in such a rush. As she said in her May speech, “weak banking systems wreak havoc”. 

The Big Six already comfortably meet the 8% minimum CET1 ratio demanded by OSFI. Indeed, as OSFI’s assistant superintendent, Mark Zelmer, explained in a speech in May, “Canadian bank capital ratios are stronger than they look because they are not relying on the transitional arrangements contained in Basel III.”

Let there be light

The title of Zelmer’s address in May was “Let there be Light”, which reflects OSFI’s advocacy of improved disclosure standards in general and of the implementation of the recommendations of the Financial Stability Board’s Enhanced Disclosure Task Force (EDTF) in particular. Canada’s  banks, said Zelmer, have already acted on most of the EDTF’s 32 recommendations and have indicated that they will implement the remainder over the course of this year and next. 

That is a commitment re-emphasised by bankers such as Eric Girard, treasurer at National Bank in Montreal. “The concern that has been raised by some investors and ratings agencies about the disclosure standards on liquidity and funding are being addressed,” he says.

Canadian bankers say their interests are aligned with the OSFI’s. “Canadian banks are well rated, well capitalised and conservative, and so I don’t think there is any disconnect between where we are and where OSFI is encouraging the banks to go,” says Francine Blackburn, executive vice president of regulatory and government affairs and chief compliance officer at RBC in Toronto.

Blackburn points to the dialogue between the two on non-viability contingent capital (NVCC). “We fully support the concept of NVCC and we have been working closely with OSFI to develop a framework which we think is workable for key stakeholders such as bondholders and ratings agencies,” she says. “We understand why other countries have opted for a statutory model, so it will be important for Canada to explain to the markets why the Canadian approach will work relative to international frameworks.”

Blackburn agrees that strong capital ratio requirements and other measures such as the 3% leverage ratio have supported rather than hampered growth at RBC. “Our capital market business in the US has benefited from recognition of the strength of the Canadian banking system,” she says. “It has grown significantly and in some businesses we are back to where we were pre-crisis.”

The OSFI’s tough regulatory stance does not seem to have done bank shares any harm. “Our share price has been steady over the last five years and has recently reached an all-time high,” says Blackburn. “So the market seems to recognise that there are still plenty of growth opportunities for the Canadian banks to harness.”