The Canada banking regulator (OSFI) is increasing the pace of reporting required of Banks. Here follows notes on a few items of note related to increasing risk pre and post SVB.

OSFI increases monitoring to daily Globe and Mail

Canada’s regulator is taking extra precautions. OSFI has told banks that, starting as early as Tuesday and until further notice, they will be required to send the regulator liquidity reports each day through an existing monitoring tool that tracks banks’ financial positions, the two sources said. The added monitoring is not a sign of imminent concern, they said, but it is an attempt to keep on top of a fast-moving situation that has dramatically increased uncertainty for the sector.

An OSFI spokesperson said the regulator does not discuss supervisory measures.

The SVB situation is unusual. It does not take deposits in Canada but performs lending activity. This would make regulatory supervision a challenge due to the practical impossibility of assessing the funds matching and balance sheet risks given the Asset column is outside the country, and while it may reflect SVB US that would only introduce more unknowns.

However the SVB amounts in Canada are noted as small by G&M.

SVB is a small lender in Canada. The tech financer had US$692-million in assets and US$349-million in outstanding loans in Canada as of December, according to OSFI filings. By comparison, CIBC had $2.9-billion in loans through its innovation banking arm as of Oct. 31, 2021. A bank looking to bolster its lending to startups could potentially scoop up SVB’s loan book at a steep discount.

In related news TD has a pending transaction that is likely under review by TD and OSFI.

The turmoil in U.S. banking also threatens to throw a wrench in some Canadian banks’ expansion plans.

Nashville-based First Horizon Corp. struggled again Monday, with its shares falling 20 per cent, bringing their total loss to 35 per cent over the past two weeks. The drop has major implications for Toronto-Dominion Bank, which has a pending deal to buy First Horizon for US$13.4-billion.

Other regulatory notes

1. In October 2022 Peter Routledge, superintendent of Office of the Superintendent of Financial Institutions noted financial institutions can expect heightened oversight.
2. Routledge noted in Jan 2023 the risks identified for OSFI.
   
   • the housing market and household indebtedness,
     
     • climate change,
     • the digitalization of financial services, and
     • the lingering impact of the pandemic.
3. Since his speech to this conference a year ago, Routledge notes three (3) major events:
   
   • Russia’s invasion of Ukraine and an extraordinary resistance to that invasion by the Ukrainian people;
     
     • An acceleration in inflation, a corresponding central bank response, the intensity of which was last observed in the 1980s, and the effect of those phenomena on markets and economies;
     • The final stages of the crypto-asset bubble followed by its popping.
4. No indication of intra Canada no trans nation systemic risk was noted and Canada was viewed as a discrete environment.
5. Bias for action at OSFI is limited to crypto, yet he refers to it as digitisation of of financial services. I would argue he meant to say Digitisation of Crypto and the inherent risks. Otherwise his comment sounds like he is investigation Bill Payment etc. I would say there are new risks associated with Digitisation of Financial Services more broadly and these would inter alia include:
   
   1. Cross reliance on KYC / AML diligence by Fintech
   2. Transaction reporting between FI’s
   3. Preparation for Payments Canada Real time Rails immediate payments which introduce new types of tracking risk of funds back to source.
   4. Consideration of Open Banking. There is an opportunity for the regulatory regime to provide air cover to Open Banking activity to cover risks that will otherwise be determined individually by each FI. The latter impact will not properly support a cross Canada consistent regime that customers can simply understand.
   5. Yahoo News reports After an extensive consultation process, the organization that supervises banks and large insurance companies in Canada — the Office of the Superintendent of Financial Institutions (OSFI) — has released guidelines for financial institutions to address climate change. This is timely, considering banks and insurers are massive funders of the fossil fuel industry.
      The release of the guidelines, called the B-15, comes more than a year after a January 2022 pilot study by Canada’s central bank and OSFI on how resilient financial institutions would be under new climate policies.
      I would suggest that the timing of this release is poor when the real risk relates to systemic bank ability to withstand forces external to Canada and which have not been adequately addressed to date.
   6. Case in point is acceptance of deposits by banks that introduce heretofore unappreciated risk. In the case of SVB it was offering deposit services to customer banks based on bundles of bonds including Government bonds. Such bonds are risk free if held to maturity but the SVB product bundle offered the fiction of par value mid term, all the while market rates are rising thus mark to market value is falling.
      

Relevance to Bankwatch.

OSFI activities are made public in general not in detail so I can only relate what is visible.

Points 5. and 6. regarding Digitisation open the door in my mind to creating a more sustainable and understandable playing field which would provide for improvement and risk managed new financial Products such as Open Banking.

This was a long post designed to capture a few current directions within Canada. More to come.

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Appendix copied from Routledge speech Jan 2023.

This appendix is 100% quote of Peter Routledge.

Source OSFI site Government Regulator OSFI Jan 2023

Let me take the remainder of my time to provide an update on what OSFI plans to do in 2023. To build up resilience and preparedness in the financial system, OSFI will:

Let me expand now on these topics.

1. Ensuring buffers are in place so that FRFIs can absorb shocks

As you know, we already began this work in December as highlighted in our announcement of the Domestic Stability Buffer (DSB). Effective February 1, the DSB will be set at 3.0% of total risk-weighted assets, leaving a Common Equity Tier 1 level of 11% for all our D-SIBs.

Our decision to raise the level of the DSB was based on our observation that systemic vulnerabilities have persisted at elevated levels and, in some cases, have risen materially in recent quarters. We also expect that these vulnerabilities will continue into 2023, making the holding in this increased capital a prudent approach.

In addition, we also established a greater range for the DSB of 0% to 4%, creating more capacity to respond to rising vulnerabilities should that be needed.

These adjustments to the DSB are perhaps the most obvious examples of us acting early. By raising both the rate and range of the buffer, OSFI has ensured that our biggest banks are better prepared for any potential periods of uncertainty by giving them more capacity to cushion any economic impacts resulting from the severe but plausible scenarios that may be on the horizon.

There’s a responsibility that comes in regards to the DSB on the side of OSFI as well – that responsibility to remember it’s a buffer, or it’s a rainy day fund – something you use in bad times.

One hundred thousand (100,000) jobs were created in December, so we’re not in really bad times, despite what we may see every day in the news. If there is a more dramatic turn in the economy we have resilient capital buffers to absorb that, and consistent with the notion that we’d rather accept the risks of acting early than be criticized for acting too late, we will act affirmatively in terms of using capital buffers.

In addition, a week after raising the DSB, we announced that we would hold our expectation for the minimum qualifying rate (MQR) for uninsured mortgages to the contract rate of plus 2.0%, or, at 5.25%, whichever is higher. The Minister of Finance set the same criteria as a requirement for insured mortgages directly or ultimately backed by the federal government.

The MQR has been a helpful measure, and many have agreed that the stress we are seeing in the financial system could have been a lot worse if it were not in place.

However, while undoubtedly the MQR is an effective tool, it is not all that OSFI has available to ensure that sound residential mortgage underwriting and that the risks associated with residential mortgage lending can be adequately managed.

We also know that we need to constantly re-examine our guidelines to ensure they remain fit-for-purpose and the best measure to guard against upcoming threats in the risk environment.

This is why in a few days from now, on January 12, OSFI will be launching a review of our B20 Guideline – guidance on Residential Mortgage Underwriting Practices and Procedures.

A great deal has changed since this guidance was first issued and we need to make sure that we are looking to the horizon and adjusting our strategies to ensure that we are prepared, and acting before issues arise.

To give you more colour, the MQR stress test has provided a margin of safety intended to limit the risks to FRFI’s from high consumer indebtedness. The question in our minds is: is this sufficient.

So we’ll look at a broader range of debt-serviceability tools including debt-to-income constraints, debt service constraints as well as the current interest rate stress test tool.

1. Continuing work to address climate related risks

Similarly, you can see our “bias towards early action” in the approach we have been taking to the prudential concerns surrounding climate related risks.

To me, the rationale for taking an early approach is most starkly outlined for us on the joint Bank of Canada/OSFI Risk Scenario Report where it showed that in the management of climate related risks the impact of acting early significantly lessens the negative impact on the economy and macroeconomic environment.

The more steadily the world moves toward a reduction in greenhouse gas emitting energy sources, the better the transition will be for Canada – it won’t be easy by any stretch, but it will be better.

We have to be prepared for an outcome where progress toward a reduction, or a transition away from greenhouse gas intensive energy sources is delayed or slowed and it speeds up suddenly… that’s the risk I will bequeath to my successor. Now is the time to begin to address that risk.

Last fall, we closed our consultations on Guideline B15, which sets out expectations related to FRFI management of climate-related risks, in which we saw unprecedented outreach and input from across the country.

We are planning to release the final version of Guideline B15 later in the spring, which will further refine our prudential expectations of the management of climate financial risk for FRFIs.

While international standard setters are continuing their work, we have decided to take action earlier and release our guidance of the prudential requirements and expectations and update it when the standard setter’s direction is made available. We would much rather be over-prepared and scale back rather than not have gone far enough, and then the need to retool.

I think it important to also call out the fact that sound climate risk management implies a response to opportunities as well as risks.

Part of Canada’s transition will be our response to the opportunities inherent in a shift towards non-green-house-gas emitting energy sources.

To that end, we look forward to the Sustainable Finance Action Council’s work on behalf of the Ministers of Finance and Environment and Climate Change Canada; particularly the taxonomy framework which we intend to leverage in our continuing work to ensure our capital rules fully capture the opportunities as well as the risks of climate change.

1. Taking a proactive approach to the risks posed by the digitalization of financial services

The digitization of financial services is another area where we know that especially in light of the events of 2022, the risks have not gone away. And perhaps more importantly, they continue to have their own momentum.

On this issue, we do not have the luxury of waiting until “things have settled” or we have better data or more refined clarity on the future direction until we address them. Part of what we need to be ready and willing to do, is act with the best information that we have now, to prevent acting too late.

Again, one of the ways OSFI has done this is by taking an “evergreen” approach to guidance, to be able to signal our expectations to industry in a timely manner.

For example, last summer we issued an interim approach for capital and liquidity requirements in relation to crypto assets. Not unlike what we are doing on climate, this approach was issued ahead of the international standard setter. If required, we may update these in 2023 when we receive the new direction.

More recently, we have continued to act when we jointly issued a tri-agency statement with OSFI, FCAC, and CDIC to reaffirm that any entities that want to partake in crypto related activities should follow our existing guidelines. We are taking the approach that the same type of activities that have the same risks need to be treated and regulated in the same manner.

At the same time, we issued our Digital Innovation Roadmap – which is our proposed approach to supervising and regulating digital innovation and cryptoassets.

To be clear, this work is not being prompted because of a specific incident, but rather to ensure that we are prepared for both the seen and unforeseen risks on the horizon.

1. Emphasize the role of governance risks

Organizational governance and norms of behaviour are a catalyst for sound decision-making, prudent risk-taking and effective risk management. Therefore, a FRFI’s culture and governance can be a competitive advantage or an accelerant for reputational risks. History teaches that when a FRFI’s reputation risks accelerate, severe financial costs to all stakeholders of a FRFI often follow.

OSFI has recognized this for some time, having taken a number of steps including most recently the development of guideline expectations for FRFIs to proactively manage risks related to their governance.

We plan to release this draft guidance early next year for consultation with the final guideline to be issued along with a FRFI self-assessment tool to be issued in late 2023.

We know we all need to do more, and to this end, we are also looking to Boards to enhance their oversight of FRFI culture as a core component of their governance accountability.

At OSFI, we rely on Boards of Directors to fulfil the important role as insightful, watchful stewards over their institutions’ franchise values, especially when risks intensify.

We count on them to focus intently on the long-term, and to realize that a dollar applied to capital or liquidity safety margins or another non-financial safety margin today is not a cost, but an investment in the long-term sustainability of their institution’s value. If a board fails in its duty, it fails its stakeholders: customers, creditors, shareholders.

While this risk usually only becomes publicly known in extreme cases, it often can be traced back as a root cause of many risks a FRFI faces. In fact, on the surface a risk can seem like it may be financial or prudential in nature, but in reality, it is only masking an issue with governance. That is why we need to be more proactive in managing this risk – to address it before a severe prudential problems emerge.

And that is why we are confident that directors of FRFI’s in Canada are mindful of their duties and humble before the personal reputation risks that would attend the failure of a financial institution on whose board they sit.