The Office of the Superintendent of Financial Institutions raised the capital buffer financial institutions must hold to three per cent as high household indebtedness and a rapidly rising rate environment pose greater risks.
The financial watchdog also increased the capital buffer’s range, or the policy tool to keep the country’s financial stability in check, to between zero and four per cent starting February 2023, rising from the previous range of zero to 2.5 per cent.
“This new level reflects our observations and high levels of systemic vulnerabilities have persisted and, in some cases, increased in recent quarters,” said OSFI assistant superintendent Angie Radiskovic during a Dec. 8 press conference. “Canadian household debt levels relative to income are approaching record highs exacerbated by sharply rising debt servicing costs as interest rates have increased. While house prices have begun to decline, they remain elevated after factoring in higher mortgage rates.”
Radiskovic added that highly indebted corporations are more vulnerable to economic shocks in a rising rate environment and sovereign debt levels are elevated worldwide compared to pre-pandemic levels.
“Finally, geopolitical uncertainty remains high, increasing the chance of a global slowdown that spills over into Canada,” Radiskovic said.
Also factored into OSFI’s decision is stress testing various scenarios and taking into account the high-profile acquisitions some of Canada’s Big Six banks have made this year. Radiskovic said banks are required to address all operations and cover all of the risks they’re exposed to, which would include forward-looking statements and contingency plans in their capital planning strategy.
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Since the buffer was created back in 2018, it has been OSFI’s policy tool to provide a capital reserve range that applies to Canada’s largest banks. During economic boom times, the reserve is built upon. Once the economy hits a contraction that strains financial institutions, it’s drawn upon to provide support.
The Bank of Canada engaged in an aggressive rate-hiking campaign over the year that brought the policy rate up 400 basis points to 4.25 per cent, prompting economists to project a stark economic slowdown heading into 2023. As debt costs rise and growth slows, OSFI is responding through policy changes.
High household debt was an issue OSFI flagged this time last year when it maintained the capital buffer for banks at 2.5 per cent. Since then, the country’s debt-to-income ratio moved from 177.2 per cent in the third quarter of 2021 to 181.7 per cent in this year’s second quarter.
OSFI said it would continue to monitor financial system vulnerabilities and broader economic environment, standing ready to respond through policy to minimize the impacts should these risks worsen.