In November 2010, the Financial Stability Board (FSB) recommended that all FSB jurisdictions should put in place a policy framework to reduce the risks and externalities associated with global and domestic systemically important financial institutions in their jurisdictions. The FSB recommended five components for the framework:
- a higher loss absorbency capacity to reflect the greater risks that these institutions pose to the global or domestic financial system;
- more intensive supervisory oversight;
- a robust core financial market infrastructure to reduce contagion risk a failure;
- a resolution framework and other measures to ensure that all financial institutions can be resolved safely, quickly and without destabilising the financial system or exposing taxpayers to the risk of loss; and
- supplementary prudential and other requirements.
How far has Canada come in implementing those recommendations? It appears that Canada has made good progress. Of course, as is typical with respect to financial services regulation in Canada, not all of the measures are transparent. Summarized below are some of the key accomplishments thus far.
Roadmap for Action
The Federal Budget for 2013 announced that steps would be taken to “implement a comprehensive risk management framework” for domestic systemically important banks (D-SIB). These steps were to include the introduction of a higher capital requirement, the implementation of a bail-in regime in the event that a D-SIB depletes its capital, enhanced supervision and a requirement for recovery and resolution plans.
Designating the D-SIBs
Roughly coincident with the release of the Budget, the Office of the Superintendent of Financial Institutions (OSFI) announced that the six largest Canadian banks had been designated as D-SIBs. A description of the designation criteria that OSFI used to make the designations is now found as an appendix to Chapter 1 of the OSFI Capital Adequacy Requirements Guideline (CAR Guideline). Based on the methodology described in the Appendix,, OSFI designated the five largest banks “without further distinction between them”. According to OSFI, The National Bank of Canada was also designated because of its importance relative to other less prominent banks and in the interest of prudence, given the inherent challenges in identifying ahead of time which banks are likely to be systemic in times of stress.
At the time that the D-SIBs were designated, OSFI also announced that an additional capital requirement would be imposed on D-SIBs beginning on January 1, 2016. The additional capital requirement or “Higher Loss Absorbency Target” was implemented in the form of a common equity surcharge of 1% of Risk Weighted Assets (RWA). Accordingly, D-SIBs will be required to meet an all-in Pillar 1 target common equity Tier 1 ratio of 8% RWA commencing January 1, 2016.
In August 2014, the federal Minister of Finance launched a consultation on a possible bail-in structure for D-SIBs. Under the proposal, certain types of debt would be converted to equity if a D-SIB depletes its capital. The comment period for the consultation closed last September. There has been no indication of the timing for the release of the final details of this bail-in regime.
The Appendix to the CAR Guideline states that D-SIBs are expected to adopt the recommendations of the FSB’s Enhanced Disclosure Task Force and any future disclosure recommendations that are endorsed by international standard setters and the FSB, as well as evolving domestic and international bank risk disclosure best practices. The FSB recommendations were developed for large international banks rather than specifically for D-SIBs.
Additionally, OSFI Advisory – Public Capital Disclosure Requirements related to Basel III Pillar 3, prescribes a set of capital-related disclosure requirements that are unique to D-SIBs.
Further, OSFI Advisory – Public Disclosure Requirements for Domestic Systemically Important Banks on Liquidity Coverage Ratio implements the Liquidity Coverage Ratio Disclosure Standards developed by the Basel Committee on Banking Supervision that apply to internationally active banks. In this case, OSFI has substituted D-SIB for internationally active.
The Appendix to the CAR Guideline also discusses the additional supervisory measures that have been implemented in respect of D-SIBs. Although OSFI notes that it has always applied a risk-based approach to determining the intensity of its supervision, OSFI noted that it had implemented the following additional measures:
- Greater frequency and intensity of on- and off-site monitoring of activities, including more granular forms of risk management reporting to OSFI, and more structured interactions with boards and senior managements;
- More extensive use of specialist expertise relating to credit risk, market risk, operational risk, corporate governance, and AML/compliance;
- Stronger control expectations for important businesses, including the use of ‘advanced’ approaches for Pillar 1 reporting of credit, market and operational risks;
- Greater use of cross-institution reviews, both domestically and internationally, in order to confirm the use of good risk management, corporate governance and disclosure practices;
- Selective use of external reviews to benchmark leading risk-control practices, especially for instances where best practices may reside outside Canada; and
- Regular use of stress tests to inform capital and liquidity assessments.
Of course, most of these measure would not be transparent outside of the D-SIBs.
Resolution and Recovery Plans
The CAR Guideline notes that OSFI is leading on recovery planning and the Canada Deposit Insurance Corporation (CDIC) is leading on resolution planning. Indeed, the CDIC Deposit Insurance Policy By-law was recently amended to permit the CDIC to request information from a CDIC member for the purpose of designing and maintaining a resolution plan. According to OSFI, CDIC has committed significant new resources to the resolution planning process.
All in all, it appears that significant steps have been taken to implement the FSB recommendations. While OSFI certainly would have devoted more attention to the large banks, even prior to the financial crisis, developing a framework for a distinct portion of the financial services industry marks a departure from the traditional approach to bank regulation in Canada. It will be interesting to see how this approach will be carried forward in the future.