On October 31st, the Office of the Superintendent of Financial Institutions (OSFI) released the final version of its new Leverage Requirements Guideline. The Guideline is based on the BCBS publication Basel III Leverage Ratio Framework and Disclosure Requirements and implements the Basel leverage ratio requirement for Canadian banks and federally regulated deposit-taking institutions. Unlike the Basel test which is just a reporting requirement until 2018, OSFI has elected to require full compliance with its new leverage requirement by the end of the first quarter of 2015.
Not New for Canada
While the Basel leverage requirement may be a new requirement in many jurisdictions around the world, Canada has had a leverage requirement since 1982. Under the current Asset-to-Capital Multiple test, every bank must meet a maximum leverage ratio based on the bank’s total capital. The fact that Canada had a maximum leverage requirement in place for banks has been widely credited as one of the factors that allowed Canada to avoid the full impact of the 2008 financial crisis.
Main Differences to ACM
The new Basel-based leverage requirement is expressed as the ratio between a bank’s Tier 1 capital and it outstanding exposures. A bank’s “exposures” include its on- and off-balance sheet assets, the value of its derivatives exposures and the value of its securities financing transactions. The Guideline includes detailed guidance on how these exposures are to be calculated. The minimum ratio permitted is 3%, however, OSFI has reserved the authority to stipulate higher ratios for individual banks.
The ACM test requires that a bank calculate the ratio of a its total on balance sheet assets and certain specified off-balance sheet items (mainly direct credit substitutes) to its total capital. Although originally the maximum ratio permitted was 20 to 1, in more recent years, OSFI has set individual limits for each bank ranging in a few cases up to 23 to 1.
There are a couple of key difference between the two tests. First, the current test is based on all of a bank’s capital and not just its Tier 1 capital. This change is consistent with the Basel III emphasis on more permanent forms of capital. The second significant difference is that the new test is based on exposures and not assets. As a result, the new test contains much more specific rules for the types of exposures that must be incorporated into the calculation including rules respecting off-balance sheet exposures, derivative exposures and securities financing exposures.
In releasing the Guideline, OSFI stated that it believes that banks are well positioned to meet the new requirements. OSFI also indicated that they did not receive any comments on the draft which further suggests that banks are not concerned about the transition to the new test.
For a link to the Guideline click here.