The Office of the Superintendent of Financial Institutions (OSFI) recently addressed a letter to deposit taking institutions (DTIs), including domestic systemically important banks (D-SIBs) and small and medium-sized banks (SMSBs), regarding the use of Pillar II capital buffers during the COVID-19 pandemic. The key takeaways are below:
- Capital expectations framework for DTIs. The current DTIs capital regime remains multi-layered and includes:
1) minimum capital requirements;
2) Pillar I capital buffers, e.g. a Capital Conservation Buffer (CCB) for all DTIs and an additional surcharge of 1% of risk-weighted assets (RWAs) for D-SIBs; and
3) Pillar II capital buffers, e.g. institution-specific buffers and, for D-SIBs, the Domestic Stability Buffer (DSB). The CCB, D-SIB surcharge and DSB are required to be met by common equity tier 1 (CET1) capital.
- DTIs using the Standardized Approach to credit risk are encouraged to use Pillar II capital buffers during the COVID-19 pandemic. OSFI reiterated the rationale that capital buffers are built-up during normal times to provide an institution with additional flexibility in times of stress. In particular, it confirmed that measured declines in bank capital ratios are acceptable in the current circumstances and entirely consistent with the functioning of a well-capitalized and prudent institution. For this purpose, OSFI stated that the ability to use Pillar II capital buffers in times of stress, such as the current COVID-19 pandemic, applies to all DTIs, including those using the Standardized Approach to credit risk. DTIs that plan to use Pillar II buffers by operating below their internal capital targets are encouraged to discuss this with their designated Lead Supervisor.
- Capital management during the COVID-19 pandemic. OSFI expects all DTIs, including those using the Standardized Approach to credit risk, to consider the appropriateness of their capital management actions in the current environment. This includes the following steps:
1) in cases where DTIs are using their capital buffers, they should use the capacity prudently and consider appropriate capital conservation actions. An institution should also have a plan for how it expects to manage its risks and restore capital;
2) DTIs should consider stress testing information (including plausible future adverse scenarios) as part of the capital management decision-making process; and
3) DTIs must ensure that they undertake prudent capital management actions to protect depositors and other creditors while taking reasonable risks.