RBC Capital Markets Canadian Bank CEO Conference

Thank you Darko for your kind introduction and for hosting this conference. I wish we could do this in person, so I’d have the opportunity to meet the many folks in the audience who I used to consider my clients.

Canada’s financial system has several underlying pillars of stability and I hope you consider the federal regulator one of them. Another pillar is surely the institutional research into financial services provided by Darko and his competitors. I used to be one of them and I always found the competitive drive to beat your opponents for unique insights and storytelling propelled our collective performance to higher levels.

Before I go any further, I would like to acknowledge that I am speaking from the traditional unceded territory of the Anishnaabeg nation. I am grateful to have the opportunity to be present in this territory. I recognize that those joining us today may work in different traditional Indigenous territory.

Recognition of our shared history is a crucial prerequisite for building trust and reconciliation with our fellow citizens of Indigenous descent. I urge you to read the Final Report of the Truth and Reconciliation Commission of Canada.

OSFI’s Transformation

Since arriving at OSFI, my colleagues and I have taken a fresh look at our risk environment. We’ve determined that responding to this environment in a manner that sustains public confidence in Canada’s financial system requires a transformational mindset and, simply put, a transformation of OSFI.

I have spoken before about this and Canadians will find a detailed strategy for our transformation on our website. But today I would like to address one specific, and core, aspect of our transformation that will set the stage for the issues I will discuss later in this speech.

That aspect is our mandate and how we interpret it.

Traditionally, we have taken the approach that OSFI’s mandate starts with protecting the depositors, policyholders, creditors of financial institutions as well as pension plan members, while allowing financial institutions to compete and take reasonable risks.

We took it as an article of faith that through sound prudential regulation and supervisory activities at the institution level, OSFI would support Parliament’s objective of contributing to public confidence in the Canadian financial system.

Therefore, our contribution to public confidence has historically been a byproduct or consequence of what we do, but not the driver of what we do.

Today, we encounter a risk environment populated with great uncertainties – climate risk, digitalization, unseen risks beyond the horizon – capable of upsetting the extraordinary resilience that has defined Canada’s financial system.

Not the least of these uncertainties, as recent history will bear out, is the COVID-19 pandemic, which is still with us in the form of the Omicron variant.

To sustain this hard-earned resilience, OSFI must adapt to these great uncertainties, which demands a broad-based yet intense focus on systemic risk.

Simply put, we cannot effectively enhance Canadian financial system resilience if we rely solely on a bottom-up, institution-by-institution approach to financial system regulation.

So we at OSFI will transform our approach to our mandate and make strengthening public confidence in Canada’s financial system the key driver of all we do.

Not by accident, this aligns with the overriding purpose that Parliament has assigned to OSFI through the OSFI Act, which states “The purpose of this Act is to ensure that financial institutions and pension plans are regulated by an office of the Government of Canada to contribute to public confidence in the Canadian financial system.”

This means that OSFI will be more forthright in sharing our perspectives, while opening ourselves up to outside challenge and debate.

This also means we will increase our contribution to public policy discussions. In so doing, we will build on our hard-earned credibility and influence, and improve our ability to act when intervention is required.

How will this transformation in OSFI’s approach manifest itself? Rather than offer a broad and general answer to that question, I will offer a perspective on four key issues that are prominent on OSFI’s agenda:

1. The Canada Recovery Dividend;
2. Household Credit and the Housing Market;
3. Climate Risk; and
4. Digitalization.

The Canada Recovery Dividend

OSFI is an office of the Government of Canada “… over which the Minister (of Finance) shall preside and for which the Minister shall be responsible.” I take that quote directly from our Act.

The Governor-in-Council appoints a Superintendent to be the Deputy Head of the office. As a Deputy Head, the Superintendent is a senior public servant whose duty it is to remain non-partisan. Part of doing that effectively is providing sound, technocratic advice to the Minister in confidence.

I shall hold to that duty in respect of all issues that implicate my office.

Yet a relatively minor part of the newly returned Government’s electoral mandate has emerged in public debate, and my office has a small part to play in that process.

I speak, of course, about the temporary Canada Recovery Dividend – a commitment articulated in the recent mandate letter to the Deputy Prime Minister and Minister of Finance.

While my advice to the Minister will remain confidential, and the matter remains subject to the Minister’s discretion, I would like to offer a few of my own preliminary thoughts on the matter to add some perspective.

First of all, there is historical precedent for a temporary recovery dividend. In the 1995 and 1996 federal budgets, the government of the day included a temporary capital tax on large deposit-taking institutions, as part of a strategy to share the burden of deficit reduction broadly and, specifically, within the corporate sector. Life insurance companies were also subject to a small capital tax.

Secondly, I think it is important to point out that the all-in, effective tax rate of OSFI’s regulated financial institutions was approximately 36% in 1996 (a rate that includes the aforementioned tax). In 2020, that rate stood at approximately 17%.

Thirdly, in 2020 OSFI’s regulated financial institutions earned approximately $73 billion before tax, which means that the temporary recovery measures—as laid out in August 2021—should add up to less than 3% of net income before tax at federally regulated financial institutions.

From our perspective, this issue is rather minor and is certainly in no way prudential. From your perspective, as investors in financial institution equity and debt instruments, I argue that it is not a significant valuation issue either.

Household Credit and the Housing Market

Now, on to the state of housing in Canada. As you may have noticed, OSFI made an announcement in December that will have a bearing on the 2022 housing market in Canada’s cities and towns. We confirmed that the minimum qualifying rate (MQR) for uninsured mortgages will remain the greater of the mortgage contract rate plus 2 percent or 5.25 percent.

On the same day, the Deputy Prime Minister and Minister of Finance announced the federal government would also maintain the same terms for insured mortgages.

I was struck by the response to our announcement. It appears that some may have interpreted OSFI’s MQR decision as a regulatory response to a tight housing market, as if OSFI was the price regulator of the housing market.

We are not. What we are is a principles-based regulator of the Canadian federal financial system, of which real estate secured lending makes up a crucial component.

In fact, our job as it pertains to real estate secured lending is to ensure financial system resilience in the face of the uncertainty in that market. How do we do that?

Our principal strategy is to ensure that residential housing finance has ample buffers to absorb that uncertainty. We must ensure Canada’s federally regulated financial institutions (FRFIs) prudently risk-weight their exposures and thereby allocate appropriate capital to those exposures.

We add an additional buffer at the household level via the MQR. At minimum, most Canadian mortgagors today must qualify at mortgages at 5.25%, well above prevailing contract rates for mortgages.

This means that those mortgagors have a buffer that will add to their financial resilience in the face of unanticipated events such as the loss of employment, or a house price correction.

We also add enterprise-wide stability buffers at the institutional level – for example the Domestic Stability Buffer for systemically important banks and specific Pillar II buffers for individual deposit-taking institutions.

What actions might OSFI take in 2022 in pursuing this strategy?

• We will re-examine the current MQR before the next annual decision in December 2022;
• We will update our capital adequacy guidelines to fine-tune capital requirements for household credit and align risk weights for exposures to private mortgage insurers with the Protection of Residential Mortgage or Hypothecary Insurance Act;
• We will ensure that lenders that offer Combined Mortgage-HELOC Loan Products (“CLPs”) risk-weight that exposure to reflect tail risk for a loan that dynamically re-advances credit to mortgagors of up to 80% of their homes’ current value;
• We may also review the B-20 Guideline (Residential Mortgage Underwriting Practices and Procedures) to ensure its provisions remain in line with OSFI’s intent as it pertains to CLP products.

Climate Risk

As 2021 progressed, market participants’ appreciation of climate risks intensified materially. By climate risks, I refer to the physical risks associated with climate change and to the transition risk that accompanies the global economy’s progression towards net zero greenhouse gas emissions by 2050, an initiative known as Net Zero 2050.

So how will OSFI adapt in 2022, and beyond, to intensifying appreciation of climate risks?

Our first priority, flowing from our mandate, is to ensure the Canadian financial system’s resilience regardless of the pathway the world follows in its pursuit of Net Zero 2050.

We will do all we can to ensure our financial system can weather the rising incidence and severity of climate events that will occur in this decade and the next. Fortunately, the insurance industry – the one that has the greatest exposure to physical climate risk in the near term – is making good progress, in my judgment.

But we will have to ask hard questions of the entities we supervise to ensure they have sufficient capacity – in the form of buffers (capital and otherwise) and risk management disciplines – to absorb intensifying physical climate risk.

OSFI has a special role to play with respect to transition risk, or the risks associated with transforming global and regional economies to reduce reliance on greenhouse gas emitting energy sources.

Collectively, the nations of the world will select a pathway to Net Zero 2050. The world may choose to start now and take a 30-year pathway. Or the World may choose to begin in the 2030s and take a riskier, accelerated pathway to Net Zero 2050.

And, I should be clear, it is far better for the Canadian financial system if the world takes a 30-year pathway instead of a 20-year pathway. The shorter the transition to Net Zero 2050, the more volatile it will be, and the greater the risk of financial system volatility for Canada.

Yet, the pathway the world takes is outside Canada’s control, and is certainly outside of OSFI’s control.

Therefore, our job is to ensure that Canada’s financial system remains resilient regardless of the pathway chosen. That means we must create the preconditions in our regulated space so that the Canadian financial system remains resilient even if the world chooses a delayed and ultimately accelerated pathway to Net Zero 2050.

Therefore, we will act this decade to drive mature climate risk management and ensure the capital build-up appropriate to sustain financial system resilience in the 2030s. Our climate risk management surveillance will reward better, more mature climate risk management and ultimately punish poor or inadequate climate risk management practices.

But more importantly, OSFI will expect federally regulated financial institutions to build up their capital buffers in the 2020s to be able to weather an accelerated and volatile transition pathway in the 2030s, should that scenario come to pass. It is for this reason that we at OSFI say that climate risk is not a 2030s or 2040s challenge, it is a “right now” challenge.

Digitalization

In Canada, we are blessed to have a well-capitalized, profitable financial sector in which the largest financial institutions have expanded to markets outside of Canada.

The digitalization of financial services turns this situation on its head somewhat: new domestic and foreign innovators are now looking to enter Canada’s regulated financial sector or occupy markets adjacent thereof. The underlying foundation for Canada’s resilient financial sector is strong regulation, fit for the country’s needs and purposes.

Our true north for sustaining systemic resilience as financial services digitalize is to ensure Canadians benefit from financial sector innovation generated by both incumbents and new players.

For innovators, we must recognize that our system, as currently constructed, is not easy to enter. We ask for rigorous governance and capital standards; an expectation that stems from our pre-occupation with financial system resilience.

We won’t change these or any other of the principles that underlie Canada’s excellent track record of financial system resilience . But we do have an opportunity to enable a higher degree of innovation from new entrants, consistent with the Minister’s ultimate oversight of the financial sector.

What OSFI will seek to avoid is a two-tiered system, with some participants heavily regulated and supervised and others lightly regulated and supervised.

Therefore, we will look for opportunities to bring innovations into the regulated system early so that incumbents and innovators have an opportunity to compete against one another for the loyalty and business of Canadians. In so doing, they will heighten the utility they provide to their customers.

We do not automatically presume this will require an expansion of OSFI’s oversight. The Bank of Canada’s retail payments oversight and provincial credit union regulators are examples of sound regulation outside of OSFI’s remit.

We will seek to limit our scope where other supervisors are better suited to enhance Canadian financial system resilience. We will also remain open to opportunities for OSFI to strengthen public confidence in the Canadian financial system via responsible expansion of the federal prudential regulator’s responsibilities.

This means OSFI may have to reconsider the expectations we put on new entrants with an eye towards lowering the de facto barriers to fast entry into our system.

This will require a clear-eyed analysis of what this could mean for near-term systemic stability. If we accept more innovators into the federal system, we must do so with the recognition of, and preparation for, the creative destruction of innovation.

I think OSFI will also have to be alert to financial system innovations that arise outside our current regulatory perimeter.

Financial innovation outside of or adjacent to regulatory perimeters has tended to produce opaque increases in financial leverage that are difficult to recognize until the market starts to disruptively unwind that leverage.

Of particular interest to OSFI are cyber risks associated with unregulated or lightly regulated digital access to Canada’s federally regulated deposit-taking system.

We are confident that the Open Banking initiative led by our partners at the Department of Finance will ease these risks while simultaneously empowering new innovators to compete for Canadians’ deposit and payments business.

We also see credit creation innovation outside the regulated sector. One example is the rise of Buy Now Pay Later (or BNPL) providers, which provide, in my opinion, the equivalent of consumer credit for purchases of consumer durables and other items.

Experience in other countries that have more advanced BNPL sectors, such as Australia and the U.S., provides useful context on credit quality and consumer protection issues.

Rapid expansion of this form of consumer credit has been accompanied by credit loss rates well above those to which we have become accustomed in Canada. Rapid build-up of these balances, if large enough, could disrupt a segment of household finance.

In terms of consumer protection, I note that some countries have seen the offering of these types of products beyond the consumer durables sector into, for example, childcare services.

Our partners at the Financial Consumer Agency of Canada have done great initial research on this product and Canadians can find this analysis on their website.

Conclusion

In conclusion, I would like to return to OSFI’s refined approach to its mandate. Preserving and enhancing Canadian financial system resiliency remains OSFI’s purpose and raison d’être. To do so in our current risk environment requires a transformation in our approach and of our institution. We have begun that transformation and it will pick up pace in 2022.

This means that we will sustain and continuously improve our supervisory competencies, which have produced exceptional results since our inception in 1987.

This also means that we will level up our contributions to financial sector public policy development in a manner that reflects the existential risks we face and in a manner that respects the limitations in our authorities delegated to OSFI by Parliament.

I have endeavored to provide you with practical examples of how this transformation will influence our activities in 2022 and I acknowledge that many questions remain – the answers to which will emerge from the steady application and re-application of our transformational principles to the variety of issues we will encounter in our risk environment.

Thank you, and I look forward to your questions.