Statement from Peter Routledge, Superintendent of Financial Institutions: OSFI will never rest easy when it comes to financial system resilience

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• Type of publication: Statement
• Date: December 9, 2022

Today, the Superintendent of Financial Institutions released the following statement:

Given the recent attention Canadians have directed towards the economy and the housing market, I thought it would be a good time to describe what the Office of the Superintendent of Financial Institutions (OSFI) does to enhance financial system resilience.

In the simplest of terms, we ensure that federally-regulated financial institutions build up safety buffers to protect the financial system when hard times arrive. One example is the Domestic Stability Buffer (DSB). Launched in 2018, the DSB applies to Canada’s six largest banks, also known as Domestic Systemically Important Banks. We expect these banks to hold an additional reserve of capital, the DSB, above our adequately capitalized minimum expectations. Accordingly, systemically important banks will, we expect, maintain their Common Equity Tier 1 capital above 11%^{Footnote 1} of risk-weighted assets, versus a minimum level for capital adequacy of 8.0%. In so doing, OSFI ensures that the largest Canadian banks hold multiples of the capital reserves they held in 2008, the eve of the Global Financial Crisis.

The real value of this safety buffer lies in its utility. During economic downturns, bank loan losses rise, and bank capital ratios fall. This is a normal characteristic of this part of the business cycle. When this happens, OSFI will lower the DSB by a considerable amount and will be comfortable moving capital requirements towards the 8.0%, adequately capitalized floor. In other words, when the next recession occurs, OSFI will lower the DSB and expect banks to use this “rainy day fund” to help weather the storm. When conditions improve, we will gradually and non-disruptively raise the DSB and replenish the reserve for the future.

On December 8, we announced the results of a review of the DSB’s design and range. The review resulted in an increase of the range from 0 to 2.5% to 0 to 4% of Common Equity Tier 1 capital. We also set the level of the DSB at 3%, an increase of 0.5% as of February 1, 2023, and we will expect banks to meet an 11% CET1 ratio at that time. OSFI is confident that these adjustments will ensure that the DSB remains an effective measure to promote systemic resilience.

We have also built a safety buffer into the Canadian residential mortgage system with a standard we call the Minimum Qualifying Rate for uninsured mortgages (MQR), commonly referred to as the mortgage stress test. This buffer obliges federally regulated mortgage lenders to qualify mortgagors at the higher of two interest rates: the mortgage contract rate plus 2.0% or 5.25%. The Department of Finance has the same MQR in place for insured mortgages. Since 2017, OSFI-regulated lenders have applied buffers to all the residential mortgages they underwrote. As a result, throughout the recent period of very low interest rates (2020 through the first quarter of 2022), these lenders usually qualified their mortgagors at a minimum rate of 5.25%, despite the fact that the contract rates of these mortgages were often below 2.0%. This margin of safety made it easier for Canadian homeowners to continue to pay their mortgages and stay in their homes when rates rose later in 2022. That is one reason, we believe, why residential mortgage defaults remain at, or are near, historic lows.

Over the past six months, some have understandably argued that OSFI should lower or eliminate the MQR. They suggest that mortgage rates may be peaking and that the MQR puts an undue burden on homebuyers. We see great risk in speculating on the mortgage rate cycle and we do not consider the MQR to be a tool to manage the demand for housing. In fact, we see the MQR as an underwriting practice that adds an important safety buffer to residential mortgage portfolios, the largest exposure Canadian lenders have on their books.

The MQR has added a successful and important safety buffer to our financial system. In mid-December, OSFI will announce the outcome of its annual review, as we have committed to do at least annually. Then, in early January 2023, we will launch a broader policy review of residential mortgage and underwriting practices as set out in a document we call “Guideline B-20, Residential Mortgage Underwriting Practices and Procedures”; a guideline to which the uninsured MQR is subject. We will conduct this review so that our guideline remains effective and fit for purpose.

The DSB and MQR are two of the many practices OSFI has employed since the Global Financial Crisis of 2008-09 to add safety buffers and, therefore, resilience to Canada’s financial system. Despite these accomplishments, we never rest easy when it comes to financial system resiliency. We will continue to proactively challenge ourselves to find new opportunities to contribute to public confidence in the Canadian financial system.