After the financial crisis of 2007-08, regulators from all over the world began developing international agreements for the financial sector. Their purpose is to ensure that institutions have enough quality capital on hand to absorb potentially severe losses. The Office of the Superintendent of Financial Institutions (OSFI) says that Canada supports this global initiative and is working to ensure that agreements are well adapted to the Canadian financial system.In a speech to the International Finance Club of Montreal on March 17, Superintendent of Financial Institutions Jeremy Rudin said that OSFI’s primary objective is to seek consensus when revising or developing international standards, but in the end, the result must be beneficial for Canada.
One area of concern is how an international standard would treat Canadian residential mortgages. Rudin pointed out that while residential mortgages make up a large portion of the portfolios of most Canadian banks, they are only exposed to risk on mortgages with down payments of 20% or more, as government-backed insurance protects lenders against default on the other, low down-payment mortgages. “We need the standard to accommodate this structure, even though it is unique to Canada, so that we do not inadvertently incent our smaller banks to take on riskier mortgages,” explained Rudin.
When it comes to determining the capital requirements for banks, Rudin indicated that OSFI prefers an internal ratings-based approach over a standard approach, as the former encourages banks to invest the resources necessary to keep their risk models accurate and up to date. “At OSFI, we constantly reinforce that it is the banks themselves that determine the risks they want to assume, risks they must subsequently measure, monitor and manage,” commented Rudin.
As for the regulatory capital standards for life insurers being developed by the International Association of Insurance Supervisors, OSFI believes they should only be based on reliable financial instruments that are truly loss-absorbing and capable of keeping insurers afloat during a period of stress.
“The capital regime’s treatment of assets also matters for Canada’s aging population and the Canadian economy. Some of Canada’s life insurance company portfolios contain a large proportion of long-term products backed by a wide range of actively managed investments,” noted Rudin. “OSFI believes that it is important that for regulatory capital purposes, companies’ policyholder obligations continue to be valued in a way that is not unduly volatile.”