Banks ordered to set aside billions more amid high debt

Canada’s banking regulator has ordered major banks to set aside billions more in rain funds amid growing concerns about consumer and banker default on debt, including lines of credit, credit cards and mortgages.

The Office of the Superintendent of Financial Institutions announced Tuesday that it will raise the domestic stability buffer from 3 percent of a bank’s total assets to 3.5 percent effective November 1.

It is the second time in six months that OSFI has increased the amount that banks must set aside. In December, OSFI raised it from 2.5 percent to three percent, and also raised the top potential rate to four percent.

“We are in a period of rising interest rates and house prices are starting to rise again. Households and businesses are still highly indebted, making them more vulnerable to economic shocks,” OSFI head Peter Routledge said when announcing Tuesday’s change.

Introduced in 2018 for Canada’s six largest banks, the Stability Buffer is essentially a rainy day fund designed to keep the financial system stable by ensuring banks have enough money to absorb losses from defaults in mortgages, credit lines and cover other loans. The rate usually rises when OSFI sees problems later on, and falls when the problems hit and the banks need the money.

It was lowered to one percent during the early days of the COVID-19 pandemic and then increased to 2.5 percent in June 2021. Lowering it to one percent provided banks with $300 billion in additional liquidity, OSFI estimated. the time.

Raising the buffer again so soon after the December increase shows OFSI’s concern about growing consumer and corporate debt, said Pedro Antunes, chief economist at the Conference Board of Canada.

“What OSFI is saying is they are concerned about the increased risk of insolvency for both consumers and businesses,” said Antunes, who added that more financial stress will come to households as a result of the Bank of Canada campaign for rate hikes designed to control inflation.

Last March, the bank launched an aggressive rate hike campaign in an effort to bring down inflation, raising its key overnight interest rate from 0.25 percent to 4.5 percent. After a short break, the bank raised interest rates again to 4.75 percent on June 7.

The theory is that by making it more expensive to borrow money, consumers – and businesses – will spend less, driving down prices and slowing down the economy.

About 70 percent of Canadian mortgages have not been renewed since the rate hikes began, Antunes said.

“We are far from seeing the full effect of higher interest rates on mortgages,” said Antunes.

And those interest rates are a big part of what is already straining household finances, said Carl De Souza, senior vice president at credit rating agency DBRS Morningstar.

“There is a lot more pressure, mainly from rising interest rates, but also from the inflation that we have seen,” says De Souza. “Canadians already have the highest household debt in the G7, and higher interest rates add more pressure.”

Expectations of trouble can become a self-fulfilling prophecy for OSFI, said Claire Celerier, an associate professor of finance at U of T’s Rotman School of Management.

Households struggling to pay their debts may find that banks are reducing credit limits or not extending their credit lines as a result of the increase in the stability buffer.

“There is always the risk that this will amplify the effect of interest rate hikes. Because if banks have to set aside that extra capital, it means less money to lend,” says Celerier.

But if it keeps banks stable, the buffer will ultimately be positive, Celerier argued.

“In the short term, this can have a tightening effect. But in the longer term, if it means the system is more stable, that’s a good thing,” Celerier said.

Still, DBRS Morningstar’s De Souza argued, ultimately the big six banks won’t need to change too much — they won’t need to crack open piggy banks to find extra cash to set aside.

“They are generally in good shape and they already have this money on hand. OSFI just tells them to keep it there,” De Souza said.

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