OSFI says regulators need to embrace risk to support innovation

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Canada may need to set aside a historically conservative risk appetite to avoid stifling digital innovation in the regulated banking system, including crypto assets, the country’s top financial services regulator said Wednesday.

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“If we want to truly encourage innovation, our mindset and our risk appetite for institution entry and institution exit (need to change),” said Peter Routledge, head of the Office of the Superintendent of Financial Institutions.

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“We have historically had a fairly significant conservative risk appetite for institutional failure. Not every innovator succeeds; some do, some don’t.”

Speaking at an Institute of International Finance (IIF) event, Routledge said he was not talking about allowing bank failures, adding that Canada’s strong set of regulations led to the resiliency of Canada’s banking system through crises from the global financial crisis of 2007 to 2009 through to the COVID-19 pandemic.

Still, he said, there is an argument to be made for adjusting requirements to encouraging cryptocurrency and other digital innovation inside the existing regulatory framework rather than outside it, where risks can become concentrated and can’t be easily monitored.

The key is to find a balance that brings the benefits of innovation to the system without sacrificing materially the financial sector resilience that is the result of the regulatory framework.

“Our first perspective on digital and crypto assets is, how can we leverage the benefits of that innovation without sacrificing materially financial sector resilience? And I do think it’s possible,” Routledge said.

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One of the things OSFI is looking at is whether approvals process and requirements for entry into the regulated financial system are too onerous or, as he put it: Are the regulatory requirements for entry “appropriately” sized?

“We’re asking ourselves what we can do in our approvals process to adjust our risk appetite in a way that supports innovation,” Routledge said. “I think if you were to ask some players out there … they would tell you, ‘Boy it’s hard to get a bank licence in Canada to operate.’ … Can we rebalance that so we get a bit more innovation in the system earlier and thereby encourage innovation within the regulated system?” 

He said OSFI is approaching innovation in the financial sector, including the use of artificial intelligence, with a “first, do no harm” mentality that means ensuring regulation does not stifle beneficial changes.

However, when it comes to capital requirements that have kept Canada’s banking system on relatively stable footing — whether through the “mini-crisis” last year that shook financial institutions in the United States and Europe or the pandemic — Routledge said OSFI is not giving up on implementation of the Basel III rules developed in 2017 to address weaknesses exposed by the financial crisis a decade earlier.

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While Canada’s regulator has paused a key plank in the final implementation due to delays in the U.S. and Europe, he declined to say whether that will be extended beyond the one-year window announced in July.

“The decision (whether) to continue that delay, we will make year by year,” he said. “Early next summer … or late spring, we’ll announce our path forward for the next year. And there may be changes to the schedule and there may not be.”

Still, he acknowledged that if Canada were to go ahead with implementation and other jurisdictions do not, it would create an uneven playing field and competitive disadvantage for some of Canada’s largest banks, an issue flagged by Royal Bank of Canada CEO Dave McKay in April.

“We are worried about the fragmentation of Basel III, and we’re worried because we really have the conviction that these reforms will make financial systems, at least Canada’s financial system, more resilient,” Routledge said.

“(But) while we do have conviction about the … reforms, it is also a competitive issue for Canada’s banks and many of them compete internationally. We can’t ignore that.”

• Email: bshecter@postmedia.com

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