Bank regulator pauses rules to prepare for tariff uncertainty

Article content

Canada’s top bank regulator has indefinitely paused implementation of a key plank of the post-financial crisis reforms and is considering other relief measures to help banks manage any fallout from a trade war threatened by the United States.

Article content

Article content

In a surprise announcement Wednesday, the office of the Superintendent of Financial Institutions (OSFI) said it was indefinitely pausing an increase to the so-called Basel III output floor and would give Canadian banks at least two years notice before implementing the controversial change, which had already been deferred by a year from an initial implementation date in 2024 after other large jurisdictions failed to adopt the rules.

Article content

Further word on implementation of the final reforms in Canada wasn’t expected until summer.

In an interview Wednesday, OSFI superintendent Peter Routledge said that while uncertainty about whether the United States and Europe would adopt the final Basel rules informed the decision, tariffs threatened by U.S. president Donald Trump and the potential for an all-out trade war was a major factor.

“I’m talking about the uncertainty around what will happen as a result of potential … tariffs,”  Routledge said.

“The prospect of them creates some economic uncertainty that could filter into the financial system so in those situations, our regulatory constituents, first and foremost, want clarity, long-term clarity about the future.”

He said OSFI is assessing a range of potential impacts of rising tariffs on banks, such as rising loan losses, and could make further adjustments to regulatory capital, liquidity and reporting requirements as was done in the early days of the COVID-19 pandemic, if necessary.

“We’re not predicting it, but we built all this resilience so that the financial system can rely on it when unpredictable things happen, and you have to absorb and adapt,” he said.

Article content

Article content

One of the key adjustments OSFI made in 2020 was to allow banks to treat mortgages and business loans as performing even when payments were deferred, including the amount of capital that had to be held against them. The regulator also temporarily relaxed covered bond limits to give banks greater access to Bank of Canada facilities, and introduced transitional arrangements for the capital treatment of expected loss provisions under the Basel framework.

Banks generally use a three-year planning horizon for capital, so Routledge said Wednesday’s announcement to pause the final Basel reforms and the further promise of a two-year notice period should help them plan a response to the tariff threat and the potential impact on the economy.

“It just seemed like the right thing to do for the system,” he said.  “The primary consideration is doing everything we can to help federally regulated financial institutions … navigate uncertainty. And that’s that’s our first responsibility.”

Routledge said OSFI, which also regulates insurers, is considering a range of capital and other relief measures that could be necessary for that segment of the financial system if Canada enters a period of enhanced volatility.

Article content

The post-crisis reforms were put in place to strengthen banks’ ability to withstand financial shocks and support economic growth while enabling them to compete and take reasonable risks, but Routledge said their success relies on full, timely, and consistent adoption and implementation across jurisdictions so “competitive balance” remains throughout the international banking system.

He added that Canada’s banks have held up well over the past century, better than in many jurisdictions, and said he took the advice of Bank of England deputy governor Sarah Breeden, who urged regulators to “avoid the stability of the graveyard” — in other words, stifling growth by piling rules on financial institutions to ensure they can withstand shocks.

The final Basel rules for banks would have increased the so-called “output floor” to ensure banks’ own internal models of risk did nto deviate substantially from a standardized approach. It affects the calculation of risk-weighted assets, and was meant to shift away from sole reliance on internal measures that have been criticized for not reflecting the risks inherent in banks’ loan books.

Article content

“Although OSFI has nearly fulfilled its commitment to implement all aspects of the Basel III framework, we will not extend the implementation lead we share with a small number of fellow jurisdictions,” Routledge said in a statement Wednesday.

“This means that the output floor will remain at 67.5 per cent until further notice. Moreover, we commit to notifying affected banks at least two years prior to resuming an increase in the output floor.”

Canada pulled ahead of other countries in rolling out the series of rules and capital requirements agreed to after the great financial crisis of 2008 to shore up stability of the interconnected global financial system. The last of the reforms were implemented in early 2024 with a three-year phase-in of the capital floor, on the timetable set by the Basel Committee on Banking Supervision.

But before the final rules, which are sometimes referred to as Basel III Endgame, could be rolled out in the United States, banks there unleashed a flurry of lobbying and insisted the requirements would squeeze their ability to make loans and hurt the economy. About a year ago, the U.S. Federal Reserve signalled that it was going to water down the new rules and, last fall, signalled it would cut previously announced increases in bank capital cushion requirements in half.

Article content

Meanwhile, implementation of the final Basel rules in Europe had faced a series of delays.

As soon as it became clear last year that there might be uneven rules for banks in jurisdictions where Canada’s largest banks compete, Royal Bank of Canada chief executive Dave McKay spoke out. He said such conditions would put Canadian banks at a disadvantage against their global peers and that they risked falling behind.

“We cannot get out of sync with our two major competitive markets, Europe and America,” McKay said last April.

“The cost (of an uneven playing field) is we have to hold more capital against the same customer. That makes you uncompetitive.”

A National Bank Financial report in June suggested the final Basel rules would come with both business and economic costs by potentially crimping lending.

Against this backdrop, OSFI said last summer that it would delay implementing the change to how banks measure their risks internally compared to established models for a year to see how things played out in other jurisdictions.

A few months later, in a presentation in October, Routledge said OSFI had crunched the numbers and found that the final Basel rules would not have a significant impact on Canadian banks. However, he did not restart the clock on implementing the output floor rules and said at the time that he was unlikely to have more to say about it until this summer.

• Email: bshecter@nationalpost.com

Bookmark our website and support our journalism: Don’t miss the business news you need to know — add financialpost.com to your bookmarks and sign up for our newsletters here.

Article content