03/26/2013 09:34 EDT | Updated 05/26/2013 05:12 EDT

Canadian Banks Too Big To Fail? ID'd As 'Systematically Important,' Big Six To Get Tougher Rules


OTTAWA - The federal financial supervisor has slapped a too-big-to-fail label on Canada's six largest banks, declaring they will need to carry a bigger capital buffer and be subjected to stricter supervision than their smaller peers.

The Office of the Superintendent of Financial Institutions said Tuesday that the "systemically important" designation stems from a framework issued by the Basel committee on banking oversight in October that set out guidelines for assessing domestic financial institutions.

Coincidentally, the Bank of Canada announced it would regulate SwapClear, the dominant global system for centrally clearing over-the-counter interest rate swaps operated from the United Kingdom.

The central bank said SwapClear has the potential to pose systemic risk to the Canadian financial system, adding the new designation would make the system "safer and more resilient."

Under the new OSFI requirement, the Bank of Montreal (TSX:BMO), Bank of Nova Scotia (TSX:BNS), Canadian Imperial Bank of Commerce (TSX:CM), National Bank of Canada (TSX:NA), Royal Bank of Canada (TSX:RY) and Toronto-Dominion Bank (TSX:TD) will be required to have to a bigger risk buffer than other banks.

Their Tier 1 capital ratio will have to be at least eight per cent as of Jan. 1, 2016, as compared with seven per cent for less important financial institutions.

The OSFI changes are also designed to make Canada's leading banks more bullet proof in the event of a financial crisis.

"The measures ... are designed to limit the likelihood that a major bank would encounter distress or failure that could negatively impact the Canadian economy or taxpayers," OSFI head Julie Dickson said in a news release.

Economics professor Ian Lee of the Sprott School of Business said the change was not a surprise given the dominance of the big banks, but that Canadians should not be concerned about the banking sector.

"I really do believe they are the most solid, secure, safest banks in the world and the World Economic Forum has said so five years in a row, so it's not just me saying that," he added.

"We also have a very diligent regulator, unlike the Europeans."

In November, the Basel, Switzerland,-based Financial Stability Board updated its list of 28 international financial institutions that were assessed too big to fail.

None of the Canadian banks made the grade. However, OSFI said the banks are systemically important to the Canadian economy by virtue of their size, interconnectedness, substitutability and flexibility.

The new rules sets up a three-tier hierarchy for capital requirements to guard against failure: a Basel floor for non-systemic banks, a middle ground for domestically important banks like the six in Canada and a higher requirement for global super-banks.

Barclays Capital analyst John Aiken said the announcement had been expected by markets and was unlikely to affect the bank's valuations.

"Given the capital positions of the banks under the Basel III guidelines and the fact that the transition will have three years to be implemented, we do not believe that this will be an onerous burden for the Canadian banks," he said in a note to clients.

"Further, given that the 100 basis point surcharge is broadly in line with the expectations of the market, we do not believe that today's announcement should have a material impact on the banks' valuations."

Lee agreed, saying he believes the markets will "shrug" at the announcement. The only possible repercussions are that the banks may wind up restricting their stock buyback and dividend programs, but even that is far from certain, he said.

In its explanation, OSFI said a "bank’s distress or failure is more likely to damage the Canadian financial system or economy if its activities comprise a large share of domestic banking activity."

It noted the six biggest banks account for over 90 per cent of total banking assets in Canada and that "the differences among the largest banks are smaller if only domestic assets are considered, and relative importance declines rapidly after the top five banks and after the sixth bank (National)."

Lee said while smaller, the National Bank is important in Quebec and a failure would likely result in Ottawa having to step in.

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