Following up on measures taken earlier by the Office of the Superintendent of Financial Institutions (Canada) (OSFI), the Bank of Canada, and the Department of Finance Canada in fighting the economic effects of COVID-19 (see our blog post here), OSFI announced a further series of regulatory adjustments applicable to federally-regulated insurers and banks in its March 27, 2020 press release.
As OSFI continues to monitor the evolving situation with COVID-19, it has been in close contact with federally-regulated financial institutions to discuss their operational capacity and plans to address developing situations in the current economic environment. As a result of these discussions, OSFI is making sector-specific adjustments for the banks, other deposit-taking institutions and insurers it regulates. The purpose of these adjustments is to reduce operational stress on these institutions so that they can focus on their financial resilience and their contributions to financial stability.
OSFI has requested banks and insurers to pro-actively inform OSFI of financial and operational challenges they face related to the COVID-19 crisis. As part of its regulatory flexibility to support financial institution resiliency in the face of the COVID-19 outbreak, OSFI is postponing previously planned regulatory changes and public consultations on proposed revisions to various OSFI guidelines. OSFI is also offering flexibility on timelines for regulatory filings.
OSFI is adjusting existing capital and liquidity requirements for banks that are not appropriate in the current extraordinary circumstances, to allow banks further flexibility in addressing economic conditions due to COVID-19.
Capital: Treatment of loans subject to payment deferrals
To assist banks that are allowing customers to delay loan payments, OSFI has announced that it will treat mortgage loans, small business loans, retail loans, and mid-market commercial loans as "performing" for the calculation of the banks' risk-weighted assets for capital purposes, for the duration of the period of the loan payment deferral, up to a maximum of six months. This measure will help preserve bank capital for lending purposes. OSFI stated that this treatment of loans subject to payment deferrals for capital purposes will be revisited in the future as necessary. OSFI has advised that banks should continue to assess borrower credit quality and follow sound risk management processes.
Capital: Credit loss positioning
OSFI has signalled an intention to introduce transitional arrangements for expected credit loss positioning that are available under the Basel Framework. This will increase banks' Common Equity Tier 1 capital and shift into this category a portion of allowances that would otherwise be designated as Tier 2 capital.
Application of IFRS 9 to these extraordinary circumstances
Related to the above two announcements, OSFI is providing guidance relating to International Financial Reporting Standards (IFRS) 9 on specific aspects of accounting for expected credit losses arising out of the COVID-19 crisis. OSFI is encouraging lenders to consider a broad range of factors (such as the exceptional nature of COVID-19, significant government support available during this crisis, high degree of uncertainty, and established long-term trends) in making their internal decisions in assessing for significant increase in loan risk. In OSFI's view, for example, use of a payment deferral program should not automatically trigger a significant increase in credit risk. These initiatives are intended to enable lenders to avoid automatic triggers built into IFRS 9 that may otherwise tighten lending requirements. OSFI expects banks to provide sufficient, timely disclosures to allow financial statement users to understand management assumptions and judgments in this time of change in economic conditions due to the COVID-19 outbreak.
Capital Treatment for Loans made through new Government of Canada Programs
In its March 30 press release, OSFI has provided direction to banks on capital treatment for exposures banks acquire through new Government of Canada programs to assist small and medium sized enterprises facing the impact of COVID-19. Loans and guarantees made through these programs come within OSFI's existing capital framework. Banks are permitted to exclude Canada Emergency Business Account loans from their risk-based capital and leverage ratios, as these exposures are funded by the Government of Canada. Banks taking on new Export Development Canada (EDC) loan guarantees for small and medium sized enterprises would include the full amount of the loan in their leverage ratio calculation and treat the Government-backed portion of the loan as a sovereign exposure as EDC is an agent of the crown and the remaining portion as a loan to the borrower. Banks participating as co-lenders with the Business Development Bank of Canada (BDC) in loans through the new BDC co-lending program to provide additional liquidity for small and medium sized enterprises are required to account for their portion of the loans in their risk-based capital and leverage ratios.
Covered bond limit temporarily increased to allow greater access to Bank of Canada facilities
OSFI will permit banks to temporarily exceed the existing limit of total assets pledged for covered bonds. The current limit (5.5% of the institution's on-balance sheet assets) is being increased to 10% of total assets, provided that the maximum amount of assets relating to market instruments remains limited to 5.5%. Allowing the banks to exceed the current limit allows them to pledge a greater value of covered bonds as collateral to the Bank of Canada for the Bank of Canada's loans to such banks. Banks which exceed the previous 5.5% limit will be expected to return to a level below this threshold when market conditions permit, and to provide a plan to OSFI outlining their proposed approach and timing to return to below the 5.5% threshold.
While OSFI normally expects banks to hold buffers above their minimum leverage ratio, OSFI is encouraging banks to use capital buffers and flexibility in their own borrowing activities. This builds on OSFI's March 13 decision to lower the Domestic Stability Buffer by 125 basis points to 1%, which increased the lending capacity of Canada's largest banks by $300 billion.
Liquidity: Use of Liquid Asset Pools
OSFI has announced its expectation that banks will use their unencumbered high quality liquid assets (HQLA) as both a defence against potential onset of liquidity stress and during a period of such stress, thereby falling below the liquidity coverage ratio (LCR) of 100%. In OSFI's view, a bank maintaining LCR at 100% under the economic circumstances related to the COVID-19 outbreak could produce unnecessary negative effects on such bank and on other market participants. To that end, OSFI provided additional guidance to banks relating to the LCR minimum standard. OSFI is also providing flexibility within the Net Stable Funding Ratio treatment for assets encumbered as part of central bank liquidity operations.
Delaying implementation of Basel III and other regulatory changes
On March 27, 2020, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced a delay in the international implementation of the Basel III reform package, intended to provide additional capacity for banks and regulators to respond to COVID-19.
Consistent with this, OSFI is deferring implementation of parts of the Basel III reform initiative.
OSFI is also delaying to the beginning of Q1 2023 the timing for implementation of the Small and Medium Sized Banks Capital and Liquidity Framework, along with the consultation work on Pillar 2 and Pillar 3 capital and liquidity requirements applicable to these banks.
For more information about these and other changes, please see OSFI's letter to federally-regulated deposit-taking institutions.
OSFI has specified that, for purposes of regulatory capital requirements applicable to OSFI-regulated mortgage insurers, payment deferrals allowed by lenders on mortgage loans will not cause insured mortgages to be treated as delinquent or in arrears. Mortgage payments missed on insured mortgages would ordinarily trigger a claim on mortgage insurance policies and increased exposure of the insurer, along with enforcement activity by the insurer.
OSFI has also announced that it will be suspending the IFRS 17 (Insurance Contracts) semi-annual progress reporting that insurers are required to file with OSFI. Earlier this month, the International Accounting Standards Board further deferred the effective date of IFRS 17 by one year, to January 1, 2023.
For more information about these changes, and the postponement of previously announced public consultations on revisions to various OSFI guidelines, please see OSFI's letter to federally-regulated life and property and casualty insurers.
We observe that OSFI Guideline E-19, the Own Risk and Solvency Assessment remains in-force and that insurers are obligated to update it as necessary, including boards and senior management demonstrating appropriate levels of oversight.
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