Nick Le Pan, Superintendent of Financial Institutions, indicated that he expects Canada’s big banks in Canada to adopt sophisticated approaches to new capital rules, known as Basel II.

Speaking at the Institute of International Bankers’ annual conference in Washington, DC today, Le Pan explained that Office of the Superintendent of Financial Institutions expects large, internationally active domestic banks to implement an advanced internal-ratings based (IRB) approach for all “material” portfolios and credit businesses in Canada and in the U.S. starting on November 1, 2007.

He added that OSFI will make available the IRB and Standardized approaches to all other banks incorporated in Canada, but anticipates that most will adopt the standardized approach for measuring credit risk.

Le Pan said that to measure operational risk, OSFI will permit banks incorporated in Canada to implement any one of the three approaches contemplated in Basel II: the Basic Indicator Approach; the Standardized Approach; or an advanced measurement approach (AMA).

OSFI anticipates that banks that plan to implement an IRB approach for credit risk will, over time, implement an AMA for operational risk as they improve their systems and processes to the point where they are able to meet the qualifying criteria, he said.

A Canadian subsidiary of a foreign or domestic bank will be permitted to use its parent’s IRB methodology subject to OSFI approval, he noted. OSFI’s approval will consider, among other things, the appropriateness for the Canadian marketplace of the data and experience used to calculate the subsidiary’s IRB capital requirement.

OSFI will also consider under what circumstances it will allow an allocation methodology for AMA for small subsidiaries in Canada, he noted. “Clearly, in considering this issue, we would want to be satisfied that the board of directors and senior management of the banks understand the risks and agree that the methodology of capital allocation was consistent with the risks undertaken in their operations,” he explained.

Le Pan, who also serves as chairman of the Basel Accord Implementation Group and vice chairman of the Basel Committee on Banking Supervision, said that OSFI takes its responsibilities as supervisor seriously and is striving to develop informal relationships with supervisors of Canadian banks’ foreign operations. “In fact, OSFI has been in contact with host country supervisory authorities that regulate significant foreign subsidiaries of Canadian banks and arranged a “college of supervisors” in May of this year where we could discuss information-sharing possibilities and hopefully lay the groundwork for establishing a level of reliance on each other’s work,” he said. “OSFI believes home-host relations will be most effective where reliance is built in part on trust and goodwill.”

He added that he believes that OSFI is well positioned to implement Basel II. “As we approach each issue of implementing Basel II — when, how and so on– I think it is important to keep in mind not only the challenges but also the benefits. Better relating capital to risk, promoting enhanced risk measurement and management practices in internationally active banks, and further enhancing supervisory focus all present huge opportunities –for banks, for supervisors, and for our markets and economies. While there are challenges, and while implementation won’t be perfect, I believe that with a combination of a practical and realistic approach, good feedback and ongoing communication, Basel II can be implemented well.”