OSFI defends Basel III reforms

“Turning back the clock and scrapping all those fancy risk models in favour of simpler tests is not an option from OSFI’s perspective,” he said. “Basel capital rules are complex because internationally active banks are complex… We had simpler rules in the past. Their deficiencies are one reason why we now have more complex rules.”

“At the end of the day, setting bank capital requirements is not a choice between complex versus simple rules. It is about using both, along with forward-looking risk and vulnerability assessments, to decide on how much capital is required so that banks can meet the needs of their clients in a wide range of economic conditions,” he said.

Moreover, Zelmer also noted that there are concerns that countries won’t follow through with implementing Basel III, leaving banks in the the countries that do, such as Canada, at a competitive disadvantage. However, he expressed faith in the peer review mechanisms to ensure that the standards will be widely adopted. “We are confident that over time these initiatives will help to foster public confidence in the implementation of Basel III and demonstrate that the promises made by G20 countries are truly being matched by deeds,” he said.

Finally, he also broached the issue of whether there should be some separation of core banking activities and investment banking in order to protect against moral hazard, and the possible failure of a bank considered too big to fail. For Canada, he cautioned, that separating investment banking could cause more problems than it solves.

Instead, if both activities are to continue to take place under one roof, he said, “it is important to ensure that bank corporate governance, risk management practices, internal controls, infrastructure and resources more generally continue to be up to the task of managing the business and the associated risks.”

Moreover, the financial system should be structured to deal with a large firm’s failure. “This thinking underlies the reforms that are being pursued internationally and here in Canada to foster more resilient financial markets through initiatives such as the promotion of central counterparties. It also underpins the work that is being done to enhance the oversight of shadow banking activities,” he said. And, financial institutions should be able to be quickly and smoothly wound down without causing a serious economic disruption, he suggested.

“There is still a lot of work to be done. But the end result will be a safer, more resilient financial system in Canada,” he concluded.