Canada’s federal financial regulator is defending the new capital adequacy regime for banks, known as Basel III, rebuffing criticism of its complexity.
Speaking at an insurance industry conference in Quebec City Monday, superintendent Julie Dickson, of the Office of the Superintendent of Financial Institutions (OSFI), said that it has been hearing “from a number of quarters” that the new Basel III regime for banks is too complex, and that regulators need to go back to a ‘simpler’ solution.
“I cannot agree,” she declared. “Basel I was simple but did not work very well; it created incentives to invest in risky assets. A simple leverage test alone cannot be relied upon either; it, too, can create an incentive to invest in risky assets. There is no simple measure.”
“What works, as we have learned, is hard work, she said. “It is not to rely on only one factor: yes, capital is critical, but so are things like sound governance, robust controls and checks and balances, strong IT systems to better aggregate and detect risk, strong management, good disclosure, and effective regulation and supervision. There simply is no simple solution.”
OSFI trying to incorporate lessons from the financial crisis into P&C oversight
The rest of her remarks to the National Insurance Conference of Canada focused on OSFI’s work reforming requirements for the property & casualty (P&C) industry, which she noted as come through the financial crisis in relatively better shape than other financial sectors. Nevertheless, she stressed that regulators don’t see that as a cue to be complacent.
She acknowledged that P&C companies are different from banks, but are still critical to economic growth, and therefore require sound supervision. “While P&C companies may not be banks, and thus may not have the same potential for being systemically important, they are nonetheless important,” she said. “The failure of a P&C company can be a big deal. And certain risks, such as a large earthquake, can simultaneously threaten the solvency of many companies.”
Which is why, she said, OSFI is constantly re-assessing industry practices, and trying to incorporate lessons from the financial crisis into P&C oversight, including the need for strong corporate governance and internal controls.
It is also reviewing the regulatory capital framework for P&C firms. “While the industry and the capital framework stood up relatively well in the face of challenges over the past few years, it has become apparent that some risks under the regulatory framework were not adequately covered or covered at all,” she said.
The first phase of this capital framework review was completed with the introduction of the Minimum Capital Test guideline, she noted. The second phase, which consists of “a review of the definition of capital and of insurance, credit and market risk factors, as well as an explicit recognition of risk aggregation and operational risk,” is scheduled to come into effect on January 1, 2014, she said.
Dickson said that the results of its analysis will be published for consultation in December, along with the results of a quantitative impact study. This will give the industry an opportunity to assess the capital impact of all these initiatives, and to comment on the draft 2014 MCT guideline, in the spring of 2013. “These consultation periods will give the industry a lot of lead time and opportunities to comment on the capital initiatives before they are finalized in the fall of 2013,” she said.
“The scope of events in recent years resulting from natural catastrophes and the global financial turmoil has been tremendous. Although Canada’s property and casualty insurance industry was fortunate to escape the worst of this, we cannot be complacent,” she concluded. “Based on lessons learned, OSFI will continue to work with the P&C sector to effectively address and manage the risks you face, so that you can continue to provide ‘oxygen’ to Canada’s economy.”