OSFI head outlines challenges in maintaining financial stability

To start, Rudin noted that, as much as possible, OSFI uses a principles-based approach to regulation. “To the extent possible, we stay away from detailed, prescriptive rules. Rather, we prefer to rely on high-level, broadly stated principles. To be sure, our guidance does include some ‘bright lines’ that institutions are not allowed to cross — clearly defined rules and requirements — but we try to keep those to a minimum,” he said.

The more principles-based approach places greater stock in the judgment and risk management efforts of the banks themselves, he notes. “In our approach, it is the boards and management of financial institutions, and only they, who are responsible for taking reasonable risks and managing those risks,” Rudin stressed. “A major strength of our approach is that it aims to ensure that regulatory compliance does not become a substitute for risk management. Indeed, financial institutions cannot comply with our expectations unless they actively measure and manage their own risks.”

At the same time, OSFI is also taking a flexible approach to the implementation of the new capital adequacy regime for global banks, known as Basel III. Historically, OSFI has chosen to exceed minimum global standards in certain areas, he says. “In the post-crisis world, our reputation for rigorous regulation has become a competitive advantage for our financial institutions as it helps them to be well regarded around the world. This pays off for them in better market access for funding, and lower funding costs. It also has paid off by giving foreign regulators comfort when Canadian financial institutions expand their operations abroad,” Rudin said.

Yet, in other areas, such as new leverage limits under Basel III, OSFI is sticking with the global minimum, he noted, “despite the fact that several high-profile jurisdictions will impose much stricter limits.”

And, in other cases, it is even deviating from Basel III standards with more accommodating applications of its requirements. “For example, subject to certain conditions, we accept preferred shares as Tier 1 capital, even though this is not consistent with a strict interpretation of the Basel III standard. We know these shares have been a reliable source of capital for Canadian banks, and we think they continue to make sense for Canada,” Rudin said.

Additionally, he observed that there is a growing gap within the domestic banking business itself, between smaller banks and the large, global players. “At OSFI, we are well aware of the increase in regulatory burden since the global financial crisis. Part of the cost of regulatory compliance is fixed, so it falls more heavily on smaller institutions,” Rudin noted. And, these smaller players also have less flexibility to manage the increase in post-crisis capital requirements, he said.

Rudin reported that OSFI has created the new role of ‘small bank advisor’ to consult with smaller banks, and help “formulate regulatory guidance and to calibrate supervision so that the regulatory burden on smaller institutions can be more closely fit for purpose.”

“We recognize that, in the wake of post-crisis regulatory changes, we need to find new and better ways to listen to the perspectives of regulated entities, particularly the smaller institutions,” he said. “At the end of the day, we may not agree to everything we are asked to do. But all institutions are looking — quite rightly — for evidence that, at a minimum, they have been heard and understood.”