Risks to the Canadian financial system, which are high and rising, have prompted the federal banking regulator to boost the capital buffers on the Big Six banks. This may affect the banks’ capital distributions, says DBRS Ltd.

On Tuesday, the Office of the Superintendent of Financial Institutions (OSFI) announced that it will increase the domestic stability buffer by 25 basis points to 2.25%, effective April 30. The increase applies to the six domestic systemically important banks (D-SIBs).

In a research note, DBRS said that the move reflects OSFI’s continued concern about vulnerabilities in the Canadian financial system, particularly high household debt and rising corporate debt. The regulator also sees heightened external risks, DBRS noted, such as ongoing trade tensions and rising leverage.

“Given the current benign credit environment and stable economic conditions, OSFI felt that this was an opportunity for D-SIBs to increase their capital holdings to protect against these vulnerabilities,” DBRS said.

The increased capital buffer will push the minimum capital requirement for the D-SIBs to 10.25%. DBRS said that when the total loss absorbing capital (TLAC) requirements kick in on Nov. 1, 2021, the minimum capital requirement would be set at 23.75%.

“The large Canadian banks continue to maintain strong [common equity tier 1 capital] ratios and already meet the higher capital requirement,” DBRS said.

Yet, DBRS added that the increase “may result in the D-SIBs maintaining [capital] ratios at or above 11.5%, which may reduce their plans for capital distributions to shareholders in [fiscal 2020] in order to bolster their internal capital buffers.”

Additionally, DBRS noted that the banks are also expecting a “small adverse impact of 10 to 20 bps” on their tier 1 capital ratios in the first quarter of 2020 due to the upcoming implementation of new accounting standards.

“Nevertheless, the large Canadian banks expect to offset this impact with internal capital generation,” DBRS said.

DBRS noted that the domestic stability buffer is set between 0% and 2.5% of risk-weighted assets, based on OSFI’s view of prevailing conditions, which means the regulator still has room for one more 25 bps increase.