Torys on Budget 2025: proposals for small and mid-sized federal financial institutions

Budget 2025 announced the first phase of a plan to foster greater competition, innovation and efficiency in the Canadian financial sector. Many of the recommendations that we suggested in our 2023 bulletin entitled “2025 review of the financial sector statutes: proposed changes for consideration” (the 2023 Bulletin) have been adopted, and we thank the Government for its continued efforts in this respect. In this bulletin, we highlight some of the specific proposals set forth in Budget 2025 relevant to our financial sector clients.

Federal credit unions

Budget 2025 proposes to amend the Bank Act, the Canada Deposit Insurance Corporation Act and the Financial Consumer Agency of Canada Act to make it easier for federal credit unions (FCUs) to achieve scale via amalgamation or asset acquisition and to make it easier for provincial credit unions to enter the federal framework, including by providing the flexibility for them to continue their existing auto leasing business on a permanent basis.

We have been advocating for changes to improve the competitiveness of credit unions (see our 2023 Bulletin, as well as bulletins entitled “Breaking down the barriers to interprovincial provision of financial services” and “Reducing regulatory barriers in the financial services sector”) and are looking forward to reviewing the specific legislative amendments once published. It is encouraging that the federal Government has made FCUs a priority, but without buy-in from the provincial authorities, some of the proposed amendments may not result in any practical change. For example, corresponding changes would also need to be made to most provincial credit union statutes to permit provincial credit unions to sell their assets to an FCU in consideration for the FCU issuing membership shares to the members of the provincial credit union. 

Budget 2025 also made reference to the Office of the Superintendent of Financial Institutions (OSFI) engaging with small- and medium-sized lenders about changes to capital requirements that will enable them to compete more effectively. We welcome this opportunity and have some specific suggestions:

• As noted in our bulletin entitled “Should OSFI rethink AT1 capital requirements, particularly for federal credit unions?”, we believe that OSFI should eliminate the requirement for Alternative Tier 1 (AT1) capital for small- and mid-sized Canadian banks (in particular FCUs) and replace it with Tier 2 capital (similar to what the Australian Prudential Regulatory Authority) has done. In our view, AT1 capital would likely never be used in practice to absorb losses on a going concern basis. Further, replacing AT1 with Tier 2 capital requirements would enable FCUs to raise qualifying regulatory capital more efficiently and cost-effectively than they currently are able to.
• We would advocate that FCUs with CET1 qualifying capital consisting of membership shares and retained earnings that are not expecting capital distributions should be subject to a Total Capital ratio lower than the 10.5% minimum (i.e., the minimum Basel III Total Capital ratio of 8% plus a 2.5% capital conservation buffer that can only be met with CET1 capital). Capital distribution constraints are imposed on an institution when capital levels fall within the buffer range, but since most FCUs do not have a significant amount of capital in the form of capital which is expecting distributions, there is a good argument that these FCUs should not be required to have the full 2.5% buffer (or at the very least, OSFI should consider setting the institution’s supervisory target at or very close to the Basel III minimum ratios).
• OSFI should also consider changing the minimum leverage ratios for smaller institutions based on total capital to ensure there is a meaningful change. The risk-based capital requirements have always been and continue to be the stated primary capital requirements for deposit-taking institutions, and the leverage ratio was intended to be a supplementary capital test (i.e., a sanity check test that was not intended to be the binding constraint). However, we are not sure that continues to be the case. Prior to the financial crisis, Canada, unlike many jurisdictions, had a leverage constraint that was based on total capital, but after the financial crisis, OSFI has imposed a higher minimum leverage ratio than the 3% of Tier 1 capital that was imposed under Basel III. We understand anecdotally that OSFI has imposed a much more conservative leverage ratio, particularly for smaller institutions, which has in many cases become a binding constraint. In our view, the elimination of the AT1 capital requirement in favour of permitting more Tier 2 capital would be a fairly meaningless change without changes to OSFI’s approach on the leverage ratio.
• Non-viability contingent capital (NVCC) requirements should be eliminated for FCUs. Based on our discussions with investment bankers, we understand that NVCC provisions likely add at least 100 basis points onto the cost of capital for FCUs unnecessarily. NVCC conversion will likely always make sense for a domestic systemically important bank (D-SIB), given the massive amount of bail-in-able debt, and may make sense for a non-D-SIB (other than an FCU) if there is a willing buyer for all the shares and the buyer wants the existing capital stack to be converted into common shares so they can easily acquire all the shares. But NVCC conversion will likely never make sense for an FCU because the membership shares will remain outstanding and be able to elect the board of directors/approve any fundamental transactions. In addition, as noted in our bulletin “Should OSFI rethink AT1 capital requirements, particularly for federal credit unions?”, we cannot envision any potential scenario where an NVCC conversion could be triggered in respect of an FCU that would allow the Superintendent to form an opinion that it is reasonably likely that the viability of the FCU would be restored post-conversion; rather, the institution would either merge with another FCU, or simply be wound up under the Winding-up and Restructuring Act (Canada).
• As noted in our bulletin “Reducing regulatory barriers in the financial services sector”, OSFI should streamline its review process for federal continuance by factoring into its review that a provincial credit union could have an established track record of carrying on business for decades and would already be subject to provincial regulatory and supervisory standards (which in many provinces are generally consistent with those of OSFI). The statutory provisions for incorporation/continuance have not changed in over 30 years (other than adding the concept of an FCU about 15 years ago), but the timeline has become extended (in the 1990s, institutions were incorporated or continued federally in nine months to a year, whereas, based on recent applications, federal continuance may take between five and seven years). In addition, we do not believe that the number of FCUs should be limited to a handful—for example, we understand that in the United Kingdom, the Prudential Regulatory Authority regulates all credit unions (regardless of their size).

Public float requirement/large bank characterization

We were pleased to see that Budget 2025 proposes to amend the Bank Act, Insurance Companies Act and Trust and Loan Companies Act to raise the equity threshold for the 35% public holding requirement from $2 billion to $4 billion (allowing small financial institutions to grow larger before having to change their ownership structure), which was one of the recommendations in our 2023 Bulletin. However, the threshold for becoming a large bank ($12 billion since 2012) should also be increased. The initial requirement for the public float was $1 billion and will now become $4 billion, so we would propose that the threshold for large banks also increase fourfold from its initial requirement of $5 billion (i.e., to $20 billion).

Real property, equities and commercial lending limits

In our 2023 Bulletin, we had recommended that the statutory limits on real property, equities and commercial loans be revisited (including the broad definition of commercial loan). Budget 2025 announced that amendments would be made to the Bank Act, Insurance Companies Act and Trust and Loan Companies Act to repeal limits on borrowing and portfolio investments in commercial loans, real property and equity and replace them with more flexible OSFI guidance. This is an encouraging development, but there should be clear direction that these statutory restrictions should not become binding guidelines in the administration of the new regime by OSFI.

Notice and access

Budget 2025 proposes to amend the Bank Act, Insurance Companies Act and Trust and Loan Companies Act to include a "notice-and-access" method of delivery of governance documents, while retaining owners' rights to request delivery by mail, which is another one of the recommendations that we had proposed in our 2023 Bulletin. We were also hoping to see amendments to the Electronic Documents Regulations under the relevant financial institution statutes to improve the ability of institutions to communicate electronically with their customers, but there were no explicit references to this in the Budget.

Unlocking capital

As noted above, Budget 2025 referred to OSFI engaging with small- and medium-sized lenders about changes to capital requirements, which includes consulting on ways to encourage business lending by banks in support of the economy through the capital treatment of certain types of loans. This is an important initiative, particularly since we understand from certain market participants that a residential mortgage with a smaller or mid-size bank using the standardized approach may require over three times with the amount of capital to support than it would for certain banks using the advanced approach for the same mortgage.

Budget 2025 also referred to recent announcements by OSFI about reducing capital requirements for Canadian infrastructure debt and equity investments made by federally regulated life insurers. While we welcome this initiative, as noted in our 2023 Bulletin, the definition of “permitted infrastructure entity” (PIE) and the corresponding Permitted Infrastructure Investments Regulations are narrowly drafted, including that all “infrastructure assets” of a PIE must involve a public body (which essentially means that investments need to be limited to government-sponsored projects). Since OSFI’s capital relief is tied to the current definition and regulations, these capital changes may have limited value as a practical matter unless amendments are made to the statutory and regulatory definitions.