OSFI launches consultations on Basel III implementation and updates to Pillar 3 Disclosure Guideline

On March 11, the Office of the Superintendent of Financial Institutions (OSFI) released proposed revisions to its capital, leverage and related disclosure guidelines (the Guidelines) for banks for public comment until June 4, 2021¹. These changes seek to implement the final Basel III reforms set by the Basel Committee on Banking Supervision (BCBS)², while catering such reforms to the unique characteristics of the Canadian market.

OSFI is also proposing changes to enhance proportionality in its capital and liquidity regimes so they remain appropriate for smaller, less-complex banks. In connection therewith, OSFI released a draft SMSB Capital and Liquidity Requirements Guideline for public consultation until June 4, 2021, which is a new guideline that outlines revisions to the capital and liquidity frameworks for small and medium-sized deposit taking institutions (SMSBs)³.

Finally, OSFI is consulting on proposed changes to its Pillar 3 Disclosure Guideline applicable to Domestic Systemically Important Banks (D-SIBs) until July 2, 2021. OSFI has also set out consultative questions for SMSB stakeholders to develop OSFI’s future Pillar 3 Disclosure Guideline for SMSBs.

What you need to know

• The revisions to the Guidelines reflect the Basel III final reforms and include enhanced disclosure requirements to support transparency and promote market discipline in Canada.
• OSFI has proposed changes to enhance proportionality in its capital and liquidity regimes so they remain tailored to, and appropriate for, smaller, less-complex banks.
• The public comment periods in respect of the proposed revisions to the Guidelines and OSFI’s new draft SMSB Capital and Liquidity Requirements Guideline close June 4, 2021.
• The public comment period in respect of proposed changes to OSFI’s Pillar 3 Disclosure Guideline applicable to D-SIBs closes July 2, 2021.
• OSFI plans to develop a Pillar 3 Disclosure Guideline for SMSBs based on feedback received from stakeholders through this consultation.

Changes to Capital Adequacy Requirements (CAR) Guideline

OSFI’s proposed changes to its CAR Guideline support the final Basel III reforms’ efforts to improve the comparability and transparency of capital ratios. These changes build on OSFI’s July 2018 discussion paper which set forth OSFI’s proposed policy direction for the implementation of the final Basel III Reforms and are meant to make the CAR Guideline more resilient and risk-sensitive, including by better aligning capital requirements with risk and reducing excessive variability of modelled outcomes.

Proposed changes to the CAR Guideline include:

• clarification of OSFI’s supervisory capital targets for deposit-taking institutions, including interactions with buffers;
• implementing a 72.5% Basel III output floor, a regulatory backstop to be phased in over three years following Q1-2023 to ensure a bank’s model-based risk-weighted assets do not fall below a minimum level;
• deductions from Common Equity Tier 1 (CET1) capital for a) certain exposures formerly subject to a 1250% risk-weight, b) reverse mortgages with loan-to-value ratios greater than 80%, and c) capitalized premiums on mortgage portfolio insurance;
• deleting the transitioning arrangements for capital instruments that were deemed non-qualifying upon implementation of Basel III;
• new operational and market risk capital rules and reductions of credit risk capital requirements for certain qualifying revolving retail exposures;
• updates to the capital treatment of privately insured mortgages; and
• eliminating the 1.06 Internal Ratings Based (IRB) scaling factor.

Leverage Requirements (LR) Guideline

OSFI has proposed changes to its LR Guideline to complement the risk-based revisions made to the CAR Guideline, and to continue to safeguard institutions against excessive borrowing, including by way of an application of a leverage ratio buffer to D-SIBs. Other changes to the leverage requirements include changes to the treatment of securities financing transactions and the treatment of off-balance sheet items to align with revisions to the CAR Guideline.

Liquidity Adequacy Requirements (LAR) Guideline

The revised LAR Guideline aims to improve risk-sensitivity and to ensure that institutions are holding enough cash or other liquid investments to provide for contingent liquidity demands and to support continued lending, particularly during periods of financial stress. The changes include: enhancements to Net Cumulative Cash Flow (NCCF) requirements to improve the recognition of cash flows related to asset growth (e.g., commitments) and operational expenses; a reduction of the time to report NCCF to OSFI for non-direct clearers; and clarifications of the time to report NCCF to OSFI for all institutions during periods of stress.

SMSB Capital and Liquidity Guideline

OSFI’s new SMSB Capital and Liquidity Guideline, based on input from its 2019 discussion paper and January 2020 consultative document, “Advancing Proportionality”, outlines revisions to the capital and liquidity frameworks for SMSBs⁴, clarifies which parts of the CAR, LR and LAR Guidelines are applicable to SMSB, and includes criteria to segment SMSBs into three different categories for purposes of determining capital and liquidity requirements: Category I for SMSBs reporting more than $10 billion in total assets, Category II for SMSBs reporting more than $100 million in total loans, and Category III for SMSBs reporting less than $100 million in total loans⁵.

Pillar 3 Disclosure Guideline

OSFI’s updates to its Pillar 3 Disclosure Guideline applicable to D-SIBs will replace OSFI's April 2017 Guideline on Revised Pillar 3 Disclosure Requirements (Phase I) and provide clarification on the domestic implementation of Phases II and III of the Pillar 3 Framework for Canadian D-SIBs. The draft guideline seeks to enhance transparency surrounding the capital, leverage and liquidity positions of D-SIBs and to promote market discipline, to ensure that stakeholders have access to key risk information to gain a thorough understanding of D-SIBs to ensure public confidence. OSFI’s draft Guideline took into account the relevance and importance of improving the overall comparability and consistency of disclosures across Canadian D-SIBs and alignment with internationally active banks in other jurisdictions.

The D-SIBs Pillar 3 disclosures are based on five guiding principles, namely, that disclosures should be: i) clear, ii) comprehensive, iii) meaningful to users, iv) consistent over time, and v) comparable across D-SIBs. In the Pillar 3 Disclosure Guideline, OSFI sets out requirements for reporting frequency, disclosure format, disclosure of qualitative narrative, and location of disclosures. OSFI also sets out its expectations for D-SIBs’ internal audit process for Pillar 3 information disclosed, which must be subject, at a minimum, to the same level of internal review and internal control process as the information provided for their D-SIBs’ reporting and reviewed periodically.

Similar updates are being developed for SMSBs and will incorporate feedback from stakeholders obtained from this consultation. 

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¹ The capital, leverage and liquidity guidelines also apply to federally regulated trust companies and federally regulated loan companies.

² The Basel III Framework is a response to the financial crisis of 2007-09. The final set of Basel III reforms were issued in December 2017. As part of the consolidated Basel III Framework, more robust market risk standards were introduced in January 2019 and the disclosure requirements (Pillar 3 in the Basel III framework) were updated in December 2019.

³ The SMSB Capital and Liquidity Requirements Guideline applies to banks (including federal credit unions), federally regulated trust companies and federally regulated loan companies.

⁴ Examples include: the option for Category I and II SMSBs to use a Simplified Standardized Approach to calculate credit risk capital for certain asset classes based on a materiality threshold; the introduction of a Simplified Standardized Approach for operational risk capital; and the introduction of a Simplified Risk Based Capital Ratio for Category III SMSBs that replaces the current risk-based capital ratio and the leverage ratio.

⁵ Subsidiaries of SMSBs are subject to the same capital and liquidity requirements as their parent institution, with some exemptions to minimum liquidity requirements based on an exemption set out in the LAR Guideline. Subsidiaries of D-SIBs are considered to be in Category I for the purposes of capital and liquidity requirements.

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