In a speech given on November 18, OSFI Superintendant Julia Dickson said:
With the new found appreciation for capital, everyone is asking what capital level is enough, particularly in the banking sector, which has been in the eye of the storm. While it is difficult to do a comparison of capital ratios across global life companies (due to differences in nomenclature and approach), it is easier to do in the banking sector, and that has been the focus of much attention.
What we see in a comparison of international banks against Canadian banks is that our big five banks went into the turmoil with high capital levels (and we would say the same about life companies). Bank Tier 1 ratios at Q3 2008 ranged from 9.47 per cent to 9.81 per cent. This compared to Tier 1 ratios at other global banks that often started with the digits 6, 7 and 8 (versus 9 in Canada).
If you look at what is contained in Tier 1 — as they say, never judge a book by its cover — you will find that Canadian banks have platinum quality Tier 1 when compared to banks in other countries. The percentage of common shares is skyhigh, something not replicated in other places around the world.
Capital injections from governments into other global banks have tended to be in preferred shares (and sometimes preferred shares with step-ups or incentives to redeem that detract from their permanence, and permanence is a critical element for OSFI to consider something as Tier 1 capital). Canadian bank Tier 1 common ratios at Q3 2008 tended to be in the high 7s or low 8s. Elsewhere in the world the ratios were typically 5, 6, and low 7s.
To summarize, quality, and level of capital, are equally important and the market needs to focus on that. Going forward, there is going to be an incredible amount of attention paid by regulators internationally on the level and quality of capital. I believe Canada is well placed to enter those discussions. I also think that decisions will likely only be taken once world economies strengthen, and financial institutions will be given plenty of advance notice regarding new requirements.
The increase in the Tier 1 preferred limit has been discussed on PrefBlog. It does seem rather odd to me that OSFI is exalting the high quality of bank capital while at the same time permitting its debasement. There’s not necessarily a contradiction here, but there is definitely a need for a wee bit of discussion on the point.
Now, in the face of media frenzy, OSFI has released a note of calm:
Recent media reports regarding the Office of the Superintendent of Financial Institutions’ (OSFI) position on capital ratio levels may have led to some confusion. On Friday, December 19, 2008, OSFI provided the following information to the media:
OSFI’s views on capital were outlined in a speech given by Superintendent Julie Dickson on November 13, 2008, and those views have not changed.In that speech, the Superintendent made a number of points, among them, that Canadian banks remain well capitalized. It noted that common equity ratios of the large banks are particularly high, and that markets ought to consider this in their views about capital adequacy. This point was made because markets were demanding that Canadian banks increase capital, possibly based on a simple comparison of Tier 1 levels across global banks, even though many global banks have had capital injections from governments.
Further, it was noted that banks should not engage in share buy-backs without first clearing it with OSFI, as capital needed to be managed conservatively. Managing capital conservatively does not mean increasing capital.
OSFI has discussed global market developments both with banks and international regulators, as a similar phenomenon of markets taking a view on capital and driving up capital levels, is being observed globally. At the same time, to the extent banks have met market expectations regarding capital, this makes Canadian banks well-positioned to continue to lend.
As well, OSFI has increased flexibility within its rules by increasing the preferred share limit to 40 per cent from 30 per cent, which reduces the cost of capital for financial institutions, and may further support lending.
In short, OSFI has not pushed for higher capital ratios across the board, and OSFI agrees that capital is a cushion that should be available to be drawn down when faced with unexpected losses.