Fast facts

• During the 2008 global financial crisis, unlike banks in many other countries, no Canadian banks were bailed out or in danger of failing.
• This crisis resulted in a series of significant regulatory changes for the international banking sector. The ongoing volume and pace of these changes mark this as the most profound period of regulatory reform in recent banking history.
• The World Economic Forum has ranked Canada’s banks as the most sound in the world for seven years in a row 1 – a ranking that highlights the fact that banks in Canada are well capitalized, well managed and well regulated.

• Canadians understand this: When asked to rate the performance of banks in Canada on stability and security, 75 per cent Canadians provided a favourable rating. 2

The bottom line

Canada’s banks have been recognized as the soundest banks in the world for seven years in a row. Canada’s prudent banks combined with effective regulatory oversight form a model of stability in the global financial system.

Profound regulatory changes are underway

During the recent global financial crisis there was significant turmoil in the global financial system and a number of banks in other countries became insolvent and either failed or received taxpayer-funded bailouts.

That crisis resulted in a series of significant regulatory changes to the international banking sector designed to prevent this type of global problem from happening again.

The bulk of the changes regarding such things as capital, liquidity and systemic risk come out of the Basel III rules agreed to by members of the Basel Committee on Banking Supervision (Basel Committee). [See pull-out box.] The Financial Stability Board, working under the direction of the G20, sets the policy direction for these changes and the Basel Committee turns that direction into regulation.

While these rules are being set internationally, it is up to domestic regulators to put them into place and to enforce them. The pace of domestic implementation is not consistent around the world, although there is a global commitment to having the rules in place by 2019. 3

Taken together, the volume and pace of these changes mark this as the most profound period of regulatory change in recent banking history.

Financial markets are globally integrated. So in the end, the aim is that consistent implementation of these regulatory changes in countries around the world will result in a better functioning global financial system.

Entering the global financial crisis Canada’s banks were well capitalized, well managed and well regulated, and they remain so to this day. No Canadian bank was in danger of failing or needed a government bailout. And while this turmoil did not originate in Canada, it did have an impact on banks in Canada.

There are many important participants – including Canadian policymakers and regulatory officials – involved in shaping and adapting these regulatory changes for Canada’s financial system. [See Table of Main Participants below.]

Canada’s banks – through and with the CBA – are working closely with domestic and global regulatory organizations to implement all of the international regulatory changes.

What is Basel III?

Basel III is a framework that sets out global regulatory rules for bank capital and liquidity. These rules were originally published in December 2010 in response to the global financial crisis and are subject to ongoing review and updates. 4

The phase-in of Basel III capital rules began in 2013. Canada implemented these changes in January 2013, well ahead of many other countries and well ahead of the Basel III timeline. The phase-in of Basel III’s liquidity rules begins in 2015.

Basel III was developed and agreed to by members of the Basel Committee on Banking Supervision – commonly called the Basel Committee. This is a longstanding committee of the Bank for International Settlements (BIS) that is mandated to review and develop banking guidelines and supervisory standards at a global level.

Regulatory Changes and Rules

While several regulatory changes are underway, there are three important areas where rules have been set: capital, liquidity and systemic risk. Regulators in Canada implement these international rules and apply them domestically as part of their ongoing oversight of the Canadian financial system.

1. Capital

A bank holds capital so that the public will have confidence in it to help protect depositors and other stakeholders against losses in the event of a default. Capital is a cushion against bank-specific and market-related activities that could have negative impacts on a bank’s ability to stay solvent.

Basel III capital rules

• There are several categories of rules related to capital under Basel III. Taken together, these rules require banks to hold enough capital to equal at least 10.5% of their total risk-weighted assets by 2019.

Global and domestic systemically important banks

• Banks that are determined to be global systemically important banks (G-SIBs) and/or domestic systemically important banks (D-SIBs) have to hold additional capital. Canadian D-SIBs (i.e. the six largest banks in the country) will have to hold additional capital by January 2016. 5
• G-SIBs and D-SIBs are treated differently under Basel III given the potential impacts that a failure of any one of them would have on global and domestic economies.

Canada’s banks are among the best capitalized banks in the world in terms of both the quality and quantity of capital, and have been judged the soundest in the world by the World Economic Forum for the last five years. Banks in Canada did not receive nor need a government bail-out during the global financial crisis.

2. Liquidity

Liquidity refers to the ease with which assets can be converted into cash (i.e. liquidated) and sold. For banks, good liquidity is important because it bolsters their resilience to internal and external shocks.

Basel III liquidity rules

• OSFI issued a revised Liquidity Principles B6 Guideline in February 2012. This describes how the regulator assesses the strength of a bank’s liquidity risk management framework and whether the bank would have adequate liquidity under stressed conditions.
• OSFI’s approach is consistent with the Basel Committee’s September 2008 Principles for Sound Liquidity Risk Management and Supervision

3. Management of Systemic Risk

Systemic risk refers to elements of risk within the global financial system and the likelihood that those elements could lead to another global financial crisis along the lines of the crisis in 2008. Managing systemic risk helps maintain economic stability as well as the resiliency and soundness of individual financial institutions.

Regulatory requirements to address systemic risk

• Regulatory changes are being made to help manage systemic risk by strengthening capital, liquidity and leverage requirements for all banks.
• Banks that are determined to be global systemically important banks (G-SIBs) and domestic systemically important banks (D-SIBs) have to hold additional capital. Rules applying to these institutions will go into effect in January 2016.

• These rules for G-SIBs and D-SIBs are meant to address concerns stemming from banks whose collapse would cause significant global and/or domestic economic damage.
• Moves to ensure that these institutions have adequate recovery and resolution plans are part of this overall reform. These plans are road maps to facilitate either the recovery of an institution or its orderly wind-down in the event of failure. Both recovery and resolution can be caused by severe financial stress. 8

Regulatory requirements to address systemic risk as they relate to banks in Canada

• There are currently no banks designated as G-SIBs in Canada.
• In March 2013, OSFI named the six largest banks in Canada as D-SIBs. As a result, these banks will be required to hold an additional one per cent of capital and will be subject to more intense supervision and enhanced disclosure.

Banks in Canada are extremely unlikely to fail. However, there are mechanisms in place to help bring about an orderly resolution in the very unlikely event of a Canadian bank failure.

Regulatory changes coming out of the United States that will impact Canadian banks

Policymakers in the United States are taking their own approach to prudential regulation that differs in some ways from the harmonized approach being taken globally. A number of these measures have extraterritorial effects on Canada.

The American approach is contained in The Dodd-Frank Wall Street Reform and Consumer Protection Act – known generally as The Dodd-Frank Act – which passed in 2010. This act covers a very wide policy spectrum and touches banks in Canada in many significant ways, as highlighted below.

The Volcker Rule

• The Volcker Rule is part of The Dodd-Frank Act .
• The Rule, named after former Federal Reserve Chairman Paul Volcker, is intended to restrict banks operating in the United States from making certain types of investments − on the bank’s own behalf and not on behalf of customers − because such investments are considered to be potentially high risk.
• The Rule, in its draft version, was so broad that it captured domestic operations of Canadian-based banks with U.S. operations as well as other foreign banks that have U.S. subsidiaries, and would restrict Canadian banks from undertaking activities in Canada that are permitted by the Canadian government.
• The final version of the Volcker Rule is expected to be issued in 2013.

Treatment of Foreign Banking Organizations (FBOs)

Table of Main Participants

A number of organizations are involved in aspects of the regulatory changes underway. The table outlines the main participants and their role(s) in global regulations as it pertains to banks in Canada.