How do the Basel III capital adequacy requirements apply to Canadian branches of foreign banks, and what are they?

OSFI regulates and supervises domestic banks and foreign banks operating in Canada. Foreign bank subsidiaries are regulated under the Bank Act. Foreign bank subsidiaries are controlled by eligible foreign institutions.

Canada has a centrally regulated banking system with a focus on macroprudential regulation and stability of the nancial system. The Bank Act, the principal federal statute governing all aspects of bank- ing, indicates its main purposes as fostering a strong and ef cient banking sector comprising competitive and resilient institutions, protecting the interests of depositors and consumers, and maintain- ing stability and public con dence in the nancial system. The Bank of Canada (the central bank) exercises a monetary policy focusing on an in ation-control target of around 2 per cent and a policy of non-intervention in a exible foreign exchange rate.

Canada is a strong supporter of the Financial Stability Board (FSB) and has been a leading jurisdiction in the adoption of the Basel III international regulatory framework. The Office of the Superintendent of Financial Institutions (OSFI), Canada’s primary bank regulator, introduced revised capital adequacy requirements in 2011, which came into effect in 2013. The revised capital adequacy requirements are consistent with Basel III and have an aggressive schedule in lockstep with the Basel III timeline for the planned implementation.

The thrust of Canadian banking regulation is guided by principles-based regulation as opposed to bright-line rule making. OSFI has issued guidelines on capital adequacy, prudential limits, account- ing and disclosure, and sound business and nancial practices that are considered ‘best’ or ‘prudent’ practices for banks and set industry standards for the nancial services sector as a whole.

[...]

Regulation of the banking industry falls under the exclusive jurisdiction of the federal government. Although provincial governments have jurisdiction to incorporate and regulate certain deposit-taking institutions, such as credit unions, only a nancial institution incor- porated under the Bank Act can conduct business as a ‘bank’ in Canada.

The Bank Act regulates domestic banks (listed on Schedule I of the Bank Act), foreign subsidiary banks that are controlled by eligible foreign institutions (Schedule II) and bank branches of foreign institutions (Schedule III). The Bank Act regulates, inter alia, the ownership, capital and corporate governance structures of banks, prohibits certain business undertakings and associations, prescribes capital and liquidity adequacy requirements, and regulates con- sumer disclosure, transparency and record-keeping.

Adequacy of capital and liquidity

485 (1) A bank shall, in relation to its operations, maintain

(a) adequate capital, and

(b) adequate and appropriate forms of liquidity,

and shall comply with any regulations in relation thereto.

Order permitting carrying on of business in Canada, etc.

524 (1) On application by a foreign bank, the Minister may make an order permitting the foreign bank to establish a branch in Canada to carry on business in Canada under this Part.

Foreign banks that have been authorized under the Bank Act to establish branches in Canada are permitted to carry on banking business in Canada. Some are permitted to offer full banking services. Generally, these foreign banks may not in Canada accept deposits of less than $150,000.

Some foreign bank branches distinguished as lending branches are subject to restrictions under subsection 524(1) of the Bank Act, and, as such, are prohibited from accepting deposits or otherwise borrowing money except from financial institutions.

11. The Filer is a highly regulated entity subject to capital requirements under subsection 485(1) of the Bank Act, which requires banks to maintain adequate capital and adequate and appropriate forms of liquidity. The Filer’s minimum regulatory capital requirements are determined in accordance with guidelines issued by OSFI. The OSFI guidelines were revised to incorporate the adoption of the significant enhancements and capital reforms, known as Basel III, to the framework of risk-based capital standards developed by the Basel Committee on Banking Supervision effective on January 2013. OSFI expects all institutions to establish target capital ratios that meet or exceed the 2019 all-in[1] minimum ratios plus conservation buffer early in the transition period. For the Common Equity Tier 1 ratio, the target is 7% by the first quarter of 2013. The Filer expects to exceed OSFI’s target.

Basel III is an internationally agreed set of measures developed by the Basel Committee on Banking Supervision in response to the financial crisis of 2007-09. The measures aim to strengthen the regulation, supervision and risk management of banks.

Like all Basel Committee standards, Basel III standards are minimum requirements which apply to internationally active banks. Members are committed to implementing and applying standards in their jurisdictions within the time frame established by the Committee.

For Immediate Release

OTTAWA ─ January 31, 2022 ─ Office of the Superintendent of Financial Institutions

Today, the Office of the Superintendent of Financial Institutions (OSFI) announced revised capital, leverage, liquidity and disclosure rules that incorporate the final Basel III banking reforms with additional adjustments to make them suitable for federally regulated deposit-taking institutions (DTIs).

These revised rules will help ensure that Canadian DTIs can effectively manage risks through adequate levels of capital and liquidity, thereby helping to bolster the resilience of these institutions. OSFI’s implementation of these rules reflects three key principles: introducing rules that are fit for Canada, setting the right incentives, and tailoring capital and liquidity requirements to better reflect the unique nature of small and medium-sized banks.

The internationally agreed-upon Basel III reforms provide a sound foundation for a resilient banking system in Canada. OSFI’s domestic implementation of these reforms will help to promote continued public confidence in the Canadian financial system by reinforcing the overall safety and soundness of Canadian banks.

Most of these revised rules will take effect in the second fiscal quarter of 2023, with those related to market risk and credit valuation adjustment risk taking effect in early 2024.

Subsections 485(1) and 949(1) of the Bank Act (BA), subsection 473(1) of the Trust and Loan Companies Act (TLCA), and 409(1) of the Cooperative Credit Associations Act(CCAA) require banks (including federal credit unions), bank holding companies, federally regulated trust companies, federally regulated loan companies and cooperative retail associations to maintain adequate capital. The CAR Guideline is not made pursuant to subsections 485(2) or 949(2) of the BA, to subsection 473(2) of the TLCA or to 409(2) of the CCAA. However, the capital standards set out in this guideline together with the leverage requirements set out in the Leverage Requirements Guideline provide the framework within which the Superintendent assesses whether a bank, a bank holding company, a trust company, a loan company or a cooperative retail association maintains adequate capital pursuant to the Acts. For this purpose, the Superintendent has established two minimum standards: the leverage ratio described in the Leverage Requirements Guideline, and the risk-based capital ratio described in this guideline. The first test provides an overall measure of the adequacy of an institution's capital. The second measure focuses on risk faced by the institution. Notwithstanding that a bank, bank holding company, trust company, loan company or cooperative retail association may meet these standards, the Superintendent may direct a bank or bank holding company to increase its capital under subsections 485(3) or 949(3) of the BA, a trust company or a loan company to increase its capital under subsection 473(3) of the TLCA or a cooperative retail association to increase its capital under 409(3) of the CCAA.

[...]

Chapter 1 - Overview of risk-based capital requirements 

The Capital Adequacy Requirements (CAR) for banks (including federal credit unions), bank holding companies, federally regulated trust companies, and federally regulated loan companies are set out in nine chapters, each of which has been issued as a separate document. This document should be read in conjunction with the other CAR chapters:

Chapter 1 - Overview of Risk-based Capital Requirements

Chapter 2 - Definition of Capital

Chapter 3 - Operational Risk

Chapter 4 - Credit Risk – Standardized Approach

Chapter 5 - Credit Risk - Internal Ratings Based Approach

Chapter 6 - Securitization

Chapter 7 - Settlement and Counterparty Risk

Chapter 8 - Credit Valuation Adjustment (CVA) Risk

Chapter 9 - Market Risk

Overview of Primary Changes

1. Capital Adequacy Requirements (CAR) Guideline

The primary changes that have been incorporated in the CAR Guideline include:

• clarification of OSFI’s supervisory capital targets for DTIs, including interactions with capital buffers (Chapter 1);

• implementation of a 72.5% Basel III output floor to be phased in over three years commencing in fiscal Q2-2023 (Chapter 1);

• introduction of new deductions from Common Equity Tier 1 (CET1) capital for (a) certain exposures formerly subject to a 1250% risk-weight, and (b) reverse mortgages with loan-to-value ratios greater than 80% (Chapter 2);

• introduction of new operational risk capital rules through the domestic implementation of the Basel III Standardized Approach for operational risk and a new Simplified Standardized Approach available for SMSBs (Chapter 3);

• maintenance of the current capital treatment for general residential real estate exposures with loan-to-value ratios between 70% and 80% (Chapter 4);

• reduction of credit risk capital requirements for certain qualifying revolving retail exposures, incorporation of updates to the capital treatment of privately insured mortgages, and introduction of a capital treatment for residential real estate exposures that do not meet OSFI’s expectations related to Guideline B-20 (Chapters 4 and 5);

• elimination of the 1.06 Internal Ratings Based (IRB) scaling factor initially implemented as part of the transition from Basel I to Basel II (Chapter 5); and

• implementation of the revised market risk capital rules, consistent with the Basel Committee on Banking Supervision’s Fundamental Review of the Trading Book (FRTB), as well as the revised Credit Valuation Adjustment (CVA) framework (Chapters 8 and 9).