Canadian Bank Regulator Tightens Credit, As The Household Debt Risk Emerges Again

Despite rainbows and unicorns, Canadian household debt problems didn’t just disappear. In fact, they got worse in many cases, and the economy is finally strong enough to start thinking about them. The Office of the Superintendent of Financial Institutions (OSFI), the country’s bank regulator, announced the domestic stability buffer (DSB) will rise in October. 

The buffer had been lowered at the start of the pandemic, to allow banks to lend more freely. This flooded the economy with hundreds of billions in additional lending capacity. Now that the economy is recovering faster than expected, OSFI is raising the buffer again. Concerns of debt vulnerability returned so fast, they raised the DSB to the highest level. Yes, even higher than it was before the pandemic.

Domestic Stability Buffer (DSB)

The domestic stability buffer (DSB) is an additional capital buffer to protect banks. All banks are required to set aside capital, those essential to the country need to put aside a little more. These banks are called Domestic Systemically Important Banks (D-SIBs), and Canada has six. The additional capital they have to put aside is the DSB. The regulator lets these banks tap the resource before touching an essential buffer. Kind of like defensive driving can let you avoid having to use your airbags.

When things are bad, the regulator lowers the DSBs so banks have more capital to lend. If the economy is weak, lenders tend to avoid as much risk as possible. This can mean tighter credit, more selective lending, and/or rising interest costs. If that happens, consumption can slow, making a downturn worse, or dampening a recovery. By lowering the DSB, even if bank revenues fall, they have a lot more capital to lend. Even if they don’t touch any of it, it being readily accessible helps to free up credit.

If the economy is doing well, the regulator increases the DSB, leaving the banks with less capital to lend. Banks aren’t as risk-averse, and are more willing to lend when incomes or revenues are flowing. Increasing the DSB tightens capital available to lend, while credit is growing. By throttling credit growth, they help to prevent too much risk to credit exposure. Less capital can mean an adjustment period or higher rates for some products.

Canadian Bank Regulators Asks Banks To Increase Buffer By 150%

The Canadian bank regulator is raising the domestic stability buffer — by a lot. The DSB will be rising to 2.5% according to this morning’s announcement. Banks have until October 2021 to set aside the additional capital. It’s always nice to get a few months notice when you’re asked to put aside billions of dollars.  

Pandemic Had Cut The Buffers, Flooding The Market With $300B More In Lending Capacity

Last year when the news of a pandemic first broke, OSFI lowered the DSBs. The buffer was cut to 1.0% in March 2020, down from 2.25% pre-pandemic. At the time they said this would free up $300 billion in additional lending capacity.

The idea is to make sure there is plenty of liquidity to keep the pipes of the financial system flowing. It may have worked a little too well though, with those pipes flooding the market. The regulator is now setting the DSB higher than pre-pandemic levels, to the highest rate allowed.

If that sounds like they’re trying to choke a little bit of credit growth, that’s because they are. Households and businesses have seen brisk credit growth. Despite this, little of that credit is turning into productive investments, like machinery. In the release, they said it was due to “key vulnerabilities such as household and corporate debt.” 

What does it mean for households? It depends on how the rest of the credit market responds, but this is credit tightening. Credit tightening generally brings higher rates and more difficult borrowing conditions. This is kind of the point — lenders don’t need additional incentive to lend in this environment.

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