THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Wednesday, May 10, 2023
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 4:15 p.m. [ET] to study matters relating to banking, trade and commerce generally; and the subject matter of those elements contained in Clauses 118 to 122 concerning cryptoasset mining in Part 2, and Divisions 1, 2, 6, 7, 26, 33 and 37 of Part 4 of Bill C-47, An Act to implement certain provisions of the budget tabled in Parliament on March 28, 2023.
Senator Colin Deacon (Deputy Chair) in the chair.
[English]
The Deputy Chair: Hello and welcome, everyone, to this meeting of the Standing Senate Committee on Banking, Commerce and the Economy. My name is Colin Deacon, and I’m the deputy chair of the committee.
I’d like to introduce the members of our committee today: We have Senator Gignac, Senator Dean, Senator Loffreda, Senator Galvez, Senator Yussuff, Senator Massicotte, Senator Smith and Senator Marshall. We also expect one or two more senators to arrive.
Today, for the first portion of our meeting, we have the pleasure of welcoming Peter Routledge, Superintendent of Financial Institutions. We’re pleased to have you here today to discuss the state of the banking sector. Welcome to our committee, and thank you for being with us today. We’ll now hear your opening comments. Mr. Routledge, the floor is yours.
Peter Routledge, Superintendent, Office of the Superintendent of Financial Institutions: Thank you. It’s wonderful to be here. Good afternoon, Mr. Chair and members of the committee. I have a short statement, and then we can proceed right to questions.
Thank you for having me here today to speak to you about your study on business investment in Canada. Specifically, you have asked me to speak about the status of the Canadian banking sector.
First, I would like to begin by acknowledging that we are gathered today on the traditional unceded territory of the Anishinaabe Algonquin Nation who have lived on and been the caretakers of this land for millennia.
I’ll keep my opening remarks brief in order to provide more time to address your questions.
[Translation]
The Office of the Superintendent of Financial Institutions, or OSFI, ensures that federally regulated financial institutions, or FRFIs, are in sound financial condition and it contributes to public confidence in the Canadian financial system. We do so by providing both the regulatory and supervisory framework for Canada’s FRFIs to help ensure that they control and manage risks.
We have witnessed significant volatility in banking systems outside Canada. However, Canada’s banking system has not experienced that level of volatility, and perhaps you are wondering why.
Since OSFI’s inception in 1987, Canada has built a resilient financial system populated by significant margins of safety.
[English]
For that reason, I believe our banking system’s resilience will prove its worth this year and beyond. We — at the Office of the Superintendent of Financial Institutions, or OSFI — never rest easy. We keep our eyes on the horizon and respond to emerging risks when they appear. We take the stability of Canada’s financial system very seriously. As a prudential regulator, it’s vital that we are prepared to act early in response to uncertainty and volatility. To do this, there are three elements that guide us:
First, when confronted with weakening financial institutions, we will take swift and decisive action to protect the interests of depositors and creditors.
Second, we remain clear-eyed and transparent about the risks to the financial sector — the principle we followed when we published our Annual Risk Outlook on April 18 of this year.
Third, we continue to advance key regulatory policies necessary to promote public confidence in the Canadian financial system.
Thank you, and I’m happy to answer your questions.
The Deputy Chair: Thank you, Mr. Routledge. We have an initial question from Senator Loffreda.
Senator Loffreda: Thank you, Mr. Routledge, for being here. Are we conducting the first panel, Mr. Chair? Are we concentrating on the budget implementation act during the first panel?
The Deputy Chair: I apologize. There’s the thought that we would have the Superintendent of Financial Institutions here on a regular basis, as we do with the Governor of the Bank of Canada. That’s the first issue that I think is well worthwhile. It’s great to overlap with banking issues related to business investment since we have that opportunity. This is part of a new tradition we hope to start where every six months we will have the Superintendent of Financial Institutions here.
Then, we will proceed to the panel regarding the budget implementation act.
Senator Loffreda: Thank you and welcome to our committee, Mr. Routledge.
Many economists hold the belief that the banking system in the U.S. is facing significant pressure — we all know that — in part due to the Federal Reserve’s recent interest rate increases. These increases have had a negative impact on the value of treasuries and other securities, which are a crucial source of capital for most banks in the United States and Canada.
Do you think Canadian banks will also have those difficulties, and are they experiencing such pressures resulting from policy rate increases from the Bank of Canada? If not, what makes the situation different for the Canadian banking system?
Mr. Routledge: Thank you very much for the question.
Senator, I don’t think Canadian banks will feel the same degree of pressure as U.S. banks. There are several reasons for that: Most importantly, structurally, we don’t have the same degree of interest rate risks on the balance sheets of the banks in Canada. You might ask why. Fundamentally, our mortgages are for a term of five years; the standard fixed mortgage runs for five years. In the United States, a standard fixed mortgage runs for 30 years. The degree of interest rate risks on the balance sheets of the banks in the United States is much higher, and that’s just a product of the math of a 5-year fixed mortgage versus a 30-year fixed mortgage.
There are other reasons, though. First, our capital rules are simply stricter than the capital rules applied to regional banks in the United States. For example, in an available-for-sale portfolio that’s marked to market, the changes in that portfolio every quarter, or every month, flow straight through to capital. For regional banks in the United States, that’s presently not the case. If a bank in the United States has more than US$250 billion in assets, then that rule applies. But in the banks that you have read about over the last several months, that was not the case.
Second, we apply Basel III, or global regulatory liquidity rules, to all of our banks. Whether you’re a billion-dollar bank or a trillion-dollar bank, you’re subject to liquidity rules. In the United States, they relaxed that.
A combination of industry structure and slightly tougher rules across the whole system means that I don’t think we’ll feel the same degree of interest rate risks at Canadian banks. It’s not that it’s not there, or that they shouldn’t be prepared to manage it, but we’ll feel it less severely.
Senator Loffreda: Thank you for that response.
The other concern that many Canadians have, and that we would analyze in depth, would be the real estate market — both the commercial real estate market and the residential real estate market. More specifically, what types of risks are associated with longer amortization periods offered to homeowners with variable-rate mortgages at this point in time? In your view, is the mortgage stress test sufficient to protect consumers from rising interest rates? Are those stress tests sufficient for our banks?
How do you feel about the virtual work-from-home scenario — in particular, commercial real estate’s decreasing value? In The Economist, lately I’ve been reading that 50% of workers in New York have returned to the office, and they’re predicting drastic decreases in commercial real estate values within the next decade.
How do you view the Canadian market regarding how it relates to our banks and their security?
Mr. Routledge: I’ll start with residential real estate, and then proceed to commercial real estate.
On the residential side, you’re right to point out that variable-rate mortgages with fixed payments are a fragility in our housing system. That is a product where, at underwriting, you agree with your financial institution to an amortization schedule at a fixed payment for 25 or 30 years, depending on the amortization period chosen. As rates increased, those payments remained fixed, but the interest charges against the mortgage increased. Some of those mortgages’ amortization periods, just by the math of the product, have extended.
The fragility is not immediate. If you happen to have that mortgage, and your mortgage payment is $2,200 per month, you’re still paying that amount per month. You’re probably not knocking down your principal at that stage, but you’re not experiencing payment shock. Employment is still pretty strong. The risk is in about three to four years when all of those payments will have to be rescheduled according to the original amortization table, unless the bank and the household agree to a different underwriting.
The risk for that product is a little further out, but it is a fragility that we’re watching very carefully.
You asked about the mortgage stress test. With five-year mortgages being the standard for a fixed rate in Canada, a fifth of all mortgages reprice every year. Throughout this year, those mortgages have been repriced, and people are paying higher interest rates than they did five years ago when they originated.
What we’ve found so far with the stress test — and whether it’s working — is that delinquencies might have been higher had we not had the stress test because, by having it, households were qualifying at mortgage rates much higher than their contracted rate. Mortgage delinquencies are near historic lows today, despite the increasing rates.
I think it worked in that respect.
What I’m concerned about is the buildup in variable-rate mortgages with fixed payments. During 2021 and 2022, there was a sizable increase in household mortgages underwritten with that product. That is a risk concentration that emerged even with the stress test. We started a consultation with the industry to understand — and we’ve proposed ideas for tackling that risk. We just finished the consultation in April, and we’re beginning to do the diligence right now.
With respect to commercial real estate, it’s one of our top four risks that we just included in our Annual Risk Outlook. The areas we’re most concerned about are office spaces in building Classes B, C and D. We do see similar stresses in the United States, although we haven’t seen a deterioration in credit quality. Now, I don’t want to say yet, but we are asking our institutions to expect that, as well as to begin to think about how they plan their balance sheet management in light of that.
In the quarters to come, I think you’ll see an increase in credit loss provisions that will be handily absorbed by bank earnings.
The Deputy Chair: Thanks very much, Mr. Routledge.
Senator Gignac: Welcome back, Mr. Routledge.
[Translation]
I want to begin by continuing the discussion on the B-20 guideline, which is the minimum qualifying rate for new mortgages.
Your rule is still 2% above the contract rate or the Bank of Canada’s five-year maximum rate. I commend you for that because that rule was put in place several years ago and it has prevented problems, as you mentioned. Do you think about changing that rule when interest rates are really high and in restrictive territory like they are now? Would you consider making the rule 2% above the Bank of Canada’s neutral rate or something like that? Some people are excluded and may not be able to buy property because of that rule.
That rule makes a lot of sense when the rates are really low, like they were two years ago, but does it still make as much sense when we are in such a restrictive period?
[English]
Mr. Routledge: I understood your question to be this: Would we consider changing the 200 basis point level — either higher or lower? You pointed to maybe lowering it in order to help new homeowners enter the market.
There are two responses to that. First, at least based on everything we’ve been able to determine, the 200 basis point stress test worked in keeping delinquencies low. From what we’ve seen so far from the evidence, Canadians have managed through higher interest rates, and we’re not seeing an expansion of defaults as a result.
If we were to lower it to help other Canadians enter the market — and we do worry because the higher the rates are, the more punitive the stress test is — what would happen in the housing market? It would increase the buying power of the buyers. And in a free market, which it pretty much is, house prices would likely rise and then offset the benefit. We’re very cautious about that.
One of the reasons we conducted the Guideline B-20 consultation was to get a feel for when lowering the stress test might be a counter-cyclical measure. We’re evaluating that now. The bank analyst in me is skeptical because as soon as we lower it, I think house prices would compensate and people would be left with the same monthly charge on their mortgage.
Senator Gignac: If I understand correctly, you have an open mind to flexibility, but your —
Mr. Routledge: If I may make an interesting point, one idea we posed was a loan-to-income limit. That wouldn’t be directed at the households; it would be directed at lenders. For highly leveraged borrowers who want to borrow 450% of their income and more, there will be a limited amount that you can do every quarter. In the United Kingdom, for example, banks can only make 15% of their mortgages to borrowers with loan-to-incomes of 450% or greater. Right now, that check is not very binding. If that were in place, it would add a margin of safety if we considered lowering the stress test.
Senator Gignac: Thank you. I think you’re doing a great job for the macro-prudential measures if the Canadian banking system is rated so strong.
Perhaps we can shift back to the U.S. and Canada. You mentioned the capital rules in Canada are more severe than in the U.S. That would explain part of the frustration, not to mention the liquidity ratio disclosure.
During the speech you made in Toronto in January of this year, you mentioned it was a penchant for action.
[Translation]
You mentioned that the domestic stability buffer is now between 0% and 4%, rather than between 0% and 3%.
[English]
Maybe you can explain for people what it is. On the one hand, it seems you’re saying that we are well capitalized — and we should not worry. But on the other hand, you are flagging that it will increase and force capital ratios higher. I hear some contradiction from you. Can you elaborate in one or two minutes to respect my colleagues’ time?
Mr. Routledge: You’re referring to the Domestic Stability Buffer for the six largest banks, which we call systemically important banks. We ask the banks to hold a minimum of 8%, and then we put a buffer on top that’s currently 3%. We’ll use that buffer if there is a recession. We’ll remove it and say, “Your capital ratio can go down, but right now, when times are good, you have to raise your capital above that number and comfortably so.”
We raised it because we wanted more insurance against a recession. It’s precautionary, and we’re able to do that because banks are doing very well; they made $90 billion last year — pre-tax. We’ve asked them to put a bit more aside to build up that insurance. At the moment, we see a recession, as well as the necessity of banks to begin to write down their loans and free up capital, which will lower that and will be counter-cyclical. We’re buying more insurance. We may not need it, but it’s better to have more of it now.
Senator Massicotte: Thank you for being with us, and thank you very much for your service to our country. I think you’re doing a very good job.
Let me talk to you a bit from memory. In 2008, I think we were quite concerned; we had a lot of players on both the security side and the business side. I think we made some changes there, whereby you now have a committee meeting with the Bank of Canada and other players to ensure you’re covering the whole territory — and to ensure that it doesn’t fall between the cracks, as it did with some countries. How is that working? Does it include all of the players at the table?
Mr. Routledge: Senator, we participate in a number of international fora. I’ll mention two of them that are most useful in regard to keeping things from falling between the cracks. One is called the Financial Stability Board. There are various committees. I sit on some committees, as does the governor and the senior deputy governor. It’s a way for central bank governors and heads of supervision to look at risks that might be coming at us from left field, such as cryptoassets and climate risk, and coordinate our policies so that things don’t fall through the cracks. The capital rules we put in place after the financial crisis basically emerged on the impetus of the Financial Stability Board.
The other important forum we sit on is called the Basel Committee on Banking Supervision. It’s in the same building as the Financial Stability Board, but it’s different — it’s a group of predominantly bank supervisors who take strategic guidance from the Financial Stability Board and put it into boring bank regulation. We receive either principles or model text, and then we apply it in our own jurisdiction. There is always a bit of variance, but, in Canada in particular, we tend to do a bit more than we’re supposed to in terms of adopting the rules and implementing them.
For example, we’ll have the latest Basel III reforms fully implemented in November of this year. We will be the top decile, top quintile performance in terms of implementing them.
Senator Massicotte: From a sense of prudence, when we consider climate change, are you happy with the information? Obviously, we’re focusing on releasing information. Are you happy with the progress that we’re making? Is it good enough?
Mr. Routledge: Senator, I’m happy we released Guideline B-15 this year. I consider it a key part of my legacy as the Superintendent of Financial Institutions. It’s going to take us two to three years, depending on bank size, to implement it. I’ll be a lot happier once we implement it.
Senator Massicotte: Our previous colleague is heavily involved internationally. Do your standards meet his standards regarding the information we have to disclose for climate change? Mark Carney is basically doing this internationally. Are the two an equal match to where you want to go?
Mr. Routledge: It’s not an equal match. I would say it’s quite well aligned. Mr. Carney has spoken at the Financial Stability Board, and he has given us a briefing on where he intends the Glasgow Financial Alliance for Net Zero, or GFANZ, work to go. We’re incorporating how we supervise financial institutions according to commitments they’ve made to their stakeholders, including their shareholders. That will be part of the governance of our climate guideline. In other words, part of the governance is making promises to shareholders about a variety of issues, such as earnings, credit risk and now climate. Part of our job in terms of managing the governance of climate risk is ensuring that bank boards are well aware of their commitments, and understand how well — or poorly — their institutions are doing in pursuing those commitments.
Senator Massicotte: Thank you.
The Deputy Chair: I’d like to keep building off the cooperation part. Domestically, you completed a cooperative report with the Bank of Canada — looking at whether we’re moving fast or slow on climate action, and determining which presents more economic risk. We’ve found that moving faster is a safer approach for all of us. It comes out of cooperation with similarly interested organizations.
We’ve heard a lot about the digital market changes we’re seeing across our economy. The British have taken the approach to create the Digital Regulation Cooperation Forum between bodies in the U.K. that would be similar to the OSFI, the Canadian Radio-television and Telecommunications Commission, the Competition Bureau and the Privacy Commissioner that we have in Canada.
Have you considered this as a way for you to work with colleagues around the sorts of systemic risks that we are seeing being introduced by the massive digital transformation?
Mr. Routledge: Senator, I’ll start with what we have, which is quite well entrenched, namely, the federal financial safety net which includes us — the OSFI — as well as the Bank of Canada; the Department of Finance Canada; the Canada Deposit Insurance Corporation, or CDIC; and the Financial Consumer Agency of Canada. That’s a real source of strength and resilience in our system. We are so networked together.
Risks that have come up recently — and I know that in the second part of this meeting, we’ll talk about the OSFI mandate risks, which I would say came up relatively recently, and we’re adapting to them — will require us, over time, to reach out and begin to talk to government agencies that we haven’t traditionally talked to.
Risk to our financial system now includes climate, cyber risk and technology with respect to telecom. We all saw what happened when there was a telecom outage about a year and a half ago.
We have informal ways of attacking those risks, but we will have to look at more formal ways over the next five years that I serve here. I don’t want to mislead you to think we have that in place. As I see risk arriving on our shores, we’ll need that. We’ll need to build more connectivity.
The Deputy Chair: If the silos don’t help us deal with problems that are not siloed — crosscutting.
Mr. Routledge: The bank was great. We couldn’t have done that study without the bank’s modelling. What we brought to the table was connections into the financial institutions that, at a granular level, allowed us to be more targeted with how we conducted that study. That’s a good model for how to cooperate.
The Deputy Chair: I couldn’t agree more. Thank you.
Senator Marshall: This question is on behalf of our chair, Senator Wallin. We’re aware that you are compiling 15 years of aggregated credit reports. Could you tell us how that’s going, and whether you have any information at this point in time that you can share with us? Is it completed? What do you know that you can share with us?
Mr. Routledge: I’m drawing a bit of a blank, so maybe I’ll come back to you with a written answer.
What I can tell you about that specific question regarding credit reports over the last 15 years by our large financial institutions is the following: We collect — monthly, quarterly and annually — an immense amount of data, and our focus in the banking sector is traditionally very much around credit risk. That’s been occurring for a lot longer than 15 years, though. That’s been occurring since our inception in 1987. Nonetheless, after 15 years, the data is better and higher quality, and we receive it electronically and in greater abundance.
I would have to come back to you on the 15-year number.
Senator Marshall: Last year — this is something that has been on my mind for a while — in the budget, the government imposed two different taxes on banks and financial institutions. This year, there is another tax where they are taxing dividends from Canadian corporations.
You were saying in your opening remarks that the banks are doing pretty well financially. My concern is that by imposing all the additional taxes on the banks, is the government undermining the stability of the banks? Do you look at that? I’d be interested in hearing your views on that.
Mr. Routledge: Senator, when we look at bank earnings, at the end of the day, we’re looking at earnings after credit losses and taxes. They take them in annually and pay them out in dividends — about 40% to 50% — and then they retain the rest as capital cushion.
I don’t want to delve too far into discussing tax policy as the superintendent. What I can tell you is the effective tax rate of the chartered banks last year was about 20%, and that’s down a good 10% since the early to mid-1990s. In other words, I didn’t see anything out of the budgets — going back to the financial crisis — that I thought would in any way materially affect the earnings generation capability of the large financial institutions.
Senator Marshall: Or the stability of the financial system?
Mr. Routledge: Yes. By definition, steady recurring earnings is your first defence against what you don’t expect. What I see from the Canadian financial institution sector are steady recurring earnings that add to capital, that provide financial institutions with the wherewithal to build additional buffers when the superintendent raises the Domestic Stability Buffer and that leave more than enough remaining to do very significant acquisitions in the United States, which we saw over the last couple of years.
Senator Marshall: During your work, you do talk to the banks and the financial institutions — don’t you? That’s part of your job?
Mr. Routledge: Yes. We have bilateral relations with every bank we regulate. The more extensive it is, the larger the bank. We do talk about earnings generation and earnings retention. The earnings machine that is Canadian banking is as healthy as I have seen it.
Senator Marshall: That sounds good. Thank you.
Senator Smith: It’s good to see you, Mr. Routledge. In April of this year, your office released its Annual Risk Outlook for 2023-24. One of the major risks identified is climate risk. The point that stood out to me was the idea that if Canada transitions too quickly and if global policies lag, we increase the probability of institution-specific financial stress, given how much our domestic economy relies on carbon-intensive industries like oil and gas.
Could you talk more about the risk in relation to business investment? What is your sense in regard to global climate-related policies? How does Canada currently compare to other jurisdictions in the transition away from carbon-intensive industries?
Mr. Routledge: Senator, the study with the Bank of Canada that Mr. Chair mentioned was an eye-opening moment for me as the superintendent in that it told this story: Climate change and the world’s adaptation to it are happening outside the country’s control. We are reacting and adapting.
Yes, a sizable portion of our economy participates in the energy sector — and participates quite successfully. If carbon‑intensive energy is to decline over time, the country has a challenge to replace that economic activity.
Our study told us that early and steady adaptation are better than delayed and slow. That’s a self-interested conclusion as the superintendent. A procrastinated adaptation that speeds up — as the rest of the world speeds up — adds additional financial system risk to our system.
With Guideline B-20, we tried to nudge the institutions we regulate toward the early and gradual. Our goal is this: Regardless of the path the world chooses, we have a financial system that will help us operate through that.
Where are we relative to international peers? With our climate guideline out, we’re certainly above the median. I don’t think we’re as far as, say, the Europeans or the British. Maybe we are a bit further ahead than where the Americans are in terms of it. We took a very deliberate approach to implementation. Governance and measurement are the focal points, and we gave a slightly shorter deadline to the bigger institutions — which have more resources — and a longer deadline to the smaller ones.
Senator Smith: As you look at moving collaboratively with international partners to a greener economy, do we risk losing out on much-needed investment in this country compared to other countries that have lagging transitional policies?
Mr. Routledge: By “investment,” you mean investment in the energy sector. Here, again, senator, it’s hard to predict that. I used to be a financial analyst and model the future. I could model a scenario where that happens and model another scenario.
By starting it early, risk management in institutions may reveal opportunities that we don’t see in terms of growth in the green sector, as well as reveal ideas for softening the transition that energy-producing economies have to undergo. From our perspective, the good that we can do is nudge and encourage the industry through our principles-based regulation to maybe do a bit more, and do it a bit earlier. I’m not saying it will be easy or pain-free, but it will be better the earlier we start and the more gradual we move.
Senator Yussuff: Thank you for being here.
We can’t escape the reality that we live with the United States. Canadians are constantly looking at what’s happening in the United States regarding bank failures. Of course, we have seen this movie before in terms of what we did in 2008 to get out of this mess — “we” not being Canada, but the world. It seems to be repeating itself because the regulation that was supposed to help prevent this was changed. We’re seeing the crisis again.
The audience hopefully wants to be reassured that we don’t have a crisis here. Can you speak directly about the fact that Canada has very stringent regulation for the supervision of the banking sector — but, at the same time, these things will have some impact on the Canadian economy? We can’t escape the challenges that the U.S. is going through because we do have investment that actually compounds this problem.
Could you elaborate further to give the audience some sense of security that they should be relatively at ease in terms of where things are at?
Mr. Routledge: There are two parts to successful regulation of the banking sector. The first part is what you said; we do hold the institutions we regulate to standards that are in the upper quintile of financial institutions around the world. We are early adopters of sound regulatory policy — we have been early adopters far predating my time in this job. We have the infrastructure of principles in place that tend to encourage more resilience.
The other factor that you need is a will to act. If you go back to our founding, which came out of the Estey Commission in the wake of the failures of the Northland Bank and the Canadian Commercial Bank in the mid-1980s, that commission’s report stated that the will to act was missing. And 36 years later, if you read the report from the Federal Reserve’s Vice Chair for Supervision Michael Barr — he put it out a couple of weeks ago — there were issues with supervision and regulation, but he is pretty clear that the will to act was a big gap.
In Canada, if you ask me what I focus on as the superintendent, it is encouraging my institution to have a will to act when, to be blunt, we haven’t had a true deposit-taking institution failure since 1996. That’s the key. There are two examples since March, and they are little ones, but they are representative of what I hope we would do if we ever have bigger problems.
When Silicon Valley Bank failed, they had a Canadian branch — no depositors, thankfully, but a few creditors. The bank failed on a Friday afternoon, and we determined — that Friday afternoon — that by Sunday night, we wanted to take temporary control of the institution because it had failed, and we wanted the news to be problems in the rear-view mirror. We worked that weekend with our colleagues in the United States to make that happen.
A week or two later, when Credit Suisse was resolved by the Swiss authorities, that resolution caused some upset to a certain class of capital securities at our banks.
That resolution which led to losses for those capital holders would not happen here. That Monday afternoon, we quickly released a statement saying how our system works, and why this won’t happen here. That’s the tempo and the tenor. We have to be out early, and that takes intent and the will to act. That is the missing ingredient when you read stories about regulatory failure — more often than not, it’s the will to act rather than missing something technical.
The Deputy Chair: In terms of information sharing, do you have a follow-up question, Senator Yussuff?
Senator Yussuff: As we look at the economy right now, there are different measurements in terms of how well we’re doing and what the challenges are. The mortgage rates are increasing, and young families are struggling with that reality. Based on what you have said so far, we’re doing okay.
However, there is also data out there that the level of Canadian debt load is the highest it’s been in any period of history. How is that impacting the other data that you are looking at? When might this have an overall impact on everybody’s loans with banks, credit card loans and the list goes on and on? That’s the other issue that’s there. We haven’t seen it in the bankruptcy data yet, but maybe it’s coming. Perhaps you can elaborate on it more.
Mr. Routledge: We look at that very carefully. What we are seeing in terms of weakness in some loan portfolios — and this is based on public information, nothing from non-public information — certain public loan portfolios and credit card securitization conduits. Creditors with lower credit scores are starting to weaken. We’re seeing delinquencies rise. That is a potential early warning indicator.
It’s less severe than I expected. The reason is probably the economy and the job market are very strong, and we did have the benefit of the mortgage stress test in place. People’s biggest debt is the household. There are two principal risks: The first one is my problem, and the second one is a challenge for us, but it is also a challenge for the Bank of Canada.
The first one is just you. If we had a sudden decline in home prices, it would probably have an impact on employment, and it would also strain households in terms of dealing with lower income and the same mortgage size. The way we have regulated the residential real estate sector through not only the mortgage stress test, but also other regulations — we call this Guideline B-20, which is the guideline of residential mortgage underwriting — I think we have enough margin of safety in there to contain that. But we are asking ourselves all the time, “Do we have enough?”
The second part of it is high debt loads. As interest rates rise, people will have to pay their debts, and that might include funds otherwise intended for savings or consumption. Many studies have shown that you can have a consumption-driven slowdown in the economy when your debt loads are high. Again, it’s not evident in the data. We have a very healthy economy — so healthy, in fact, that we’re still in a fairly restrictive interest rate environment. I’m cautiously optimistic and forever concerned that we will detect early any weakening of the situation.
[Translation]
Senator Ringuette: I thank our witnesses for being here with us today.
[English]
In regard to the financial institutions that you supervise, how many of them have ventured into the new concept of lease‑to‑own houses? Do you have a set of rules in regard to this model that you can apply to those institutions?
Mr. Routledge: By “lease-to-own,” you mean a product where a consumer starts leasing a place, and then there is a small amount set aside for equity over time — and then, over time they transition into a mortgage?
I would have to double-check our Guideline B-20 to see if a large or a small financial institution could offer that product within the guidelines set forth in Guideline B-20. My instinct is it probably can’t, but I should come back to you on that to confirm. This is a higher-risk product; it tends to be offered by institutions that we don’t regulate. I’d have to double-check to make sure that our guideline would dissuade institutions from doing it.
I don’t believe it’s a product issued by any of the institutions that we regulate, but, again, I’d have to confirm that.
Senator Ringuette: Are you saying that you don’t have a set of rules as of yet because the financial institutions that you supervise have not been offering such a financial product?
Mr. Routledge: We have something called Guideline B-20. We call them guidelines — not rules — because in Canada we follow a principles-based regulation system, as opposed to rules‑based. But I take the spirit of your question.
Our principles in that guideline dissuade financial institutions from offering aggressive and predatory residential real estate products. I’m not suggesting that lease-to-own is or is not predatory. I’m saying it’s certainly a higher risk. I’m skeptical, but still unsure, whether that guideline would permit that activity.
The Deputy Chair: Thank you very much.
Senator Galvez: Superintendent Routledge, thank you so much for coming here and answering our questions. I also hope that you will be recognized for your legacy on Guideline B-15. It’s a step in the right direction.
In the latest Financial System Review by the Bank of Canada, they highlighted six vulnerabilities, including mispricing of assets exposed to climate-related risk.
Very recently, the Commissioner of the Environment and Sustainable Development did an audit on your activities. It was mentioned that implementation is still not only years away, but it also remains short of incentivizing the transition to a net-zero economy.
If we are not addressing climate-related risk, and not attenuating the finances and the facilitated emissions, then we are also not prioritizing aligning the technology development with climate commitments. Can we say that Canada is prepared to compete with these new game-changing rules given by the U.S. infrastructure, the jobs, the U.S. Inflation Reduction Act, the European Green Deal and the taxonomy? Will we be resilient enough to endure the increasing and more destructive climate change — the extreme weather events — happening to our infrastructure before the end of their lifetimes?
Mr. Routledge: Senator, we did have a great exchange with the Auditor General regarding our progress on the climate file. We accepted all five of their recommendations, so it was quite a constructive experience. You’re accurate in explaining what they told us about incentivizing climate change.
We were straightforward with the Auditor General, and have been in our public comments. Our job is to ensure the financial system is resilient through what will be a challenging adaptation to climate change in our country. That system will remain resilient regardless of the policy incentives toward climate change that the government of the day chooses to adopt.
We don’t see ourselves as part of that policy apparatus. We see ourselves as providing a financial system that will be there to finance consistently and safely regardless of the adaptation path the country chooses to take.
I think by doing that indirectly, and by getting the start that we have on governance, which kicks climate up to the board level in a formal way — as well as getting our institutions started on measuring, which they were actually doing well without our help, and now we’re giving them a bit more incentive to do it — the indirect effect is that Canadian financial institutions will price climate risk more effectively. That will aid in, again, a steadier and more manageable adaptation to climate change.
Senator Galvez: As a scenario, there are four or five provinces experiencing extreme weather events at the same time, and they claim reimbursement from their insurance; this has happened. Is the insurance sector ready to buffer this?
Mr. Routledge: Senator, the property and casualty insurance sector, in my judgment, is the most advanced in turning to face climate change and climate risk. The reason is they’re seeing it in their claims. They’re seeing greater incidence of natural disasters that are related to climate change, and they’re beginning to price their risk accordingly — they’re beginning to think about their capital accordingly. That has come out of economic necessity.
Learning from the institutions we regulate in one particular industry has fuelled our work more broadly. For example, the leader of our climate practice comes from the property and casualty supervision business. He became inspired by what he was seeing from his work with property and casualty insurers five or six years ago, and he’s led the charge for us regarding climate for the entire system.
Senator Galvez: Thank you.
The Deputy Chair: I don’t think we’re going to have a second round. We’re moving into Division 33 of Part 4 of the budget implementation act. For those who would like to ask a question during the second round, maybe we can put the questions on the record, and, perhaps, Superintendent Routledge, you can get back to us with the answers to those questions.
Senator Cardozo: I have two questions on two distinct issues. My apologies for being late, and I apologize if you’ve covered these issues.
My first question is with regard to foresight and cooperation. You talked about working with the rest of the apparatus — if I can use that word — like the Bank of Canada, the property and finance and the CDIC. Do you folks think about what could be coming down the road? For example, a year before Russia invaded Ukraine, was somebody saying, “Hey, this could happen”? It just seemed like we were so surprised by the enormous worldwide effect it had on so many industries.
Are people around your table or from other institutions thinking this, or are you receiving input from the bank where they’re saying, “Look at this thing that could emerge down the road”?
Mr. Routledge: Senator, it’s an important topic. The metaphor I’ve used is that we’re looking out on the horizon, and there are risks that we see. Climate would be one. Digitization of financial services would be another.
Then, there are risks beyond the horizon, such as the interest rate risk and U.S. regional banking, or the first war between sovereign European countries since the 1940s. Those are beyond the horizon. Usually, we don’t see them. You want to build discipline so that when you do see them, you act quickly.
To try to lengthen our vision, we talk to our leaders of financial institutions. They may have a particular insight into what’s going on in a particular part of Canada, or maybe a smaller institution, and we talk to big institutions with businesses all around the globe, such as in Asia or Europe. You can receive some insight from leaders of those institutions or their boards.
For me, the most regular and recurring source of broadening that horizon would be the Financial Stability Board and the Basel Committee on Banking Supervision.
You try to incorporate all of it. In regard to if we saw Russia’s invasion of Ukraine three months beforehand, honestly, no we didn’t.
Senator Dean: Thanks for this. On the question about risks, you mentioned cyber risks. How comfortable are you that individual banks — and the banking system as a whole — are staying comfortably ahead of known risks? And presumably there are some risks that are unknown. In that context, do banks operate under the rubric or advice from the Communications Security Establishment? How often are banks tested by cyber actors? Are any of them state actors?
Mr. Routledge: In regard to the first part of your question, which is around the relationship between the bank and the Communications Security Establishment, I won’t venture there. I’ll let my colleagues in the Communications Security Establishment address that.
In regard to the cyber threats and attacks that banks and financial institutions face, they face standard attacks every day. In fact, after Russia’s invasion of Ukraine, it was interesting; we saw an increase in attacks that banks were used to repelling. Occasionally, there will be a new one that passes through, and there are mechanisms for sharing learnings from that. We have a framework put in place — which the Financial Stability Board has worked on — that aids that. These are competitors, and sometimes they’re a bit careful about sharing information. We’re taking that from the Financial Stability Board and implementing it here in Canada.
The source of cyber attacks is difficult to detect, in response to one of your questions. It would be naive to assume that state‑based actors weren’t behind at least some of them. However, from what we’ve seen so far, the banks have been repelling them. Just like with so many risks, we can’t rest.
The Deputy Chair: If we can quickly proceed to offer the second-round questions.
Senator Loffreda: Thank you, Mr. Routledge, for answering all of our questions.
Once again on the state of the Canadian banking industry, in essence, when you look at the bank failures in the U.S., Silicon Valley Bank’s downfall was due to its practice of using uninsured deposits that were susceptible to runs to finance portfolios of long-term bonds and loans, and a lack of portfolio diversification also played a major role in its downfall.
How can we ensure that Canadian banks don’t make such risky investments, considering that only the first $100,000 of deposits are insured by the CDIC. And are you satisfied with the mitigation strategies on the impact of the Bank of Canada’s rate increases to combat inflation under the financial stability of the Canadian banking system? Lastly, with respect to bank portfolio diversification and concentration, are you contemplating standards or criteria going forward, and are you comfortable with our banks’ current portfolio diversification?
The Deputy Chair: Superintendent Routledge, we’ll have you come back with written responses under this series of questions, if you agree.
Senator Gignac: Since the Bank of Canada started normalization, lawyers have learned a new expression: trigger rate. According to the Desjardins Group, 80% of people who have a variable-rate mortgage have a trigger rate. That means they suddenly have to increase their payments.
Based on the lessons learned in the last two years, are you comfortable with that product? It could be misled to some point. Are you comfortable with the disclosure made by financial institutions to offer people a variable rate? It came as a significant surprise to some of them. Maybe you can share something about that. Thank you.
Senator Marshall: The size of the mortgage market in Canada is about $1.7 trillion, and the federal government, through the Canada Mortgage and Housing Corporation, is backing about $620 billion worth of these mortgages — that’s about 36%. How many mortgages in Canada are at risk of default? Do you have a precise number or percentage?
Senator Massicotte: I’ll skip my turn.
Senator Ringuette: Thank you. I don’t agree with your assessment of higher risk in regard to rent-to-own. There’s no experience in that new concept that you can rely on to make that assessment. It’s a question of the chicken or the egg.
Do you make the regulations in regard to a new model that is desperately needed by young Canadians and new Canadians to build assets? Or do you wait until the financial institutions that are extremely risk-averse in looking at any new financial products to create the regulations?
The Deputy Chair: Thank you. After Senator Cardozo, I’m going to ask the final question, and ensure you have the transcript tomorrow to be able to follow up.
Senator Cardozo: Thank you for doing this. I have two quick questions. The first question is continuing from the short discussion we had. What would be a better foresight system for the big challenges facing Canada and the world, such as COVID and the Russian invasion, where the only constant is change?
What is the role of the OSFI in encouraging banks to issue loans to underserved communities, such as Black and Indigenous peoples? The program I’ll mention is the Black Entrepreneurship Program by the federal government. How do we reach a point where we don’t need those programs — and the banks will be loaning to underserved communities?
The Deputy Chair: In our business investment study, we’ve been hearing about the importance of competition as a driver of innovation and productivity growth.
I’m wondering about competition in the banking sector, and the length of time it takes to become a federally regulated financial institution. Are there any innovations you may be considering in an era where there is so much change and we do like stability in our financial institutions? If you’re looking at finding that sweet spot — not too fast and not too short, but just right — I’d love to hear about that three-little-bears middle spot, if you’re considering it.
Thank you very much, Superintendent Routledge. Your transparency and your clarity in how you answer questions stimulate a lot of interest, as evident in this crowd. I want to thank you for the fact that you have brought that to your role in a way that is very helpful for Canadians.
Colleagues, for the second portion of our meeting, we will continue our examination of the subject matter of certain elements contained in Bill C-47, the budget implementation act, 2023, no. 1.
Today, we’re examining Division 33 of Part 4 which deals with modernizing the financial sector oversight to address emerging risks and legislation related to financial institutions.
We welcome back Peter Routledge, Superintendent of Financial Institutions. Thank you for staying with us, Superintendent Routledge.
We also have Michael Mignardi, Secretary of the Banks and Trust Companies Association.
We’ll start with some opening comments from Superintendent Routledge, and then proceed to Mr. Mignardi for opening comments.
Mr. Routledge: Thank you, Mr. Chair and members of the committee, for the opportunity to stay with you to speak about your study of the budget implementation act, as well as the OSFI’s role in executing or supporting certain provisions of the act.
Budget 2023 proposes targeted amendments to the federal financial sector framework to enhance the authorities of the Superintendent of Financial Institutions and the Minister of Finance in order to better address emerging security and integrity risks, including those stemming from foreign interference.
[Translation]
Threats to financial integrity and security, including foreign interference, can undermine the confidence that Canadians have in their financial institutions.
Canadians must be satisfied that federally regulated financial institutions and their owners are acting with integrity and that Canadian financial institutions are protected from all foreign interference.
[English]
From an OSFI perspective, the proposed enhancements include expanding our mandate and adding to the suite of compliance and intervention tools available to the superintendent and the minister. These changes would continue the strong oversight of the financial sector that underpins a sound and stable Canadian economy.
I’m happy to take questions.
The Deputy Chair: Thank you very much. Mr. Mignardi, the floor is yours.
Michael Mignardi, Secretary, Banks and Trust Companies Association: Good evening. Thank you, senators, for the opportunity to attend here this evening.
I’m here as a representative of the Banks and Trust Companies Association, or BATCA. BATCA represents more than 30 small and mid-sized banks and trust companies in Canada. We represent a critical and growing provider of financial services to Canadians, offering deposits, bank accounts, mortgages and lines of credit, among other services.
Our goal as an association is to foster sound and equitable principles, as well as to promote the interest and welfare of our constituents and those we serve. We are grateful to have this opportunity to share our perspectives on Division 33 of Part 4 of the bill.
Let me begin by saying that we absolutely agree with the aim of the proposed legislative change. Financial institutions are critical institutions that represent trust and stability to Canadians and, indeed, to the world, as we’ve seen recently — protecting them against threats to their integrity and security is of utmost importance.
That said, we are very interested in the manner in which the proposed legislation would be implemented, and we wonder whether we’re using the right or, perhaps, the most appropriate tools to accomplish the intended purpose.
First, we note that while it is still early days, there is no additional guidance on what is required specifically from the policies and procedures in place to protect against threats to integrity or security, so it is difficult for our members to understand how onerous these requirements may be. In particular, we are concerned that perhaps a one-size-fits-all approach, if that were the approach taken, could have a disproportionate impact on small and mid-sized institutions as compared to larger ones, for example. With more limited resources and employee bases, it is important for us to recognize that any new obligations may potentially represent a much larger lift for small and mid-sized institutions to adopt and operationalize.
Establishing a baseline of what policies and procedures the regulatory authorities consider appropriate is critical, in our mind. We would hope to avoid implementing something that disproportionately impacts these institutions, as well as their ability to serve the million-plus Canadians who bank with them. We see, for example, that while the implementation would take effect in 2024, the OSFI will effectively have the ability to carry out examinations with respect to integrity and security immediately after the bill receives Royal Assent.
BATCA understands and appreciates that part of the OSFI’s role is to support the government’s objective of contributing to public confidence in the Canadian financial system, and we support its efforts to address the real and troubling issue of foreign interference. But it is essential that any proposed solutions not inadvertently and disproportionally impact these institutions — and their customers — in the process.
Finally, we note that the OSFI’s mandate has expanded in the last few years to include things like cyber and climate risk — and appropriately so. The way we read Division 33 of Part 4 of the bill, it is about new integrity and security requirements for financial institutions. Respectfully, we struggle to see how this further expansion, which can potentially include a quasi-police or national security aspect, fits well within a prudential principles-based regulation. The OSFI has done a fantastic job in establishing a framework for a strong and resilient financial sector — one that we are proud of for sure — but, in our mind, this expansion doesn’t seem to fit neatly with what you typically associate with the OSFI’s oversight.
Thank you.
The Deputy Chair: Thank you very much, Mr. Mignardi.
Senator Loffreda: Thank you, Mr. Mignardi, for being here, and thank you Mr. Routledge for staying for the second round.
As the sponsor of the budget implementation act, or Bill C-47, I welcome any comments you can share that will elaborate on your opening remarks as to whether you agree with — or have any concerns about — Division 6 amending the Bank of Canada Act. You expressed some improvements you’d like to see, as well as concerns.
Are you also concerned about an impact on the operations of the Bank of Canada? Will there be an impact on our economy, banks or the Bank of Canada in general? Lastly, if we have time, how concerned are you with foreign interference risk to our financial industry or system?
Mr. Routledge: Senator, let me start by saying that I can understand how the words “security” and “integrity” could be interpreted as big new words. We don’t really see them as new, though. “Security” is defined as free from threat. We have cyber risk management guidelines and climate risk guidelines in place to combat those threats.
For “integrity,” the definition is being trustworthy. We have rules and guidelines around accounting and capital. When we read “security” and “integrity,” we think that much of what we do falls nicely within those two terms.
What is new is foreign interference. As events have evolved, certainly going back to Russia’s invasion of Ukraine, but even more recently regarding what we’ve heard over the last several months here in Canada, it is an issue, and we think confidence in the financial system comes from knowing the institutions and the financial system writ large are free from foreign interference — we think that would be consistent with our mandate. We’re still waiting for Royal Assent. We are continuing to plan for how we would adapt our approach and our organization.
To use a military metaphor, we don’t see this as regular army; we see this as special operations. We will not become a security service; we will not become a police force. We will simply develop a small group that can better connect to and interpret information that we might receive through those channels.
I do not see a whole-scale increase in the OSFI’s footprint as a result of this. I see something fairly adaptive and incremental.
Senator Loffreda: Are you satisfied with what you are seeing in Bill C-47?
Mr. Routledge: I hesitate because giving advice to ministers does have consequences, and I would like that advice to remain confidential.
What I can say is this: Through the variety of fora we have with our partners at the Department of Finance, including the Senior Advisory Committee on which I sit, we have been fully briefed and involved in these deliberations, and we have felt enfranchised in our part of the policy development.
The Deputy Chair: Mr. Mignardi, would you like to add some comments?
Mr. Mignardi: Sure, thank you.
Mr. Routledge’s remarks were certainly helpful in providing additional context there. Our point was that after reading the legislation, we wondered, for example, whether this fit more appropriately within the scope of a different agency — perhaps the Financial Transactions and Reports Analysis Centre of Canada, or FINTRAC, or an agency with a bit more of a law enforcement focus. That said, I do understand and take note of Mr. Routledge’s remarks that this does not represent a whole‑scale enlargement of their footprint. We do appreciate that additional colour, and that is helpful context as well.
Senator Marshall: I have a follow-up question from Senator Loffreda. Mr. Routledge, did you see the proposed amendments before the bill was released, or did you receive them at the same time as we did?
Mr. Routledge: This falls under the category of advice to ministers, but what I can tell you is that we did not see the budget document before it came out, just like everyone else. We felt fully enfranchised in the policy development process at the Department of Finance where the OSFI was concerned.
Senator Marshall: You were consulted — I read into that. Do you support the amendments?
Mr. Routledge: Again, senator, with all due respect, that falls under advice to the minister.
Senator Marshall: Okay.
There is a phrase in the briefing notes where it states that the proposed legislation is going to provide authority to the Minister of Finance to direct the Superintendent of Financial Institutions to take control of a federally regulated financial institution.
Is that the way it’s usually done — where the minister can order you — or do you have that authority to do it on your own?
Mr. Routledge: Senator, under the current act, taking control of an institution is a judgment the superintendent takes on the basis of the evidence of the case — applied to the conditions set forth in section 648, in the case of a bank.
With respect to the Minister of Finance — and this may address some of the concerns raised earlier — the superintendent is unlikely to have the full panoply of national security information that the Minister of Finance does.
It would seem to me that a decision maker who is making that significant of a decision may want to have the full panoply. The legislation is reflective of that.
Senator Marshall: Thank you.
I have a question for Mr. Mignardi now. Are you representing a small bank or all of the small banks? I just want to get a handle on who you are representing here today.
Mr. Mignardi: Thank you. BATCA is comprised of 30 small and mid-sized banks and trust companies in Canada. To be clear, it wouldn’t be every single small bank or trust company. There are 30 of us.
Senator Marshall: Was your group, or your association, consulted with regard to the amendment? You indicated that — I think you said that it doesn’t fit in some places, or it doesn’t necessarily fit. Was there any consultation, or did you see the amendment when the bill was released and that was your first inkling?
Mr. Mignardi: That’s correct, senator — it’s the latter; we saw it when it was first released.
Senator Marshall: Did you know it was coming?
Mr. Mignardi: I can’t speak for every single institution in our membership, but, from my experience, we did not have a prior indication.
Senator Marshall: Okay. You didn’t have advance notice.
Can you be a bit more specific when you use the phrase “it doesn’t fit” — you mentioned it in your opening remarks, but maybe it’s complicated or convoluted. Could you explain that a little bit more?
Mr. Mignardi: Sure.
When we look at the OSFI’s mandate being a prudential regulator, and the things that they review for the institutions that are underneath their scope, and then we look at the aims that we initially saw this bill being focused on — integrity and security — we didn’t think those two things were a perfect marriage. Going one step further, we wondered, for example, whether the OSFI would have the information or resources to be able to execute upon the mandate, and we thought, perhaps, that was more likely within the scope of an organization like the FINTRAC, the Canadian Security and Intelligence Service or a different government organization. That’s what we meant when we made those remarks, senator.
Senator Marshall: Thank you very much.
Senator Yussuff: Thanks. Again, my question is for Mr. Routledge in regard to Division 37 of Part 4. That is where they are amending the Canada Deposit Insurance Corporation Act, giving the minister some leeway in increasing the coverage.
As you know, it’s mostly for older Canadians, but I think all Canadians generally have deposits. I could never understand this for the life of me: If you want to go to the bank, and you have a $300,000 deposit, you have to do it in three different trunks if you want to have it covered. It seems kind of repetitive in the context of how this happens, but there is a logic to it, and this amendment seems to be addressing that concern. I don’t know for certain.
But should that take place? In regard to the coverage for additional deposit amounts, would that premium be borne by the depositor or by the financial institution?
Mr. Routledge: Senator, in regard to the first part of your question on the amendment, I would highlight that there was a similar amendment in the COVID-19 Emergency Response Act. It gives the minister the flexibility during a crisis to add some resilience and stability to the funding system.
In terms of how the CDIC might apply that, I would encourage you to speak — I don’t want to speak for the CDIC. I used to be the CEO of the CDIC, and I don’t want to speak for her. I think she could provide some perspective on how they might charge that through.
It is a provision that sunsets in April 2024, so it is an emergency provision in case there is an issue.
I want to return to one point you made regarding the limit being $100,000. You are right; the limit is $100,000 per institution. There are eight categories — such as savings accounts, RRSPs and RESPs — so you can actually realize more than $100,000 in coverage per institution for a single depositor.
Senator Yussuff: Mr. Chair, given that the individual is not here to answer the specifics of this question — this is in the division — I think it would be good if we could have the clerk forward a question to the CDIC so we can get an answer.
The Deputy Chair: Yes, next week — you are already ahead of the curve.
Do you have anything related to that, Mr. Mignardi?
Mr. Mignardi: No, Mr. Chair, there’s nothing to add from our perspective. Thank you.
Senator Massicotte: Thank you again for being with us, Mr. Routledge. You’ve answered the question, but let me ask it just in case. Your initial response was climate change, and you mentioned earlier what that means. From a practical sense, what does it mean? How does it change the risk factor and your own calculations for how to manage risk? It’s a big number; it’s a big issue. Can you comment on that?
Mr. Routledge: Senator, the math is incomplete in order to price climate change, as well as how banks charge and set aside capital for their loans, which will drive what they charge. A lot of what we’re doing over the next couple of years is encouraging the institutions to begin to collect empirical data in order to measure the extent of climate risk, apply that to known events that have costs and perhaps — depending on how well the analysis progresses — begin to run scenarios about how climate change might change credit risk outcomes, and then think about how to incorporate that into how they evaluate loans, set capital aside for them and price them.
The honest answer to your question is the math is not finished. In our judgment, capitalization against climate loans and pricing of climate loans should flow from that math. All capital rules right now flow from fairly significant financial analysis, and it’s proved to be a fairly useful practice since the global financial crisis. Our objective is to encourage that work and let it produce that pricing of the risk.
Senator Massicotte: With the specific mandate, if you wish, it’s relative to your clients — relative to the banking system — but not business institutes at large, and not the public at large. I’m simply asking what the prudential risk is, and how should we manage it? I guess by doing such and taking a position on that, it will move through the rest of our economy.
Mr. Routledge: An example from the insurance sector is as follows: As more natural disasters have occurred and have produced costs, the insurance sector is using that data to price their products differently. I don’t want to say it’s the benefit, but they have knowledge, data and insight into the actual costs of climate risks that they can use to price their products and their risk.
One of our objectives in Guideline B-15 is to create preconditions for the banks to do that a bit earlier and hopefully more gradually over time.
Senator Massicotte: Thank you.
The Deputy Chair: Mr. Mignardi, do you have anything to add from your perspective?
Mr. Mignardi: No, Mr. Chair. Thank you.
Senator Gignac: My question is for Superintendent Routledge. The Canada Pension Plan fund is pretty big. If you go with the biggest provincial pension plan fund, it is equivalent to 100% of GDP. Some are provincially regulated, like teachers, OMERS and Caisse de dépôt et placement du Québec, but two of them are federally regulated by a federal body: the Public Sector Pension Investment Board, or PSP, and the Canada Pension Plan Investment Board, or CPPIB. My question is as follows: Division 33 of Part 4 gives you more power, so they could be covered by that? Some of the pension funds now invest in significant illiquid assets or alternative assets. Some are even close to double-digit exposure to China. You never know what could happen; that is what happened in Russia. They have frozen assets and nationalized — this kind of thing.
Could they be covered by that if anything goes wrong with geopolitics, or are they not affected by that amendment? What gives you more power to intervene?
Mr. Routledge: Senator, just to clarify, are you referring to the amendment that alters the OSFI’s mandate with respect to integrity and security?
Senator Gignac: Yes, exactly. That gives you more power, and you can intervene and ask questions. We know that China could interfere in the big data control. I’m curious, as they have two aspects: There’s integrated security, but also the fact that — it’s so big now when you think about that — the CPPIB is bigger than some Canadian banks, to be honest. I’m curious if that gives you more power to ask for more disclosure or scrutiny regarding the process of risk management. For example, the CPPIB has close to 10% exposure in China, but the PSP, Caisse de dépôt et placement du Québec and teachers have only 2% exposure in China. It’s a question from left field, I understand, but I’m curious if that could give you a little bit more power.
Mr. Routledge: Senator, the proposed amendments to our mandate are in the objects clause of the Office of the Superintendent of Financial Institutions Act in respect of financial institutions. Those same amendments are not in the objects clause in respect of pension plans, which isn’t to say we would ignore the issue. Investment portfolios are a pretty significant component of our evaluation of pension fund risk. To answer your question directly, it’s not in the amendment.
Senator Gignac: I understand that it’s not covered by that, but could you reassure us that this is on your radar? You are very transparent in public on the insurance companies and banks, and our comfort zone is pretty high with the way that the OSFI is doing their job. On Monday evening, the House of Commons Special Committee on the Canada–People’s Republic of China Relationship invited the CPPIB to disclose and elaborate more on China. I’m curious if you have the authority to ask questions and ask for more disclosure because they are not exposed to the same transparency, I would say, as banks and insurance companies.
Mr. Routledge: Senator, with respect to pension plans, we regulate about $250 billion in pension plan assets on a system which is $2.5 trillion. It’s about 1,200 federally regulated pension plans. There are some big ones and a lot of small ones. Defined benefit plans are about half of it, which is where that risk would be.
The answer to your question is “yes.” We will be supervising — cognizant of the risks that are part of geopolitical risk. The reason I’m confident in saying that is we reorganized our supervision sector just a little over a year ago. Now the same team supervises banks, insurance companies and pension plans — it is managed as an integrated team. We did that because risks in the insurance sector and the banking sector may be applicable to the pensions and vice versa. While it may not be codified, our awareness of geopolitical risk is rising, and that will affect our supervision in all of our sectors.
The Deputy Chair: I’m going to build off the types of foreign interference that you see yourself building the capacity for in order to respond in a strike force type of manner. It seems to be predominantly cyber. However, certainly Senator Gignac’s question caused me to consider other risks related to foreign interference that might be under your jurisdiction now. Could you speak to what types of risks you will be considering — to the extent that you feel comfortable?
Mr. Routledge: Senator, we are still very much in the formative stage of this, so it’s hard to give you defined answers on it. Cyber is certainly a risk that we’re familiar with regulating.
The stories in the public discourse around foreign interference — speaking candidly — are risks that we are less familiar with regulating. If the legislation passes and receives Royal Assent, we’ll be able to better define how we think about those risks and how we might react to them — stay tuned. I do want to wait until the legislation is passed.
In regard to the work we’re doing right now in anticipation of it passing — I’m not predicting that it will; I’m just preparing for the outcome where it is passed — it seems to me that, to be frank, we’re still defining that for ourselves, and that will be more public when we have clear messages.
The Deputy Chair: The likelihood is it’s going beyond pure cyber. Thank you very much for that, Mr. Routledge.
Senator Smith: Thank you again, Mr. Routledge. Looking at Division 37 of Part 4 — deposit insurance — it’s been noted that other countries around the world are also reviewing their deposit insurance supports in the wake of the banking crisis unfolding in the U.S. Some have argued that this move isn’t the silver bullet and doesn’t address the structural issues that banks may face.
Are these increasing deposit insurance limits the only way that governments can address the issues, or are there other measures that could increase confidence in the banking system and limit the potential contagion that we are starting to see spread?
Mr. Routledge: Senator, the answer to that question is “yes.” We have implemented them here and in other jurisdictions. In Canada, coming out of the financial crisis, we implemented the recapitalization regime. It is a regime that obliges certain financial institutions — the systemically important ones in particular — to issue more capital, or what we would call contingent capital, that converts into loss-absorbing equity in a stress scenario, or a scenario where the tangible equity of an institution isn’t sufficient. That is an additional margin of safety that we haven’t had before, and it provides many of the benefits of deposit insurance.
If you look at a standard Canadian systemically important bank, their capital ratio, which would be tangible equity to risk‑weighted assets, would be about 12% — that’s pretty healthy. The total loss-absorbing capital at a systemically important bank in Canada is about 27%. That capital protects all of their depositors. I do think that in the stress we witnessed over the last couple of months, that margin of safety has been less visible, but it’s something that gives me comfort.
Senator Smith: Do you see foreign countries having these types of challenges? Is there confidence that internationally there are enough people talking to each other?
Mr. Routledge: At the Financial Stability Board, it’s been a recurring topic. Since March, we have had special meetings. I had many bilaterals with my peers.
If you were to look at the events over the last few months, you will see that the systemically important banks — with one exception, I acknowledge — fared pretty well globally and were sources of strength. We didn’t have that in 2007, 2008 and 2009 — we did this time.
Now we have to look at what happened in the United States, in particular, in understanding regional banking models. We then begin to adapt our oversight and regulation of those sectors to add a bit more resilience, or to ensure there is enough resilience in that sector.
Here in Canada, we have been fairly strict about applying the capital and liquidity rules across institutions, even if they are not as large as the systemically important institutions.
Senator Smith: Thank you so much.
Senator Galvez: Thank you so much. In our National Finance Committee, we received officials, and we are studying your mandate change. I asked questions because the World Economic Forum says that 5 of the top 10 risks will be environmental in the next two years. In the next 10 years, six risks will be environmental. The progression is increasing.
My question at committee was as follows: Will these threats to integrity and security include the cost of living, extreme weather events or the failure to mitigate climate change? The officer answered that it will be all of the above. I think that you will have to look into that.
This is going to evolve with time. At this point, it’s general, and eventually you will put together guidelines to address each one of these reasons, I suppose.
My second question is about the insurance company collecting data, but I also want to say that the climate-related risk is difficult to calculate because it has compounding effects. It’s not based on the stories; you know that. I can’t project from the past to determine what will come in the future. It doesn’t work like that.
Are you planning to also put together some rules in order to better assess the radical uncertainty in the climate-related risk?
Mr. Routledge: Senator, the first part of your question relates to what we have long called financial risks and non-financial risks. Financial risk would be capital sufficiency, and non‑financial risk would be corporate governance or cyber risk management.
We have sound financial conditions part of our current mandate, and then the proposed amendments bring this concept of security and integrity. It kind of fits nicely against financial and non-financial.
Climate is a transversal risk — it affects financial and non‑financial. You are right; we haven’t been through climate change, and we don’t have historic data. The early part of measurement is to establish a foundation to begin to project forward. We’re not there yet. Our sense is that we need to build a foundation of data according to international standards so that it’s comparable, and then we have high confidence that the financial institutions we supervise will choose — without us nudging them — to begin to extrapolate and have a forward‑looking view, as well as begin to determine prospectively how climate risks might change.
From my conversations with analytical firms — for example, rating agencies and climate data firms — they are already beginning to think about that, and figure out how they might apply a more forward-looking lens on historic data. I’m optimistic, given the technology and a build of data, that we’ll be able to deliver a forward-looking view to credit risk as affected by climate change.
Senator Galvez: Do you think that we could have predicted the fire in Lytton, B.C. or the flood on the Fraser River?
Mr. Routledge: I used to river raft north of Lytton on the Thompson River, so that event did significantly impact me.
The honest answer is — just like with cyber risk and the foreign interference provisions that we’re talking about — those events were over the horizon, and the severity was shocking. That shock has informed our response vis-à-vis our Guideline B-15.
Senator Ringuette: I’m trying to make a picture here in my head. My question will be directed first to Mr. Mignardi.
Mr. Mignardi, of your 30 small banks and trust companies, how many of them are branch offices from said U.S. regional banks?
Mr. Mignardi: None of them, senator.
Senator Ringuette: Are your banks federally chartered?
Mr. Mignardi: Yes, both banks and trust companies are federally chartered.
Senator Ringuette: I have the same question for you, Mr. Routledge. You mentioned that you had to take some action with regard to one branch of a U.S. regional bank. How many of them do we have in Canada that are under your supervision?
Mr. Routledge: Senator, I can provide you with the exact number — it’s a few dozen.
Foreign banks participate in Canada through two mechanisms: a foreign subsidiary or a foreign branch. A subsidiary is a separate legal entity. A foreign branch is part of the legal entity in the home country. We regulate them differently.
I can provide you with the exact number when we return for all of the questions, but it’s a few dozen.
Senator Ringuette: Thank you.
Senator Cardozo: My question is for both Mr. Routledge and Mr. Mignardi regarding clause 118 — cryptoassets are the subject of this clause.
Where are we at in terms of cryptoassets in Canada and the world? We hear various things. There is an industry in Canada. They had a day on the Hill a few weeks ago.
Is this going to be real? Is it going to make a difference to the banking industry? How does the OSFI look at that?
Mr. Mignardi, do you see them as part of your portfolio? How do you plan to address cryptoassets?
Mr. Routledge first, please.
Mr. Routledge: Senator, cryptoassets had a boom and then had a pretty significant correction last year. The industry is still recovering. With that prognostication, as the superintendent, I’m not planning on it going away. I’m planning on renewed growth in that sector.
Within the system that the OSFI regulates — federal financial institutions — it’s not a widespread asset class. In anticipation of it growing, we’ve put in place standards and expectations around capital that treat it as a fairly high-risk asset. If the financial institutions that we regulate seek to own these assets, they’ll have to set aside ample capital to protect their balance sheets from it.
Outside of our system, it could grow very fast within Canada. Canadians have bought and owned cryptoassets, often from exchanges that operate outside of Canada. That is a real consumer protection issue for the regulators in the securities market and the regulators in consumer protection. I’ll leave them to answer that.
The longer-term risk, in our view, is a form of payment arising outside of the regulated system. We think that most innovations in financial services outside of the regulated system are quite unstable. As evidence to support that argument, I would point to what happened with FTX last fall.
Senator Cardozo: Would you like them to be within your regulated system? Is that even a thing that can happen?
Mr. Routledge: I’ll say two things regarding that. First, that’s a policy issue for the Department of Finance and the government to work through. Whatever they choose to work through, we’ll support.
For financial stability — and to further the OSFI’s mandate for public confidence in Canadian financial institutions — I would prefer for financial services innovations to occur within a regulated system. There are provincial deposit systems that are fully regulated which I’m comfortable with — and then there’s the federal deposit system that is fully regulated which I’m comfortable with. It’s better when the innovation occurs within regulatory protection.
Senator Cardozo: Mr. Mignardi, do you have anything to add?
Mr. Mignardi: I would add that we’re an association — not a regulator — and our members conduct their businesses individually. They compete amongst one another as well. Crypto is not a widespread asset offered, by any means. In fact, I would be surprised if we have more than two of our members that even offer the service, to be frank, senator.
Senator Loffreda: Canada’s banking sector is widely recognized as one of the strongest and most stable in the world. We do live in a dynamic world with emerging risks, such as geopolitical, environmental and more, that are emerging on a regular basis.
Are you satisfied that the current amendments in the budget implementation act will keep us as one of the strongest and most stable in the world? If not, what is missing with respect to legislation in doing so? Without delving into ministerial advice, I’d like to have some reassurance on your part that we are making the proper amendments, and that we will remain amongst the strongest in the world.
Mr. Routledge: Senator, I will answer that in two parts: The first part is a word of caution. The nature of risk in our system is that some of them are over the horizon, and I don’t know what they are; I wish I did. We’re always trying to expand that view, but, 18 months ago, I wouldn’t have said that foreign interference would be a risk that we’d be talking about today, to be honest.
With that humility, one of the advantages we have in the Canadian financial system, as I spoke of earlier, is the integration of the financial safety net, which includes the Department of Finance. They run a regular committee that usually meets quarterly to discuss policy issues — they fully enfranchise the OSFI and seek our points of view on the state of the financial system, as well as what the risks are and what we think would be helpful.
I’ve now worked in Ottawa and the financial safety net since 2017, and that habit and discipline continue to this day.
Senator Loffreda: Thank you.
Senator Marshall: What impact do these amendments have on the resources within your office? To me, some of the new requirements look to be extensive. The one I’m referring to is the examination into the business and affairs of federally regulated financial institutions at least once in each calendar year to determine whether they have adequate policies, et cetera. Just that one requirement sounds like a big undertaking. I don’t recall seeing anything in the budget to give you additional resources.
Could you explain to us what impact that will have on your office?
Mr. Routledge: Senator, the honest answer is we’re still working through it. I don’t want to overcommit by saying it’s only an incremental change. Our hypothesis is it is incremental. It will be as much technology as it is people.
In terms of funding ourselves, we fund through a direct bill‑back model to financial institutions. There is a governance process that we have in place for that. I meet annually with our departmental audit committee to talk about the budget, and then we go to the industry and give them advance warning of what we’re thinking. I don’t anticipate funding to be a challenge, given what our initial analysis is and given our funding model.
Senator Marshall: You’re working through it.
Mr. Routledge: Yes. We’ll be more transparent once — and if — the law comes into force.
Senator Marshall: Once you start implementing.
Mr. Routledge: Yes.
Senator Marshall: Thank you.
The Deputy Chair: Thank you very much. I see no further questions. Mr. Mignardi, is there anything we haven’t asked about that you’d like to put on our table, or do you have any concluding comments?
Mr. Mignardi: No. Thank you for the opportunity, senators.
The Deputy Chair: Thank you for being with us, Mr. Mignardi. Thank you, Superintendent Routledge, for being with us — the horizon of which you speak is no longer creeping toward us. It’s catapulting toward us. It’s great that you’re keeping your eyes so firmly peeled for a variety of risks that we’re going to be seeing, and for looking at this change in a way that’s quite open to what you could be doing in a targeted manner.
Thank you very much to all of you for being with us today.
(The committee adjourned.)