THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Thursday, November 2, 2023
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 11:30 a.m. [ET] to study matters relating to banking, trade and commerce generally.
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: Hello to everyone in the room and joining us online. Welcome to this meeting of the Standing Senate Committee on Banking, Trade and the Commerce. My name is Pamela Wallin, I serve as the chair of this committee. I will now introduce the other members of our committee, We have with us Senator Loffreda, our deputy chair, Senator Bellemare, Senator Deacon, Nova Scotia, Senator Gignac, Senator Marshall, Senator Massicotte, Senator Miville-Dechêne, Senator Petten and Senator Galvez is with us.
Today we have the pleasure of welcoming back to the committee, Peter Routledge, Superintendent, Office of the Superintendent of Financial Institutions. We’re pleased to have you here today to talk about the state of the banking sector, and specifically, of course, we’re focused recently on the housing issue. I’m sure there will be some questions there as well.
Thank you, and we will turn the floor over to you now for your opening remarks.
[Translation]
Peter Routledge, Superintendent, Office of the Superintendent of Financial Institutions: Thank you for the opportunity to speak with the committee today.
In my role as Superintendent of Financial Institutions, I am particularly focused on ensuring that federally regulated financial institutions adopt responsible and sustainable mortgage underwriting practices.
[English]
In recent years, household debt has increased substantially. This threatens lenders with increasing probability of defaults. The lenders we regulate underwrite 80% of all mortgages in Canada. We are and have been working to address this risk by setting clear expectations for mortgage underwriting and what we call Guideline B-20 requiring lenders to adopt a consistent approach for calculating debt serviceability measures through the minimum qualifying rate, implementing new capital rates for variable fixed mortgages and increasing the domestic stability buffers of our largest banks from 0.5% to 3.5%.
[Translation]
Together, these policies and other measures help to ensure that Canadians are able to manage their mortgage payments in the face of unexpected events and challenging conditions, that lenders properly manage the risks inherent to their lending portfolios, and that lenders have an adequate level of capital to absorb defaults. This supports the stability of Canada’s financial system and contributes to public confidence in it.
I would be happy to answer any questions the committee may have.
[English]
The Chair: Thank you for those opening remarks. Can you just set the stage a little more for us? As you know, yesterday we heard from the governor of the bank who is holding the rate, but expressed concern about where we’re headed. We’re in a technical recession, if you look at the numbers.
Are you significantly worried about this, or do you have time to react if, in the next quarter, we see the numbers worsening?
Mr. Routledge: Thank you for the question. Last year at OSFI, the overnight rate was going up and we knew that Canada’s household sector and commercial sector had high debt loads relative to GDP, we needed to put ourselves in a preparedness mode.
Over the last year, we have been getting ready for the potential of a recession. Do I worry about that every day? Yes. If it arrives, we spent the last year getting ready. An example of that was raising the capital expectations for systemically important banks. That, just over the last year, has added about $25 billion in loss absorbency into the system, which is a fair amount.
Senator Loffreda: Thank you, Peter, for being here this morning. We did briefly discuss the new proposals OSFI suggested to our lenders with respect to debt serviceability before our meeting this morning. Despite the lenders not being supportive of adopting new debt serviceability measures, would you still consider implementing them? What are the consequences on the housing market if they are not adopted?
Mr. Routledge: Thank you. Senators, earlier this year, we conducted a consultation with all the federally regulated lenders in our system and asked them to think about alternative or additional debt serviceability measures that we could bring into force through what we call our Guideline B-20, which is the guideline for a mortgage underwriting.
The overwhelming response was that the minimum qualifying rate for mortgages, which is the mortgage stress test, was good enough. We at OSFI may not entirely agree with that, but that was what we heard from our regulated constituents.
Given the relative stability of the housing market this year, and given the very low credit losses overall, we decided that we weren’t going to rush to changing the mortgage stress test. By that I mean either changing the way we calibrate it, just to add 200 basis points or 2 percentage points to your contract rate, or to consider it a systemic level of new debt serviceability offsets.
Having said that, we regulate bank by bank, and we have the supervisory flexibility to look at complements to mortgage debt service ratio that might add a little bit more protections into the system.
The Chair: Okay. Thank you very much.
[Translation]
Senator Miville-Dechêne: It is now widely recognized that climate change poses a certain number of risks to businesses, including financial institutions. Those risks tend to be categorized as physical or transition risks. The climate change risks to financial institutions mainly take the form of business bankruptcies, and the loss or depreciation of assets to which financial institutions are exposed.
Can you explain how your office is currently addressing those risks? Do you think it’s smart to tackle those risks at the source by limiting the amount of financing provided to businesses that produce the emissions that create the risks?
We had quite the discussion on sustainable financing yesterday.
[English]
Mr. Routledge: Senators, we see climate risk as a major and emerging risk for Canada, certainly, for the global economy. But in our little world, we see it as a financial risk for the institutions we regulate. Climate risk, transition risks and physical risks are already changing cash flows to assets. Some of the most innovative climate research work done has been by our general insurers who are affected today by the rising severity and incidents of natural disasters.
We are determined to ensure that the institutions we regulate price climate risk into their business, their balance sheets and to how they value the assets, i.e., the loans with the securities they buy. At the highest level, that’s our job.
If we price it accurately, we believe quite strongly that institutions will make intelligent decisions about managing and mitigating both climate and transition risk.
The tool we use to do that is something we call Guideline B-15 or climate risk management. We brought it into force earlier this year. There are two central parts to it. The first part is that we require boards of directors to treat climate risk just like any other financial risk — credit risk, market risk, cyber risk. You need governance, measurement and structure around that.
The second thing is that we have presented expectations for measuring and disclosing climate risk. Over the next two to three years, you’ll see banks starting to do that. They will do that because we, as the regulator, are obliging them to do that. They will do that because their investors are obliging them to do that.
To go into more depth, that’s the big picture way we’re addressing climate risk.
[Translation]
Senator Miville-Dechêne: Do you think it’s necessary to go a step further to mitigate the risks, and introduce climate-adjusted capital requirements, for instance?
[English]
Mr. Routledge: That’s a great question. There are two ways we could investigate climate-adjusted capital requirements. The first one would be to take our capital ratios and say that you need an extra buffer of capital for climate risk.
The second way is to say that you have all these loans, securities and assets on your balance sheet. How is climate risk going to change the value of those assets over time? And how should we change what we oblige you to hold in terms of capital against those risks? That is a very technical, asset-by-asset analytical process that, in our judgment, is the better and more effective way to go. To be straight and honest, it takes longer to do.
Credit risk and market risk are based on historic data. We ask institutions to look at that historic data and assign capital on the basis of what they know from that historic data.
Climate risk by definition is forward-looking. We haven’t had climate change. Over the next few years, we have to work with our institutions to incorporate the forward look into current credit risk ratings or capital requirements.
Senator Miville-Dechêne: Thank you. But climate change has started. You said we haven’t had climate change.
Mr. Routledge: We haven’t been able to measure it in the assets and liabilities of the institutions we regulate discretely. We’re not accepting that. We are saying we need to be creative analytically to begin to do that, forecast what will happen and bring that forecast into how you set capital against those assets.
Senator C. Deacon: It is wonderful to see you again, superintendent. We are glad to have you appear at our committee again.
The Auditor General released a report a couple of weeks ago that said 38% of the federal government’s IT systems are in good health. The other organizations in this country that tend to rely on tech stacks that are built on COBOL software programming language are financial institutions. They have been known to have a technology deficit that is quite substantial.
Many have suggested that part of the problem in the development of Canada’s real-time rail, which would have a major positive impact on our economy, has been in the fact that the tech stacks are so old and initial efforts were hindered; progress was hindered because of that. Could you speak to that and how you’re viewing that risk, the cybersecurity risks associated with it, the investments needed to make sure that our banks are leading the world in this regard?
Mr. Routledge: Senators, we have a 156-year-old confederation. Many of our largest banks, and even smaller banks, are older than that. That’s a blessing in one sense; it tells us that our banking system is fairly stable. The cost — the downside to that — is they have been around for a long time and they have legacy systems.
Depending on the institution, some institutions invest more and are shifting off to new technologies and other institutions spend less. Regardless, there is always that tension between day-to-day operations in a system that works and taking the risks to leap into a new system. We would be open to suggestions from industry as to how our rules could be adjusted — not in a grand way, but in intelligent ways — to make it easier for them to invest and bring their systems up to par with the risks and the environment.
My general assessment is that because the Canadian banking system is stable and profitable, if you look at us across other banking systems, we’re certainly better than the median. We can probably do more. It would not disappoint me if our institutions found ways to invest in their technology platforms, particularly in light of all the risks around cyber.
Senator C. Deacon: One of the numbers I’ve been told is that, of the technology investments that the banks make in general broad strokes, about 80% to 90% of that money is maintaining legacy systems and adjusting to changes they need to put into their systems based on market or regulatory issues, and such a small amount is going into building the future. Is that a fair assessment as far as you know it?
Mr. Routledge: I’m not sure about the 80% to 90%. I haven’t seen studies on that. I’m not saying it’s wrong. I can tell you that’s probably an average and you have a fairly wide variance around that. The institutions that are investing for the future are probably going to be winners down the line.
The way to get at it is not to have the regulators say do this or do that. The way to get at that is ask the institutions how we might adjust the rules that they operate under in a manner that makes the returns from those investments better.
If, indeed, a particular bank is spending only 10% to 20% of its technology budget on new technology development, perhaps there are some things we can do to shift that weight a bit. That also comes down to the risk appetite of the institution. If you want to replace a legacy system with something brand ne, there is huge operational risk associated with that. Some institutions have more boldness on that than others.
Senator C. Deacon: It could be seen as a systemic risk if investments are not made.
Mr. Routledge: Yes. Again, a tool we use principally on that is our cyber risk tool, because the threat from cyber risk is the biggest in terms of technology.
We do other things like third-party risk management, which has a technology component, but it is cyber risk that causing us the most.
Senator C. Deacon: Thank you, superintendent.
The Chair: Let’s go there, as you have raised it twice; the clear and present danger in this system is AI, cyber risk. The hacks are already there.
AI poses a huge and immediate threat to transactions. Where are you on that? How are you grappling with that, because that’s now, not even tomorrow?
Mr. Routledge: We are at, in all candour, the development stages of how we might regulate artificial intelligence usage at financial institutions.
We completed a paper earlier this spring, I believe; we wrote it in conjunction with the Toronto-based Global Risk Institute. In that, we laid out the building blocks for a potential regulatory framework. Out of that work, you could see an artificial intelligence guideline emerge. Now, so that our regulated constituents don’t get carried away by that remark, before we embark on that, we’ll talk to them about the regulatory burden. We have a lot going on.
That work we published earlier this spring was foundational to setting up a regulatory framework for AI.
The Chair: To me, that doesn’t sound like you’re ready.
Mr. Routledge: We don’t have a timeline on the shelf. We have to develop it.
The Chair: You are getting ready.
Senator Marshall: Thank you for being here this morning.
We have had a lot of discussion on the variable-rate mortgages, but I was more interested in the fixed-rate mortgages. Based on the information we have, it seems there is going to be a big wave going through in 2025-26. There would be a couple of options open to homeowners. They could make a big downpayment if the interest rates remain high or they could extend the term of their mortgage.
Have you done any analysis on that? Are you doing any preparatory work? Have you got your hand around the problem that is looming a couple of years down the road? I would be interested in hearing your views on it.
Mr. Routledge: We have done a lot on it. I’ll just talk about fixed-rate mortgages. Until recently, most Canadians who chose fixed-rate mortgages chose five-year terms. That means every year, about 20% of mortgages renew.
What has happened this year is the mortgages from 2018 have rolled over and renewed at higher rates. The good news is we haven’t seen a great deal of rising delinquencies. It has stressed households. We are seeing it in retail spending and in surveys that a variety of institutions do. Households are feeling the strain, but they are managing.
Every year in perpetuity, about one fifth of all mortgages will renew. You are right. The next two to three years the problem gets more difficult. I’ll explain why.
In 2018, before COVID, interest rates were not as high as they are today, but mortgage rates were generally fairly high. The stair step up in rate is manageable and within the mortgage stress test we put in place.
As we go into 2025 and 2026, that step up is more onerous, so we know how big the problem is. For our purposes, our stress testing indicates that the large banks, in particular, will manage their way through higher incidence of default. That doesn’t mean it’s a good thing that there will be more defaults. It is a good thing, however, that our system can handle it. We don’t see any cause to think that our capital cushions and our earnings cushions aren’t adequate to that potential rising cost.
Senator Marshall: When you say the banks will manage it, that means on an individual basis. Is that what you mean by that?
Mr. Routledge: Yes; the largest six banks, in particular. Even if we go below that, smaller and medium-sized banks look to be quite sound on capital too. Just as we have done in a more public way with systemically important banks, we have raised capital. We have done that less visibly with the small- and medium-sized banks.
We also know and have identified the institutions that have perhaps enhanced risks. As you might imagine, they are spending more time with their lead supervisors.
Senator Marshall: Okay. Thank you.
[Translation]
Senator Gignac: Welcome to the witness.
I’d like to follow up on certain practices of financial institutions in the mortgage lending industry. Negatively amortizing mortgages represent 20% of the lending portfolios of three major Canadian banks.
On October 20, the Office of the Superintendent of Financial Institutions, OSFI, released new guidelines requiring that institutions hold more capital. I’d like you to tell us about that.
The second part of my question relates to a concern I have: young couples or families with variable-rate fixed-payment mortgages who do not have enough capital to cover higher payments. Is that a situation you’re comfortable with?
Is it necessary to step in and prohibit lenders from giving first-time home buyers these kinds of loans, since they don’t have enough capital and could end up having to give back their keys if the banks or their parents don’t help them out?
[English]
Mr. Routledge: We are sort of in an interesting position with respect to variable rate mortgages with fixed payments. We’re meant to ensure that lenders or banks know what the risks are that they take in mortgage lending and that they are managing them. We do not interpose our judgment on product design. It’s not in our mandate. That’s not what Parliament has asked us to do.
Our view is that if you design a product that your customers buy, provided you’re managing to the risks, your product design and product purchases are between lender and borrower.
However, a variable rate product with fixed payments is a dangerous product, in our view, because it can put the homeowner, in the position of an extended period — not always but in this environment certainly — of paying a flat rate of, say, $2,000 a month and the interest on their mortgage is $3,000 a month. That means their mortgage balance is growing. That increases their vulnerability and the risk of default.
All else equal, while not wanting to impose a judgment on product design, we would like less to have that product. We think the system would be healthier with less of that product. We immediately addressed it by changing our capital requirements for negatively amortizing mortgages. That may make the product less attractive to the borrowers.
Senator Gignac: It’s a consumer protection issue. I understand it’s not your mandate. Maybe your colleagues in the other departments —
Mr. Routledge: We are not uninterested in consumer protection, just to be clear.
Senator Gignac: But if I read between the lines, in plain English, you will support strengthening consumer protection because people have no clue what could happen if the interest rate increases much more than they thought.
Mr. Routledge: Yes. We have done that. I’ll give you an example. My team and I have worked closely with the Financial Consumer Agency of Canada on their guideline for mortgage underwriting. While we were bringing up capital for the product, we were working with the FCAC on their guideline that ensures customers who are dealing with that problem in the near term receive fair, temporary fixes to their solutions, for example, an ability to do a large pay-down on a balance without incurring an unreasonable fee. There is a variety of measures in the FCAC guideline. We worked hand in hand with the FCAC to do that. We thought of it as a joint effort of OSFI doing its prudential job and the FCAC doing its consumer protection job. We thought both those mandates supported one another.
Senator Massicotte: Thank you for being with us again. It is much appreciated.
Last time you were here with us, we were talking about risk and surprise risk. One of the discussions we had is about the environment whereby you can’t predict some of the risks. It could be dramatic to the cost. Your answer was such that, while we are not experts in every field of insurance, the insurance companies have immense experience. They know how to price it, and they can better predict or lay over the financial cost.
I presume the answer would be the same, but is that adequate? Is that system, which is kind of informal, where you rely on the insurance companies to help you, adequate? Have you made any progress to allow you and your institution to individually figure out that risk and predict it more than waiting for somebody else to give you advice?
Mr. Routledge: Financial risk and climate risk, yes. We have what we are calling a standardized climate scenario exercise under way. Let me explain what that is and what we may learn from the industry by virtue of that exercise.
We have now gone out to the industry and said that for 2024, we are going to ask all the institutions we regulate, including insurers, to run this climate scenario in their stress testing models and tell us what the impacts are. Through that, we’re hoping to obtain from the industry a much more granular view on how climate impacts — whether it’s transition or physical risk — and how they are seeing the price of their assets. From that, perhaps we can draw broader conclusions about overall systemic risk. On the basis of those learnings, we can go from there.
The broader point is, to truly get the institutions in our system to manage climate risk more effectively, we need to have exercises where we’re prodding them to do some work. Then they are coming back to us and telling us what they found, and then we are adapting how we regulate. It’s going to take time to do that, but it’s the most effective way of bringing more clarity to an uncertain future.
Senator Massicotte: Some people will argue that there is a risk of alignment whereby perhaps some of the financial institutions all related to government are not on side to sharing information or managing the risk. Therefore, some are proposing legislation to create a new entity whereby it would be a board, and the board would ensure that all the members that have a group align themselves to the interest.
Do you feel a sense of necessity relative to the creation of that new organization, or is there any other way to get that information across to the other members in a more informal and productive manner than setting up a formal legal organization per se?
Mr. Routledge: There is a two-part answer to that. The first part is if Parliament decides to create a board where we faithfully execute the instructions from our boss, Parliament, we’ll work with it.
We’re working as if there wouldn’t be that kind of body. We’re working on our own devices to price climate risk as effectively as we can, knowing that it is a forward-looking exercise with a lot of uncertainty. We think our approach — certainly as we have outlined in our climate guideline, our climate risk work — is adequate to that task.
To give you an example of the good news we’ve had on climate, to facilitate this work, we’ve put together a voluntary, climate-risk forum and said to our industry constituents, “Come one, come all. Work with us on this. We’ll meet every couple of months. We’ll talk about climate risk scenario analysis and talk about B-15, disclosure and all of that.” We had 780 volunteers show up to these meetings. We are going to have to change and upgrade some of our technology to make sure that we can handle the video and data requirements of a 780-person forum.
The willingness of the industry to get at this is very high, not just because we’re putting an emphasis on it, but because their investors — the institutions that buy their bonds and equities — are demanding that work. We feel that we have a lot of momentum on that.
Senator Massicotte: Briefly, to be sure that we all understand one another, you are the key individual regarding that system. I know there is an organization in place already where the Bank of Canada and those on the government side meet together.
In light of the fact that all of this weight is upon you, you are saying that you think you are okay; you can manage it, and in a worst-case scenario, we’ll create the institution in an informal manner.
Mr. Routledge: Whatever Parliament decides to do, we will work with that.
Senator Massicotte: I appreciate that.
Mr. Routledge: Am I restricted in terms of the current setup and getting after this risk at a pace and a rate that I want to? No, I am not. No, we are not.
The underlying driver of that is that the institutions that we regulate, because they are listening to their investors, know that inaction is not an option. What we’re doing is creating, at least in our industry, a forum for individuals to act in concert against these risks.
Senator Massicotte: Thank you.
The Chair: To come back to the same question I raised earlier, and the process that you have under way of being forward-looking on the climate issues, am I hearing that on the AI side and with the tech issues, right now you are not at a stage to be able to do that?
Mr. Routledge: AI is a new risk emerging, and we’re not as mature on climate, to be straight up.
There are more industry forums on cyber risks. We participate in some. Some are with other government agencies, and we’re more advanced on that.
The Chair: But including the tabletop exercises, the kinds of things that you have been talking about, are you engaged in that?
Mr. Routledge: We are still developing our regulatory approach to AI and so we have not gotten to that stage with it yet.
Senator Galvez: Thank you, superintendent. Thank you for recognizing that climate change is one of four key worries. You stated that in the annual Scotiabank financials.
Thank you also for recognizing the uncertainty of the climate risk, and looking forward it is difficult to calculate. You also mentioned that this impacts, as my colleague said, on the insurance rate and the ability of Canadians to get the insurance that they need in risk areas.
You mentioned Lytton, B.C. as being an example. What will happen if this happened to a bigger city? Actually, it happened this year in Lahaina, Hawaii.
I heard you say that you have B-15 and have convened, but you are not as mature in your thinking, reflection and progress. Can you please tell us what is the impact specifically to the banks and to insurance? With respect to other jurisdictions such as the U.S. and Europe, how are we moving? Are we at a snail’s pace? Are we catching up?
Mr. Routledge: Thank you for that question.
Senators, I would like to touch on Lahaina and the electricity provider there. It is called Hawaiian Electric who ran the wires severed by the hurricane, and then they landed on dry grass and that caused the fire.
If you want to know whether climate risk is a financial risk, or if you need proof of it, look at the stock price chart of Hawaiian Electric. It went down 80% that week. It was a similar story for Pacific Gas & Electric several years ago in California. That underlines to me that climate risk is fundamentally a financial risk.
How are we stacking up? Candidly, two years ago, we had a person and a half on the climate initiative, and we were a little behind. I would like to think we’ve got up to about the median, in terms of how we compare to international peers. We’re behind some, ahead of others. I would like to, over the next couple of years, go beyond the median and get into the upper quartile. The work we are doing on climate is going to happen.
I have broader concerns about a fraying and heterogeneity in terms of climate risk management at national levels. Some regions are slowing down and others are speeding up. I worry that in a few years, we will not know which nation we want to follow, or that the distance between the most advanced and least advanced will be much wider.
I worry about and will take affirmative action to prevent a situation where we’re slowed down by reference to what other countries are doing or unduly sped up by reference to what other countries are doing. We are going to follow our analytical ground-up work on climate risk and make the progress that is befitting to the risk that Canada faces from climate change.
Senator Galvez: The National Bureau of Economic Research places Canada as one of the first economies to be heavily impacted by climate change. Do you agree with that?
Mr. Routledge: We had similar findings in our study with the Bank of Canada a couple of years ago.
Senator Galvez: Thank you.
Mr. Routledge: That motivated our acceleration on our work in climate two years ago.
Senator Petten: I have a simple question for you. What do you suggest that your sector could do to assist with the housing crisis?
Mr. Routledge: My sector is pretty broad. There is no one thing.
The housing crisis has a lot of contributors to it. The root cause is that Canada is a magnet country. People want to come and build lives here. Our household formation is the highest in the G7 and amongst the highest in the G20. Meanwhile, we’re not building enough homes to keep up with that.
In my first couple of months as superintendent, I gave a speech and I said this is what we’re really worried about. That imbalance between supply and demand is really what is driving the housing crisis and is a core root cause.
What can we do in our system? Our banks and insurance companies could provide more capital to building more homes. If you had witnesses from that industry, they would tell you that OSFI needs to do more in terms of adjusting its capital rules. We have made a start on it. We are always in tension between wanting to make sure that the system is safe and then wanting to stay out of the way and let investment happen and produce more homes.
We need to do a better job with our regulated constituents in understanding how we can help them make more loans to bring into balance supply and demand for housing.
[Translation]
Senator Bellemare: [Technical difficulties] Like OSFI, the Bank of Canada has a mandate to ensure the stability of the financial system. What is the relationship between the Bank of Canada and your office? Do you provide the bank with research? Are you in frequent contact?
Tell us, if you would, about the interface between your two organizations.
[English]
Mr. Routledge: Our relationship with the Bank of Canada is quite in-depth. It runs at all levels of the organization.
The Governor of the Bank of Canada sits on my primary governance committee, which is called the Financial Institutions Supervisory Committee where my supervisory and regulatory judgments are subject to quarterly scrutiny.
We both sit on the Canada Deposit Insurance Corporation board of directors. I am part of his heads of agency group with the securities regulators. We work together on the Financial Stability Board and the Basel Committee on Banking Supervision. I quite enjoy spending time with him. Even if I didn’t, I would still have to see him 12 to 14 times of the year. At the top of the institution, we are constantly talking.
We share data. Our teams and their teams are operating off of the same data sets. When they have gaps in their data, they can come to us and ask us to adjust what we ask from the banks and the insurance companies; that fills in their holes.
One of the advantages we have in terms of housing and mortgage risk is that, because of the work that OSFI and the bank have done, we have better insight into granular risks in the mortgage system. We have it for the benefit of our work. The bank has it for the benefit of its work.
I would call our institutional relationship very in-depth, very strong and constant, as in day-to-day.
Senator Bellemare: You said you have granular information.
[Translation]
Do you have an idea of — or information on — the risk variation across Canada’s major regions? Do you work with averages? I wouldn’t think so, since you have granular data. Can you talk about the risks associated with mortgages Canada-wide, from Eastern Canada to Western Canada?
[English]
Mr. Routledge: Yes. Specifically on mortgages, we have enough granular data to understand we have a very significant fragility with respect to variable rate mortgages with fixed products; 10 years ago, we would not have had that.
We can break that data out by province to understand where it is more or less acute. We can do that for fixed rate mortgages as well. I don’t think we can do it yet by demographics by age, but we can do it by age of mortgage. That gives us some sense of where the risk is in terms of Canadians in their thirties versus Canadians in their fifties. That is one example.
Another example of where we’re working to get granular data is we have merged our climate data-gathering with the Bank of Canada.
Working with the Bank of Canada, we’re doing studies on where the costs from severe floods might be felt most acutely. Because we can combine their data and modelling with ours, we can narrow down where flood risk is most acute. We have not done it yet, but we will do the same for wildfire risk.
With the analytical relationship where we can merge the Bank of Canada’s systemic view with our institution-by-institution view, we have got a lot of analytical returns from that exercise. It is really over the last four or five years been a source of strength for our system.
[Translation]
Senator Bellemare: Are those data publicly available or private?
[English]
Mr. Routledge: In general, the data we presented in our climate study with the Bank of Canada a couple of years ago was public.
Senator Bellemare: Okay.
Mr. Routledge: For an institution that gives us climate information — say, on flood risk — bilaterally, we do keep that private. That is the way we get it. If they trust us to keep it private, they give it to us.
The Chair: Before heading into a brief second round, this committee is focused at the moment on the issue of housing and the affordability crisis that is out there for so many people, regardless of age. Our intent is to provide some advice to government in the pre-budgetary process.
To respond and deal with your regulated sector, the people that you regulate, what would make it easier for you to react and move more quickly to deal with this, how you transmit information to those you regulate? I know you are walking a fine line there. Is there a paper or a bureaucratic holdup somewhere? Can you give us a sense of where we’re at on that?
Mr. Routledge: If we heard from parliamentarians here, or from the House of Commons, and if they were to ask us to do certain things, we would pursue it.
What would be helpful for us to be asked to do? To look at how we can balance supply and demand, balance the supply of housing with the demand of housing.
What could we do in terms of consumer protection to make mortgages fairer for Canadians? By the way, it is not my specific mandate to deal with consumer protection, but mortgages that are fairer for Canadians will default less by definition. That would be an aid.
On climate, for example, or on cyber, express where you think the risks are and what you think the bank regulator or the insurance regulator should do to address those risks. At the end of the day at OSFI, we serve Canadians and we serve Canadians by working for the Parliament, obviously reporting directly to the Minister of Finance. We want and need your direction.
The Chair: It is housing in particular I’m trying to focus on at this moment.
Mr. Routledge: Okay.
The Chair: If you have thoughts on that later, drop us a line while we do that.
Senator Loffreda: Thank you, superintendent, for being here again this morning.
You started your comments this morning with household debt. I would like further comments on your part or take a deeper dive into this.
According to the Canadian Bankers Association, as of August 2023, only 0.15% of mortgages in Canada were in arrears. In the current environment, we’re talking about an economic slowdown, higher interest rates and inflation still not where it should be, does it concern you? Do you see more delinquencies increase drastically? Do you foresee that and a possible effect on our economy, housing affordability crisis and consumers? The consumer is the motor of every economy.
Mr. Routledge: Right.
Senator Loffreda: How do you see that impacted? How concerning is that for you? What can government implement or put forward to appease those concerns and risks?
Mr. Routledge: Yes. Your figures are correct. They are the same as ours.
Mortgage delinquencies are at historic lows. I think there are a variety of reasons for that. One unintended benefit of an imbalanced housing market is prices tend to stay high if supply is running well short of demand. Because of that, when folks do get in trouble with their home loans, they can solve the situation through the sale of their homes.
We see delinquencies rising over the next year as households adapt to higher interest rates and higher costs of living. There is not a hockey stick effect anywhere that we’re seeing from the data we’re getting.
We are seeing households that are particularly indebted, say their loans are 450% or more of their income, households in that category of indebtedness, we are seeing some increasing delinquencies in that cohort. You are not seeing it in the broad data because it is a smaller cohort. We expect that to intensify.
What can government do? The work we’ve done with the FCAC is to encourage financial institutions to call their customers early and start providing fair workouts of their lending situation, either through big down payments, refinancing a mortgage at fixed rates or a variety of other tools in place. Provided that is done fairly, it can lessen the incidents of delinquency and failure.
In terms of discrete policy, any policies that would tend to increase housing supply in this market and make more housing available to Canadians would be a net positive to the long-term stability of the housing system. That is not just a federal government issue. That is an issue at all levels of government.
Senator Loffreda: The three levels of government. Thank you for that.
Senator C. Deacon: Thank you, again, Superintendent Routledge.
I want to keep going on the cybercrime and fraud line. Fraud is the most reported and fastest-growing crime in Canada. Three quarters of Canadians have been affected over the last five years. Extortion through cybercrime is growing. Identity theft is growing. The ability for money laundering to be better managed in this country through certainty around identity is a significant issue. Fraud through Interac transfers, credit card fraud and the need for our banks to be able to fight this requires a lot of sophisticated technology solutions. It requires greater trust in the identity of individuals when they are not physically in front of you. That is, some form of identification digitally with certainty around individuals, to start to bring these crimes down that are affecting a lot of Canadians and are undermining our financial system.
Could you broaden out where you see yourself moving in next couple of years as it relates to that bundle of issues? Foreign interference seems to be well entrenched in all of these activities. There are foreign entities that are supported to cause us difficulty.
Mr. Routledge: Yes. It is a big risk. It would qualify, senator, as one — the last time that I was here I said that there are those risks that you see on the horizon and then those risks beyond the horizon that you do not quite see — that is coming up and we’re starting to see it.
The government has seen fit to adjust our mandate to focus on what is in the legislation called the integrity and security of the institutions we regulate.
What does that mean? That means we’re going to develop, over the next year, a unit that will be specifically charged with plugging in with a broader array of partners in the federal government. Think of the RCMP and FINTRAC. We want to create a much more systematic, rigorous approach to dealing with the risks around security and integrity. Those risks that you mentioned, like dealing with fraud and foreign interference, will be within the scope of this group.
What we need to do a better job to handle those risks as soon as we can is to create a set of relationships with FINTRAC, CSIS and the RCMP so that they trust us as much as OSFI and the Bank of Canada trust one another, so that we are working in common purpose within our mandates to attack and mitigate these risks.
As we go forward, we will have to look at issues like investment in technology, because that is going to be a major plank of defence, or another initiative such as digital ID. There are dozens of other things that we will look at, but over the next year we will build a capacity and a facility for advancing those protections. We are starting now.
Senator C. Deacon: Thank you very much.
[Translation]
Senator Miville-Dechêne: Thank you for being here, Mr. Routledge. If you don’t mind, I want to come back to the issue of climate risks.
Traditionally, climate risks are assessed on the basis of the financial risk they may pose to financial institutions, and you referenced that again, here today. There is another side to that equation, though. It works the other way — financial institutions can pose risks to the climate through their financing operations. That is what’s called double materiality. The term is a bit technical, but it actually refers to the idea that, while global warming of course poses risks to investors, it also poses risks to humanity, so risks that are much broader in scale.
Do you, as superintendent, see that as important? I’m talking about the broader risks to humanity? Do you feel you have the responsibility to consider that side of the equation? Do you actually have the financial authority under the act to do that?
[English]
Mr. Routledge: I agree with the premise of your question. Climate change is a threat to our economy and a threat longer term to civilization. All you have to do is read the intergovernmental panel report from the United Nations and you get a pretty clear picture of that.
So far, the way we’re approaching climate risk through B-15, through institution by institution bilateral supervision, is sufficient to the risks we see financially. To be completely straight, we are not of the view that we need to take particular affirmative actions to dissuade investment in particular asset classes, which I think I interpreted from your question is where you are getting to. Reasonable people hold an alternative position. But in our view, as a potential regular later, we have to focus on the underlying risk, on measuring it, on disclosing that underlying risk and on ensuring that institutions are managing to that. As we do that, as investors oblige — that is, their investee institutions, banks and insurance companies to advance these rising risks — we think that you will see the shift in capital towards different forms of energy that will tend to offset, in particular and directly, transition risk and climate risk.
I acknowledge that there are folks who would like regulators to affirmatively set different capital rules on the basis of asset classes. We’re bottom-up credit risk analysts and we think that the way that we are doing it is effective.
[Translation]
Senator Bellemare: My question is about investing in intangible capital, human capital. Do you regulate student loans?
I know that financial institutions vary the amounts they lend students depending on their field of study.
Given the economic situation and inflation, have you noticed that investment in human capital is declining?
[English]
Mr. Routledge: At OSFI, we do not regulate student loans nor do we treat them any differently than any other loan other than if they had some implicit backing from government, the capital we would put against those loans would be lower. If the capital is lower, there tend to be more of them. We do not specifically regulate student loans.
Senator Gignac: Let us go back to financial stability. I have had the opportunity to work in the finance department during the financial crisis with the current Bank of Canada Governor. I am pretty secure about the relationship between OSFI and the Bank of Canada. You mentioned financial institutions being regulated, but there are big players out there that are not regulated with the pension funds, the big Maple 8. It is close to 8% of Canadian GDP. In the U.S., the similar figure is about 12%; the U.K. is about 15%.
I know that every three years your office actuary will check to see if we have enough money for our retirement, but there is the financial stability angle of that. We noticed what happened in the U.K. and a few weeks ago even the regulator questioned the valuation that the pension uses for private equity, property and so on.
Could you ensure us about our pension fund, while very big in Canada, what do you do exactly? Is this something that you have to drill a bit more regarding the financial activity aspect and valuation used for their return depots?
Mr. Routledge: We do two types of pension work. We do direct actuarial consulting through the Office of the Chief Actuary for the Canada Pension Plan. We work closely with the Canada Pension Plan Investment Board in that work. The PSP, the Public Service Pension Plan, would be another example.
Our work there is actuarial. We make sure they have the assets and the incoming premiums to pay off their promises over the long term. Generally speaking, by the way, we’re in good shape with those pension plans. We oblige them to think about adverse scenarios and test whether they can meet the fundability question in those adverse scenarios, but that’s the extent of it. That’s the actuarial work that we’re tasked to.
We also regulate about 20% of the private pension plans in Canada. The provinces basically regulate the rest. We regulate none of the Maple 8, just to be clear.
The work we have done, coming out of events we saw in the United Kingdom — and by the way, with the private-sector pension plans, we do have more regulatory authority. The work we are doing there is obliging them to think more about liquidity risks and longer-term financial risks. We have them work with us so they understand they have thought about the risks and they are prepared for it. We have far more degrees of freedom to oblige the institutions to do work than on the actuary side, and we’re doing it.
However, we talk to our provincial counterparts quite frequently, and certainly a fair bit coming out of the crisis in the United Kingdom. I’m comfortable they are doing good work in this field, but it’s not work we do, and I’m not paid to evaluate it, so we don’t.
The Chair: Thank you. We’re over our time. Let’s keep it brief.
Senator Massicotte: To make sure I know what you’re talking about in detail and the words are specific, I presume you’re not foreseeing any banking problems. None of the small banks will be threatened, I presume. Could you comment on that?
Mr. Routledge: As superintendent, I’m paid to worry about the worst-case scenario, so we’re always asking what could go wrong. From where we sit right now, over the last 15 years, coming out of the financial crisis in 2007-08, we have doubled and redoubled the number of protections we have in place for the entirety of the financial system. As we come through the next few years — and I’m not predicting a downturn or recession — and whatever hits us over the next few years, I think Canada’s reputation of having a sound financial system will be well intact and perhaps even fortified.
Having said that, we have to be constantly on guard for institutional stress and — I’m not predicting it will occur, but when and if it occurs — OSFI will act early and quickly to address the situation so as to protect the broader system.
Senator Galvez: You say that you are planning for the worst-case scenario. You know that our six big banks are heavily involved with the finance of fossil fuels, so they are therefore financing greenhouse gas emissions.
I know you talked about the physical and the transition risk, but I’m worried about another risk rising from the other side of the coin. It is the attribution science that is coming more and more and is stronger and stronger relating to making the cost effect. For example, for the wildfires this year in Canada, it was attributed to the major carbon producers, which is the fossil fuel industry, in which our banks are invested heavily. So it is increasing the reputational risks but it is also very important about litigation.
That is without talking about the health and the social impacts —
The Chair: Let’s just get to the question, please.
Senator Galvez: Sorry. Are you also looking at those sides of the coin?
Mr. Routledge: The litigation risks?
Senator Galvez: Yes.
Mr. Routledge: This is a two-part answer. Generally speaking, when our lead supervisors work with individual institution, one area of conversation is the unplanned charge that might — litigation risk would fall into that. Yes, we do speak generally about that.
With respect to litigation risk that might come from climate, we’re aware of what happened with Pacific Gas and Electric. We’ll see what happens with Hawaiian Electric. It’s something our climate team is mindful of, but we have not yet developed specific regulatory or supervisory initiatives to zoom in on that particular risk. That’s not to say we would never do it or we wouldn’t consider it, but I’m answering your question straight. We haven’t really started that effort in earnest.
The Chair: To be clear, it is not your job to tell investors what to invest in or banks what to finance.
Mr. Routledge: We don’t seek that.
The Chair: Yes, I understand that.
We have concluded our session today. We’re very grateful you have taken all our questions from a wide range. We will invite you back very soon; you can count on that.
We are so pleased to have with us Peter Routledge, the Superintendent of Financial Institutions. That brings our meeting to an end. We’ll see you again soon.
(The committee adjourned.)