Canada's new capital rules challenge banks' competitiveness and may lead to reduced lending and economic growth
New capital rules for Canada’s largest banks are expected to bring significant business and economic costs.
These rules may reduce lending and put Canadian banks at a disadvantage compared to their counterparts in the United States and Europe.
According to the Financial Post, veteran analyst Gabriel Dechaine from National Bank Financial discussed these impacts in a report published late Tuesday.
The phased-in Basel rules introduced in 2023 will affect how banks calculate risk-weighted asset ratios, with full implementation approaching in early 2026.
These rules will move away from sole reliance on a measure criticized for not reflecting the risks in loan books, impacting banks’ common equity tier one (CET 1) capital ratios.
The new Basel rule, known as the output floor, will impose “greater conservatism on banks…conservatism that comes at a cost,” Dechaine wrote.
He added that the lower CET 1 will mean less return on equity for banks. Applying the full impact to the Big Six banks' balance sheets in the second quarter of fiscal 2024, Dechaine estimated an additional $80bn of risk-weighted assets.
This would result in a 45-to-50-basis-point hit to bank CET 1 ratios, except for Toronto-Dominion Bank, which saw no impact.
Dechaine noted that some banks have already started shedding certain loans or curbing lending.
This strategy, while possibly unrelated to the upcoming Basel rules, reduces individual bank earnings potential and could shift banks from low-risk activities to higher-risk ones better suited under the existing regulatory framework. Restricting lending ultimately reduces competition and hurts consumers.
There has also been activity in credit risk transfers, which Dechaine described as an “originate to distribute” business model that could introduce additional risks to banks’ business.
Beyond banks, restrictions on credit supply due to increased capital regulation could limit broader economic growth. Dechaine pointed out that regulators outside Canada are rethinking the costs of such conservative capital management.
In the United States, bank rule-makers are considering softening the final stages of Basel III, known as Basel III Endgame, while the European Union has deferred the fundamental review of the trading book.
This cautious stance by regulators suggests that the regulatory approach could change.
In an April interview with the Financial Post, Royal Bank of Canada CEO Dave McKay urged Canadian regulators to reconsider capital requirements imposed on the country’s largest financial institutions to maintain competitiveness with Europe and America.
McKay emphasized that having to hold more capital would make Canadian banks uncompetitive.
The apparent shift in the US came after strong opposition from American banks, arguing that stringent final rules would reduce the money available for lending.
McKay noted that Canada’s Office of the Superintendent of Financial Institutions had already implemented the final Basel reforms for Canadian banks starting in 2023. He indicated that if other markets change their approach, Canada may need to rethink its trajectory.
