Bank capital reforms poorly timed, Scotia warns

Adopting the latest global capital requirements over the next two years could push Canada’s big banks to shed assets and slash lending at a time when the need for financing is growing, warns Scotiabank Economics in a new report.

Federal banking regulator the Office of the Superintendent of Financial Institutions (OSFI) is on track to implement the latest version of the Basel capital rules by mid-2026, the report noted.

The new requirements, which will require banks to shift from using bank-specific internal models to calculate risk-weighted assets to a standardized approach, may mean the banks have to dispose of large volumes of risk-weighted assets by mid-2026, it said.

While banks can keep their capital ratios at the minimum required levels by either boosting capital or reducing assets, the report says that, given the current conditions for raising capital, it’s likely that banks will prefer to reduce assets.

“As a whole, banks would have to shed about $270 billion in assets by 2026 if capital ratios remain unchanged and banks do not raise capital. This represents about 9% of current nominal GDP and would represent a major pull back in lending relative to the current situation,” it said.

Even if banks decide to meet their capital requirements by both raising capital and shedding assets, the change would still have a significant impact on lending, it said.

For instance, in a scenario where the banks’ efforts to adapt to the new requirements are evenly split between raising capital and cutting assets, “the system would still see banks shed assets worth around 4.5% of GDP,” it noted.

Pushing banks to dispose of assets runs in direct opposition to the need to boost investment and facilitate housing market access, the report argued.

“While it is clear that a more capitalized banking system is a safer system, there is an economic cost to making an already-safe system safer,” it noted, particularly at a time when the need for productivity-enhancing investment and improving access to housing is acute.

“This seems to be another instance of policy inconsistency in the Canadian policymaking landscape,” it said. Adopting the latest Basel reforms “could force banks to cut back lending to the very sectors of the economy [that] governments are trying to mobilize financing for,” potentially exacerbating these long-standing economic challenges, it said.

Moreover, the capital reforms for the Canadian banks are being adopted much more quickly than their rivals in the U.S. and Europe, the report noted.

Regulators in the U.K. and Europe won’t be adopting the same measures until 2030 and 2032, respectively; and U.S. regulators are rethinking their final adoption of the requirements, the report said.

“While this will mean a more resilient banking system in Canada relative to these countries, it will place Canada at a competitive disadvantage at a time when access to finance is critically important in meeting the needs of Canadians and for transforming our economy,” the report said.