OSFI confronts rising liquidity risks

Amid continued high interest rates, elevated stress in the financial system and financial benchmark reform, the Office of the Superintendent of Financial Institutions (OSFI) is consulting on proposed changes to banks’ liquidity rules.

The federal financial regulator launched a public consultation on its liquidity guideline, including proposed changes to intra-day liquidity monitoring tools, new monthly reporting requirements, and revisions to the treatment of bankers’ acceptances in the wake of benchmark reform (as the Canadian dollar offered rate — CDOR — is phased out).

OSFI said the proposed changes will, among other things, enable it to assess how well banks are managing their intra-day liquidity risk, and help it better monitor institutions’ ability to meet their payment and settlement obligations during stressed markets.

In its latest annual risk report, OSFI said that “liquidity and funding conditions remain sensitive to an uncertain financial market landscape.”

Given the uncertainty about the future path of global interest rates, OSFI said, “Liquidity shocks are a persistent concern and can arise if depositor behaviour shifts dramatically.”

And as the turmoil in the U.S. banking industry revealed last year, the increased digitalization of the banking industry means that depositors can move their money more quickly and easily than in the past, which can allow for rapid deposit outflows.

The higher interest rate environment has increased competition for deposits, as investors seek higher fixed-income returns.

“This has an impact on depositor behaviour and could affect bank deposit persistency and the assumptions deposit-taking institutions make when estimating funding costs,” the report noted.

Interest rate shifts also impact the value of assets that banks hold for liquidity, which can affect market stability.

“Funding and liquidity risk remains linked to credit risk as deteriorating conditions can negatively impact securitization markets,” it said. “This can trigger increased liquidity risk for institutions that rely on securitization as a key source of funding.”

Against this backdrop, the regulator noted its growing concern about intra-day liquidity oversight.

“Heightened risks in the financial system have highlighted the importance of monitoring intra-day liquidity,” said Peter Routledge, superintendent with OSFI, in a release.

In its report, OSFI said, “Intra-day liquidity risk affects not only the bank’s own liquidity but also that of third parties, and could result in additional borrowing costs, loss of stakeholders’ trust, and disruption to payments, settlements and clearings.”

During periods of elevated market stress, collateral calls between banks can trigger liquidity shocks, it also noted.

Routledge said OSFI believes that its proposed changes to the liquidity rules, which are out for comment until Aug. 30, will beef up the resilience of the financial system.

OSFI aims to publish its final guideline in November, with the revisions taking effect on April 1, 2025.