The Office of the Superintendent of Financial Institutions Canada issued a proposal on Tuesday to relax its disclosure guidelines for banks writing off bad debt. Under the proposal, banks will have to adhere only to Canadian generally accepted accounting principles (GAAP) to disclose foreseen losses resulting from bad loans.

Released in 2001, OSFI’s C-5 guideline was implemented to increase the use of general allowances in banking financial statements. General allowances are estimated total loan write-offs. The OSFI and the Canadian GAAP principles required banks to file different sets of similar reports in their financial statements. OSFI’s requirements were slightly more rigorous since they required specific reports for a number of specific areas.

The banking industry has lobbied OSFI to eliminate its extra disclosure requirements and just allow the banks to use the GAAP principles, where disclosure is left to the judgment of preparers of financial statements.

In addition to the changes for disclosure in C-5, OSFI has relaxed the reporting requirements of C-1 as well, which deals with “impaired loans” — loans that have to be reduced in value because the borrower is unlikely to be able to pay the lender back. In both instances, the banks will have to adhere only to GAAP.

OSFI, which considers itself a “principles-based” regulator, says it’s comfortable that GAAP strikes an appropriate balance between the need for public disclosure and the protection of proprietary information. It also says the 2001 rules were to motivate the use of general allowances, which it says are pretty much standard practice in the industry now.

Julie Dickson, acting superintendent of OSFI has made it clear though that her organization is still going to be on the lookout for increases in credit defaults. At a speech delivered on Friday, she explained how her organization is very aware of the high risk of “sub-prime” lending problems in the U.S., although she doesn’t think Canada is quite as susceptible.

“Recent U.S. experience tells us that institutions should have their antennae up regarding commercial real estate exposure, and sub-prime lending,” she said. “The current differences between the Canadian and U.S. sub-prime mortgage market are significant. Sub-prime is just over 2% of the Canadian market, but close to 15% in the U.S. The type of products you see in the U.S. are very aggressive, and the loan conditions are more exotic. In Canada, we still see mostly 25- to 30-year amortizations, and we have not seen the kind of features that the U.S. market has been offering.”

Dickson says OSFI is nonetheless investigating the prevalence of high-risk lending in Canada.

“Using a questionnaire, we will be asking the institutions whether they consider themselves to be involved in sub-prime lending, what definition they themselves would use to define a sub-prime mortgage, and the size of their sub-prime portfolio,” she says.

“This will allow us to more effectively identify the nature and size of the market, and will help guide further assessment. It will also give us an idea as to which institutions are more involved in sub-prime lending.”

OSFI is also urging financial institutions to conduct similar internal reviews and stress-testing that it recommends be broken down by region.

“For example, the situation in Western Canada, where there is a boom [seen in high levels of construction activity and strong appreciation in real estate markets], is very different than the situation in Ontario and Quebec,” she says. “Both markets can pose challenges, and institutions need to be on top of those challenges.”

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com

(06/19/07)

Originally published on Advisor.ca