New rules designed to curb the counterparty credit risks of Canada’s big banks is positive because it reduces banks’ individual exposure and the potential for financial turmoil to cascade through the sector, says New York-based Moody’s Investors Service in a new report.
Measures proposed last week by the Office of the Superintendent of Financial Institutions (OSFI) for Canada’s domestic systemically important banks (D-SIBs) will, if adopted, represent a credit positive for the big banks “because it will lower overall concentrations at individual banks … and reduce potential contagion risks by limiting the interconnectedness of DSIBs,” Moody’s says in the report.
OSFI’s proposals to limit the big banks’ exposures to either a single counterparty or an interconnected group of counterparties will also bring Canada’s regulatory framework into line with updated global standards from the Basel Committee on Banking Supervision.
“While both the current and proposed guideline limit the maximum exposure to 25% of a D-SIB’s capital, the proposal would change the base to Tier 1 capital from the current base of total capital,” Moody’s says. The change will effectively lower the limit on large exposures and link the limit to a higher quality form of capital.
“D-SIBs that wish to increase their exposures to counterparties to which they already have a significant concentration will need to consider the effect that such an increase would have on its levels of Tier 1 capital,” says Moody’s.
Additionally, OSFI is proposing to limit a D-SIB’s aggregate exposure to other Canadian D-SIBs and to global systematically important banks. This will “reduce interconnectedness between these institutions, which will help limit the propagation of idiosyncratic stress shocks among large banks in both the Canadian and global banking environments,” Moody’s says.
The rules will also improve the accuracy of measuring banks’ exposures, which will “lead to better decision-making by risk managers,” Moody’s says, and increase “protection for the banks’ bondholders against unexpected losses.”