New report calls for greater focus on the ‘home advantage’ of Canadian assets
Rising geopolitical tensions, including those on Canada’s doorstep, are posing an increased treat to Canadian financial institutions, according to a new report published today (9/25).
The CD Howe Institute report, ‘Home Advantage: Helping Financial Institutions Prepare for Financial Distress Amidst Rising Geopolitical Tensions’ is written by Mark Zelmer, former deputy superintendent of financial institutions at OSFI, and emphasizes the importance of ensuring Canadian financial institutions keep more capital and liquidity in Canada.
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Zelmer’s report highlights how, historically, financial institutions have operated under the assumption that they could deploy capital and liquidity internationally to maximize profits, assuming they would continue as a going concern.
However, the global financial crisis of 2008 demonstrated that banks are "international in life, but national in death", meaning that that when an internationally active bank fails, authorities in each jurisdiction may ring-fence or freeze local assets to protect their own domestic stakeholders, such as depositors and creditors.
This is especially relevant for Canadian banks, as several have very large operations in the United States, with some now rivalling the size of their Canadian businesses in terms of assets and revenues.
The report warns that foreign authorities may prevent the repatriation of surplus assets from their jurisdictions until the claims of their own creditors are satisfied. This ring-fencing risk could make it difficult for Canadian regulators to ensure that banks can access enough assets to fully cover Canadian depositors and creditors.
Mark Zelmer proposes several ways to manage the risks and protect Canadian interests:
- Review Capital Requirements: Canada's banking regulator, OSFI, has rules for how much capital banks need to hold on their own (solo TLAC). However, the report suggests these rules might not be strict enough given recent geopolitical changes. The current rules assume that if a bank fails, it can still recover 30-35% of its investments in foreign branches and subsidiaries. The report notes that other countries have stricter rules, often requiring that these foreign investments are fully deducted from a bank’s capital.
- Increase Transparency: The report recommends that major Canadian banks share more public information about their financial and operational structures. Currently, their recovery and resolution plans are not public. Zelmer argues that more transparency would allow the market to better assess and manage risks, and would help prepare the public for a potential crisis.
- Strengthen Liquidity Oversight: OSFI should pay closer attention to the amount of liquid assets a bank holds in Canada. Foreign authorities could freeze these assets, making it harder for a bank to access cash when needed. The report supports OSFI's idea to have banks create a plan (ILAAP) to manage the risk of transferring liquidity across borders.
- Encourage Domestic Investment: Authorities should find ways to incentivize major financial institutions to keep more of their surplus capital and liquid assets in Canada. This would reduce the influence that foreign regulators might have during a cross-border resolution. A significant portion of these assets are currently held in foreign branches and subsidiaries.
Zelmer concludes that Canada's financial system needs to adapt to the changing global environment and that it is "better to do act now in a thoughtful way while time is still on our side than to punt the issue until a crisis forces change.”
