Rideau Canal skating rink, Parliament of Canada in winter

The Office of the Superintendent of Financial Institutions (OSFI)’s decision to boost the capital buffer requirements on Canada’s big banks is wise, given rising systemic risks, Fitch Ratings says.

In a new report, the rating agency said that OSFI’s move to boost the domestic stability buffer by 50 basis points to 3.0% — which effectively raises the common equity capital requirement from 10.5% to 11.0%, as of February 2023 — supports the banks’ capital positions, and addresses rising economic and financial risks.

Fitch said that it “views the higher capital requirement as appropriate, as it coincides with building risks related to the rapid rise in interest rates this year, including an ongoing housing market correction, declining household savings, and an anticipated economic slowdown.”

In its latest forecast, Fitch said that it expects GDP growth to drop to just 0.6% next year, down from a forecast 3.5% this year. As the economy slows, it also expects the unemployment rate to climb from 5.1% to 6.1%.

Alongside the increase in the buffer itself, OSFI also boosted the maximum range for the buffer. This signals that OSFI could raise capital requirements further, Fitch said.

Additionally, Fitch noted that the higher buffer will be implemented at the same time as the final Basel III rules are being implemented, which it estimated “could reduce risk weighted assets by approximately 3% across the six largest banks in 2023.”

In the short term though, Fitch said that the higher capital requirements are most relevant to Bank of Montreal (BMO) and Toronto-Dominion Bank (TD) as they are in the midst of completing large acquisitions.

For instance, BMO’s capital ratio is expected to drop below 11.0% with the acquisition of Bank of the West, it said.

As a result, it suggested that the bank “could resort to continued use of loan sales, syndications and synthetic transfers to shore up capital above the new requirement, if necessary.”

Similarly, TD is expected to close its acquisitions of First Horizon Corp. and Cowen Inc. by April 2023.

While its capital ratio is forecast to remain above 11.0% even with those acquisitions, Fitch said that TD also has options to shore up its capital if needed.

Royal Bank of Canada (RBC) also has a large acquisition in the works, with its recently-announced deal for HSBC Canada.

However, with that transaction not expected to close until late 2023, RBC “has sufficient time to adjust its capital planning to the revised requirement,” Fitch said.