Supervision of Canadian Financial Institutions - PowerPoint PPT Presentation

1 / 27
About This Presentation

Supervision of Canadian Financial Institutions


... cash ... the Netherlands, Spain, Sweden, Switzerland, the UK and the US. ... hoc analysis and project management. 25. Supervisory Tools. Quarterly ... – PowerPoint PPT presentation

Number of Views:35
Avg rating:3.0/5.0
Slides: 28
Provided by: cibcm


Transcript and Presenter's Notes

Title: Supervision of Canadian Financial Institutions

Supervision of Canadian Financial Institutions
James Dennison
  • Regulatory Capital 101
  • The Basel Accord
  • OSFI

Regulatory Capital 101
Regulatory Capital
  • Capital is
  • a measure of a financial institutions net worth.
  • Regulatory capital is
  • net worth as defined by rules adopted by a
    regulatory agency (e.g. OSFI).
  • designed to require financial institutions to
    hold enough capital relative to the risks they
    are taking.
  • calculated using financial statement and other
    relevant data.
  • different for deposit-taking institutions, life
    insurance companies and property casualty
    insurance companies.

Regulatory Capital
  • Regulatory capital for deposit-taking
    institutions consists of two key rules
  • 1. Asset-to-Capital Multiple (ACM)
  • 2. Risk-Based Capital Ratio

Regulatory Capital
  • The Asset-to-Capital Multiple (ACM)
  • is simply a measure of a financial institutions
  • is calculated by the using the following
  • ACM Total assets
  • Total capital
  • is a measure of a financial institutions
  • is compared to the prescribed regulatory limit
    (e.g. 12x, 20x, 23x)

Regulatory Capital
  • The Risk-Based Capital Ratio
  • is a measure of how much capital a financial
    institution is holding, relative to the amount of
    risk it is taking.
  • is calculated by the using the following
  • Risk-Based Capital Ratio Total capital
  • Sum of risk-weighted assets
  • is compared to the prescribed regulatory limit
    (e.g. 8)

Regulatory Capital
  • Total capital has 3 primary considerations,
    including its
  • permanence.
  • being free of mandatory fixed charges against
  • subordinated legal position to the rights of
    depositors and other creditors of the
  • Total capital includes
  • Tier 1 (core capital) highest quality.
  • Equity capital
  • Disclosed reserves (share premiums, retained
    earnings and general reserves)
  • Tier 2 (supplementary capital) lower quality.
  • Undisclosed reserves/hidden reserves
  • Asset revaluation reserves
  • General provision/loan loss reserves
  • Hybrid debt capital instruments
  • Subordinated term debt

Regulatory Capital
  • Risk-weighted assets has several components.
  • Credit risk (on-balance sheet) conversion factors
  • 0 cash OECD governments
  • 20 Canadian banks, OECD banks, non-domestic OECD
    public sector entities
  • 50 residential mortgages
  • 100 all other claims
  • Credit risk (off-balance sheet) conversion
  • 100 direct credit substitutes (e.g. credit
  • 50 transaction related contingencies (e.g. bid
    bonds, performance bonds, etc)
  • 20 short-term, self-liquidating trade-related
  • 0 unused portions of commitments with original
    maturity of one year or less.
  • Market risk conversion factors
  • On-balance sheet assets held in trading book
    subject only to market risk requirements.
  • Derivative instruments held in trading books
    subject to both market credit risk reqmts.
  • On-balance sheet assets held outside trading book
    and funded by another currency and unhedged for
    f/x exposure are subject to both market and
    credit risk requirements

Regulatory Capital
  • Example ABC Bank
  • Only one asset - 300,000 residential mortgage
  • Total capital of 15,000
  • Risk-weighted assets 300,000 x 50
  • 150,000
  • Risk-based capital ratio 15,000
  • 150,000
  • 10
  • Conclusion 10 gt 8 regulatory minimum
  • ? Compliant with regulatory requirements

  • MCCSR Total Capital
  • Required Capital
  • Minimum 120
  • Target 150
  • Required capital includes charges for
  • Asset default
  • Mortality, morbidity and lapse risk
  • Interest rate risk
  • Segregated fund guarantee risk

The Basel Accord
The Basel Accord
  • The Basel Committee
  • was established in 1974 by the central bank
    governors of the G-10 countries (Belgium, Canada,
    France, Germany, Italy, Japan, Luxemburg, the
    Netherlands, Spain, Sweden, Switzerland, the UK
    and the US.
  • was created to provide a forum for regular
    cooperation between its member countries on
    banking supervisory matters.
  • sets the standards for the regulation of capital
    and capital adequacy for internationally active
    financial institutions.
  • does not have supranational authority, therefore
    the Basel Accord does not have any legal force.
  • satisfies its mandate by influencing national
    regulatory bodies to implement supervisory
    standards and guidelines, and best practice

The Basel Accord
  • The first version of the Accord
  • was first released in July 1988.
  • was introduced to address the need for a
    multinational accord to strengthen the stability
    of the international banking system and to remove
    a source of competitive inequality arising from
    differences in national capital requirements.
  • was limited in focus to credit risk and provided
    a framework for the implementation of a minimal
    capital standard of 8 by the end of 1992.
  • was amended in 1996 to incorporate market risk.

The Basel Accord
  • The first version of the Accord has several
  • Inadequate differentiation between credit risks
    does not allow for varying levels of credit
  • Securitization banks have securitized high
    quality loans, thus leading to a deteriorating
    loan book.
  • Credit mitigation techniques does not recognize
    the benefits of techniques such as collateral
    guarantees, netting and use of credit
  • Diversification does not consider portfolio
    risk and completely ignores the benefits derived
    from diversification.
  • Operational risk does not consider operational
    risk into calculation of required capital.

The Basel Accord
  • The second version of the Accord is based on 3
  • Minimum Capital Requirement
  • to cover credit, market and operational risk (new
    risk category under Basel II)
  • financial institutions have a wider choice of
    models to calculate risk charges
  • Supervisory review process
  • supervisors (e.g. OSFI) have an expanded role,
    including ensuring financial institutions have a
    process in place to for accessing capital in
    relation to risks, and that they operate above
    the minimum regulatory capital ratios.
  • Market Discipline
  • Basel II emphasizes the importance of risk
    disclosures in financial statements by setting
    out disclosure requirements and recommendations

The Basel Accord
  • Financial institutions can now choose from
    numerous approaches to calculating required

The Basel Accord
  • Choices regarding credit risk include
  • Standardized Approach uses credit ratings from
    external rating agencies together with risk
    weights applicable to each rating category to
    calculate the credit risk capital charge.
  • Foundation Internal Ratings Based (IRB) Approach
    use internal estimate of creditworthiness,
    subject to regulatory standards. Under this
    approach, institutions estimate the probability
    of default (PD) and together with inputs provided
    from the standardized approach, is used to
    determine the credit risk capital charge.
  • Advanced Internal Ratings Based (IRB) Approach
    builds on the Foundation IRB approach, by adding
    other inputs such as loss given default (LGD) and
    exposure at default (EAD) to further refine the
    credit risk capital charge calculations.
  • Note in order to use either the Foundation or
    Advanced IRB approach, regulatory approval of
    credit models must be obtained.

The Basel Accord
  • Choices regarding operational risk include
  • Basic Indicator Approach institutions using
    this approach must hold operational risk capital
    equal to the average over the previous three
    years of 15 of positive annual gross income.
  • Standardized Approach institutions using this
    approach are required to divide its activities
    into eight predefined business units and apply a
    predefined factor to each business line to
    determine operational risk capital. The total
    operational risk capital charge for the
    institution would be the three year average of
    the sum the charge for each business unit.
  • Advanced Measurement Approach the operational
    risk capital charge is generated by the
    institutions internal operational risk
    measurement system using quantitative and
    qualitative criteria specified in the accord. Use
    of this method is subject to supervisory

Operational Implications
  • Bank business line/group impacts
  • Key Risk Indicators
  • Operational Losses
  • Operational Risk Modelling
  • Financial Regulatory Returns
  • Independent Assessment (Internal Audit)


  • The Office of the Superintendent of
    Financial Institutions (OSFI) is the primary
    regulator of federally chartered financial
    institutions and federally administered pension
    plans. OSFI's mission is to safeguard policy
    holders, depositors and pension plan members from
    undue loss. OSFI supervises and regulates all
    banks, and all federally incorporated or
    registered trust and loan companies, insurance
    companies, cooperative credit associations,
    fraternal benefit societies and pension plans.

Organizational Structure
Supervision Processes
  • Quarterly monitoring process
  • On-site examinations
  • Cross-industry reviews
  • Ad-hoc analysis and project management

Supervisory Tools
  • Quarterly monitoring process
  • Stage Ratings
  • (Stages 0 to 4)
  • Supervisory Framework
  • FI Ratings
  • (Low, Moderate, Above Average, High)

RMCF Characteristics
Overall Assessment
Stage Rating
  • ?
Write a Comment
User Comments (0)