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BOC overnight interest rateEffective October 31, 2019, the Office of the Superintendent of Financial Institutions (OSFI) is increasing the Domestic Stability Buffer by 25 basis points to 2% of total risk-weighted assets.

The Domestic Stability Buffer is an important number, especially for those who represent a large financial institution or one of Canada’s big banks. It ensures that adequate capital is held to protect against risk to the financial system. OSFI also encourages financial institutions to use the buffer in times of stress to avoid asset-sales or drastic reductions in lending.

The buffer came into effect in June of 2018 at 1.5% and was raised to 1.75% in April of 2019. It is reviewed on a semi-annual basis.

“This reflects OSFI’s view that key vulnerabilities to Canada’s Domestic Systemically Important Banks (D-SIBs) remain elevated,” OSFI wrote in a June 4 release about the increase to 2%.

These key vulnerabilities included Canadian household debt, asset imbalances, and institutional indebtedness.

“Against this backdrop, a favourable credit environment and stable economic conditions continue to provide a window of opportunity for D-SIBs to increase their capital holdings,” OSFI wrote.

Analysts do not expect the change to have a large impact on capital decisions at Canada’s big financial institutions, according to the Financial Post, because their overall capital buffers exceed the levels set by OSFI.

However, one anonymous Toronto-based analyst was quoted as saying that it does speak to OSFI’s concern about the economic outlook and operating environment for the banks.

According to Gabriel Dechaine, a National Bank of Canada analyst, the total capital buffers at Canadian banks is tracking well above OSFI requirements.

The average was 11.5% at the end of the recently reported second quarter, with a range of 11% to 12%, Dechaine said in a note to clients.

The Canadian Press quoted Dechaine as writing, “If a downturn actually does materialize, then banks will not only be in a better position to withstand it, they may be able to deploy capital opportunistically (buybacks, M&A), which would be better for investors in the long term, in our opinion.”

The buffer increase may signal to financial institutions, large and small, to make sure enough capital is set aside to mitigate lending risk.

“Announcing the buffer demonstrates OSFI’s view that increased transparency will support banks’ ability to use this capital buffer in times of stress by increasing understanding of the purpose of the buffer and how it should be used,” OSFI stated in its release.

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