Remarks by Superintendent
Julie Dickson
Office of the Superintendent of Financial
Institutions Canada (OSFI)
to the
2014 Financial Services Invitational Forum
Cambridge, Ontario
May 8, 2014
SPEAKING POINTS
For additional information contact:
Brock Kruger
Communications and Consultations
brock.kruger@osfi-bsif.gc.ca
www.osfi-bsif.gc.ca
Remarks by Superintendent
Julie Dickson
Office of the Superintendent of Financial Institutions Canada (OSFI)
to the
2014 Financial Services Invitational Forum
Cambridge, Ontario
May 8, 2014
I‟m happy to be here once again. As my term comes to an end, I am often asked
to comment on what sticks out for me in my experience as Superintendent.
Certainly my visits to this forum have been a highlight, and I am happy to have
one final opportunity to speak to you.
As I reflect on my time as Superintendent, I can say that it was the best of times
and the worst of times. It was the worst of times in 2007 with the asset-backed
commercial paper market freezing in Canada, and in 2008, when the global
financial crisis hit, because there was so much we did not know: markets were
seizing up globally; governments were forced to step in at taxpayers‟ expense in
many countries; and country after country, bank after bank, began making major
announcements on a daily basis that were incredibly difficult to track, let alone
assess.
Nonetheless, the past seven years were also the best of times – at least for
regulators. For example, contrary to the period leading up to 2007, there was far
less pushback on regulatory issues such as often happens in good times.
Institutions responded quickly to initiatives such as having Chief Risk Officers
(CROs) report to CEOs, and agreed that CROs needed to be highly skilled and
have clout. New initiatives such as risk appetite frameworks were embraced. We
began to see improvements in corporate governance. The Basel Committee on
Banking Supervision (BCBS) developed new capital rules in record time (months
instead of years). And for the first time, BCBS moved forward with liquidity and
leverage rules. Stress testing became a serious practice, and clearly has evolved
substantially since 2008. Furthermore, banks began to do recovery planning.
Resolution authorities (like the Canada Deposit Insurance Corporation here in
Canada) began work on planning bank resolutions, should they ever be
necessary. Pre-crisis, this was unheard of. Although some had wanted to test
what would happen in real life if a big global bank failed, pre-2007 it was
considered too “dangerous” for such an exercise, lest anyone thought it was for
real.
While I can characterize the period as the best of times and the worst of times, I
am also saying that it can be challenging to be a regulator in good times as well
as in bad. The challenges may be different, but they nonetheless remain
challenges.
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Since this is my last time to address you as Superintendent of Financial
Institutions, I would like to spend a bit of time replaying some of the highlights
that have framed our discussions over the past seven years.
In 2007, my speech drew on the image of sow ears being sewn into silk purses,
since, at the time it seemed that sub-prime mortgages were magically being
turned into AAA securities. The speech questioned whether this made sense,
and suggested that institutions needed to focus on capital and liquidity and on
keeping an eye out for downside risks materializing, because none of us has the
ability to change balance sheets or market positions in a hurry. That speech is as
relevant today as in 2007, as globally there is evidence of search for yield – such
as in the leveraged loan market – and a potentially insufficient appreciation of the
associated risks. This can backfire, especially when rates move back up or when
markets change.
In 2008, the message was that we needed to learn the risk management lessons
being taught by the crisis. Reputation risk, model risk, and the need to have
excellent information systems at banks, among other things, were mentioned.
That theme is as relevant today as it was in 2008 as there is still work to be done.
Domestic systemically important banks (D-SIBs) must meet global data
aggregation standards by 2016, which is challenging. And today, the merits of
capital models are being openly questioned in global circles. The debate is about
the extent to which models should be allowed to determine capital requirements.
OSFI‟s view is that capital models must continue to be part of the mix. Otherwise,
major banks will be using pre-set „one-size-fits-all‟ formulas that will not
necessarily do a good job of reflecting the risks that are being taken. We also
think all global supervisors need to assess their ability to oversee bank models.
In 2009, I turned my attention to board composition, and how boards needed to
put talented teams together to deal with the high risks still evident in the
marketplace. The speech suggested that bank boards needed more skills, such
as having some members who come from the industry the boards are
overseeing. I am pleased to see that progress has been made in this regard.
Today, we are not only seeing changes in board composition for the better, but a
reduction in overall board size and an increase in the level of engagement
between the board and OSFI. Furthermore, attention has focused on risk
committees (including the need to separate risk and audit committees), the HR
committee (given the importance of compensation and succession planning), and
the audit committee, as the overseer of internal and external audit.
In 2010, I took the perspective of the consumer, the taxpayer, looking at
systemically important banks and thinking they might ultimately end up footing
the bill if these massive entities become non-viable in the event of significant
problems. I noted that some of the more elaborate proposals being suggested by
various parties probably would not work. I summed up by talking about the
important role contingent capital could play.
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Concrete steps have been taken since 2010: Capital surcharges have been
implemented, contingent capital is now part of Basel capital requirements, and
greatly enhanced supervision of G-SIBs is underway. Similar measures exist for
D-SIBs in Canada. We remain very focused on resolution of systemic institutions
globally and in Canada, with CDIC leading the way domestically, along with other
federal agencies.
In 2011, many of us felt we were in uncharted territory, with a sovereign debt
crisis in Europe and other concerns, like the U.S. fiscal situation and quantitative
easing. Meanwhile, a battle was brewing globally about whether more capital
would be beneficial, whether regulators had been too demanding, and whether
the pendulum had swung too far the other way. The pendulum swung back
shortly thereafter, as announcements concerning the “London Whale”, LIBOR
fixing and anti-money laundering violations were made.
Today, while still in unchartered territory to some degree, we are in the early
stages of a normalization process. The Canadian banking system is well situated
in the event of a shock. The 2014 Financial Sector Assessment Program report
indicated that stress tests conducted as part of the review show that major
Canadian financial institutions would continue to be resilient to credit, liquidity,
and contagion risks arising from a severe stress scenario.
The 2011 speech also noted that organizational culture issues are a very
important component of many previous crises and failures. Culture has now
become a big area of focus for global banks and supervisors, and a Financial
Stability Board (FSB) paper on interaction between supervisors and institutions
on risk culture was released on April 8, 2014. It provides indicators of risk culture
that tend to be important at financial institutions. The paper legitimizes
discussions between supervisors and financial institution boards and senior
management about behaviours that can lead to problems. Many global
institutions have already been working on this, ahead of regulators; others are
just beginning. The FSB paper will help to ensure that focus continues, as we
turn from a “risk-off” to a “risk-on” environment.
In 2012, my speech focused on the fact that while stress testing is extremely
important, it can also lead to a false sense of security, and its limitations must be
understood. We should never mistake a model for reality.
The situation with stress testing today is very different from what it was pre-crisis
and has evolved further since 2012. Prior to 2007, stress testing was done, but
the scenarios employed were not severe enough and the work was high level
and broad brush. Post crisis, the scenarios are severe, and their duration has
increased. The work is in-depth. Furthermore, in the past two years, progress
has been made in modelling the initial impacts of severe scenarios, and in
modelling the additional losses that can arise due to liquidity shortfalls and
contagion in reaction to the initial adverse effects.
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There has also been progress in how we consider results from stress testing to
help form judgements. Institutions are responding to the seriousness with which
regulators are treating the issue, and this is leading to further improvements.
In 2013, the theme was cyber security risks and the risk associated with low
interest rates. Cyber security has become a major threat – as we were all
reminded of recently by the “Heartbleed” bug. It was another indication of how
much time and money needs to be spent on dealing with cyber security. OSFI
and the institutions we regulate and supervise remain focused on this issue.
Also, we need to be conscious of the impact of interest rates, which have been
historically low for an extended period of time. While there are good reasons for
low interest rates, dependence on low rates can become significant, such that a
transition to higher rates could be very painful. This is especially true in the
household sector in Canada, which is why we have been so focused on the real
estate market, and remain so. In this regard, we have combed through mortgage
portfolios to test the quality of underwriting, issued guidance on mortgage
underwriting (Guideline B-20) as well as draft guidance applying to mortgage
insurers (Guideline B-21), collected more data, required enhanced disclosure of
key mortgage lending data by institutions, assessed retail risk governance and
risk appetite frameworks in retail banking, and assessed capital models backing
real estate portfolios.
So, all in all, we have seen a lot of progress occur in the last several years. But
some messages warrant repeating again and again: Don‟t be complacent
because banks survived the crisis and emerged in good shape. Don‟t downplay
continuing threats (such as housing and cyber-attacks). And do continue the
work on stress testing.
As my term draws to a close, I will leave you with a few observations.
First, globally we are striking out into new territory, in areas such as stress
testing, risk appetite, risk culture, and resolution. The advances in supervisory
practice over the past seven years have been amazing and I think they will bear
fruit.
Second, the financial system has become increasingly global. Not only are many
rules established at the global level, but Canadian banks (and insurers) continue
to expand their global footprint, sometimes being bigger outside Canada than
within it (with Canadian earnings becoming relatively smaller). Further, when my
term began, I had two international meetings a year for the Financial Stability
Forum (now the Financial Stability Board). With the global financial crisis, the
number went up to approximately 15 international meetings a year. While this
number should go down slightly, given where we are in the global reform effort, it
is an indication of how global the sector has become.
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This will continue and there will be a need to stay on top of what is being done
elsewhere and to reflect on what that means for Canada. There was a race to the
bottom before the crisis -- now there seems to be a race to the top and, frankly,
beyond. A good recent example is the US decision in April to require U.S. G-SIBs
to meet leverage ratios much stricter than what the Basel Committee has
proposed. We will need to assess implications for Canada (and the Basel
Committee will need to discuss implications for its own rule). OSFI has always
been accused of being a boy scout, but we are now seeing significant
conservatism elsewhere.
Third, there is a shift in Canada toward regulating and supervising institutions by
size and importance. This was made clear with the D-SIB designation and the list
of requirements being imposed on D-SIBs, including capital surcharges, annual
supervisory colleges, recovery and resolution plans, considerably enhanced
disclosure requirements, enhanced governance requirements such as separate
audit and risk committees, data aggregation and IT system requirements, and
greatly enhanced supervision (including more cross-sector reviews, more drill
downs, and more ad hoc data requirements). The institutions that OSFI
supervises and regulates are not one-size-fits-all. We are now focusing on
smaller institutions and on identifying how to ensure that our requirements make
sense for their smaller size and less complex business models.
Fourth, OSFI has changed a lot since the crisis began. We have added
resources to deal with a range of new work, from reviewing the commercial
operations of Canada Mortgage and Housing Corporation, to increasing
oversight of D-SIBs in line with international expectations as noted earlier, to
adding horsepower in the area of insurance. We have received positive feedback
in these areas. For example, a survey of the life insurance sector conducted a
few months ago commended OSFI on the strength of the expertise we now have
in insurance (which increases the quality of interaction with industry). As well, the
recent FSAP report focused on OSFI‟s clear mandate, its independence and
resources and commented that we meet best practices in these areas, with
attendant results. This situates OSFI well for the future.
Let me close by saying that Canada has a lot of advantages. My dealings
internationally have shown that we can act quickly compared to other countries.
We can get our arms around the industry, given its size. We can communicate
effectively with institutions, and they with us. We have a “no surprises”
philosophy. It is important to focus on our advantages and minimize the
disadvantages, the main one being the risk of complacency, given how well we
did in the crisis.
So, as I take my leave and move on to another adventure, I would like to thank
you for having provided me with this speaking venue during the past seven
years. I wish you all strong corporate governance and sound risk management in
the years to come!
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