What to Expect for Canadian Banks from Final Basel III Reform Implementation

Basel III reforms have finally begun for regulated Canadian banks. Back in January 2022, the Office of the Superintendent of Financial Institutions released revised Capital Adequacy Requirements, Leverage Requirements, Liquidity Adequacy Requirements, Small and Medium-Size Deposit-Taking Institutions' (SMSBs) Capital and Liquidity guidelines, and Pillar 3 Disclosure Requirements that incorporated the internationally agreed-upon Basel III reforms. Most of the guidelines came into effect as of April 1, 2023. DBRS Morningstar has released a commentary discussing some of the primary changes incorporated into the aforementioned guidelines and implications for the federally regulated Canadian banking institutions in its rating universe.

Key highlights include the following:

-- Some of the primary changes include the implementation of a 72.5% Basel III output floor, application of a leverage ratio buffer to Domestic Systemically Important Banks (D-SIBs), segmentation of SMSBs into three categories, and separate Pillar 3 Disclosure Requirements for D-SIBS and SMSBs.

-- Overall, we expect the revised guidelines to have a limited impact on the capital, leverage, and liquidity ratios of federally regulated Canadian banking institutions we rate.

-- Although capital ratios at most banking institutions will increase in 2023 now that the first phase of the Basel III reform implementation has begun, certain banks might see a reduction in capital ratios in later years as a result of the credit valuation adjustment risk and market risk reforms being implemented in 2024, along with the output floor being phased in through 2026.

“We believe these revised guidelines further strengthen federally regulated Canadian financial institutions' ability to withstand financial shocks, considering the proportionality of the capital and liquidity frameworks for smaller, less complex institutions,” said Shokhrukh Temurov, Vice President, North American Financial Institutions at DBRS Morningstar.