OSFI Extends Output Floor Phase-In Timeline, While Awaiting Clarity on Basel III Reform Rules in Other Jurisdictions

On July 5, 2024, the Office of the Superintendent of Financial Institutions (OSFI) announced a one-year delay in the phase-in period for the implementation of a 72.5% Basel III output floor in Canada. The Basel Committee on Banking Supervision's revised capital floor intends to reduce excessive variability of risk-weighted assets (RWAs) derived from the internal ratings-based approach in relation to the standardized approach.

Key highlights:

-- OSFI remains committed to the implementation of Basel III Output Floor in Canada despite its announced delay to the transition period.

-- The Canadian banks will likely use a combination of various tools to manage heightened capital requirements. These could include equity/debt issuance, sale of non-core assets, suspending dividend increases, and/or balance sheet optimization measures, such as synthetic/credit risk transfers and loan sales.

-- Despite potential implementation challenges, the adoption of the revised output floor will further strengthen Canadian banks' ability to withstand financial shocks.

“The full implementation of the capital floor means that to maintain their current capital ratios, the Canadian banks must increase their capital levels and/or utilize capital optimization measures to reduce RWAs,” said Shokhrukh Temurov, Vice President, North American Financial Institutions at Morningstar DBRS. “The adoption of the revised output floor without any capital raise or balance sheet optimization strategies would result in a significant reduction in several Canadian D-SIBs capital buffers, albeit likely remaining above the current minimum regulatory CET1 ratio of 11.5%.”