Commentary

SRTs: Another Tool in the Toolkit as Large Canadian Banks Increasingly Look to Manage Capital and Risk

Banking Organizations

Summary

Large Canadian banks are facing heightened regulatory capital requirements, including the Office of the Superintendent of Financial Institutions' final Basel III reforms as well as pending requirements in other jurisdictions where the Canadian banks operate. Although the full implementation of the Basel III output floor has been delayed in Canada, along with more broad-based Basel III reform delays globally such as in the U.S. and U.K. (see "OSFI Extends Output Floor Phase-In Timeline, While Awaiting Clarity on Basel III Reform Rules in Other Jurisdictions," July 18, 2024), many banks have begun to explore alternative forms of capital relief, including synthetic risk transfers (SRTs).

Key highlights include:

-- In our view, SRTs can be an effective tool for capital efficiency and/or risk management, allowing the originating bank to transfer risk on an underlying loan portfolio to investors.

-- The Big Five Canadian banks have all completed at least one SRT transaction, as the market grows both in Canada and globally, and now have the framework, processes, and infrastructure in place to execute future transactions more quickly.

-- We believe upcoming regulatory changes in Canada and the U.S. could lead to increased usage of SRTs by the Big Five over the longer term.

"SRT activity has grown significantly in Canada over the past two years; as of Q3 2024, the Big Five had synthetic securitizations referencing nearly $81 billion of wholesale loans, up from only $22 billion in Q3 2022," said Josh Veenkamp, Assistant Vice President, North American Financial Institution Ratings. "We believe the Big Five are unlikely to originate material volumes of SRTs in the near-term (with the likely exception of BMO); however, if SRT activity ramps up over the longer term we expect banks to take a measured approach, setting internal risk limits to mitigate the amount of risk-weighted assets that could potentially come back to the bank in any one period."

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