On May 1, 2020, the Office of the Superintendent of Financial Institutions (OSFI), Canada’s prudential banking regulator, issued guidance on the use of internal capital buffers by small and medium-sized banks (SMS Banks) and related capital management expectations during the current COVID-19 pandemic. OSFI’s guidance is set out in an industry letter issued to Canada’s deposit-taking institutions that use the standardized approach for calculating credit risk and in updates to OSFI’s frequently asked questions about COVID-19 measures.

The industry letter clarifies that “measured declines” in capital ratios are acceptable in current circumstances for SMS Banks. Internal capital buffers can be used to absorb unexpected losses arising from the impact of the COVID-19 disruption and allow banks to continue providing financial services. OSFI acknowledges that this may result in SMS Banks operating below their internal (Pillar II) capital targets, and sets out several capital management expectations to determine the appropriateness of such actions. In particular:

• Where SMS Banks consider using their capital buffers, OSFI expects that they would use the capacity prudently and will consider the required capital management and restoration actions. OSFI expects banks to closely track their credit portfolios and report on developments to OSFI on a regular basis. Banks should consider stress testing information, including plausible future adverse scenarios, as part of the capital management decision-making process.

• Prior discussions with the OSFI supervision team are required if a bank plans to use internal capital buffers by operating below its internal capital target. Banks planning such action must provide OSFI with a “credible plan” as to how and when the institution intends to restore its buffers.

• OSFI’s review of planned capital buffer usage will consider whether the SMS Bank’s expected use of the capacity is prudent and whether appropriate capital conservation actions have been incorporated.

Please refer to OSFI’s updated frequently asked questions for deposit-taking institutions for additional information.