Stricter rules on deposits proposed by Canada’s banking regulator could drag down profits at alternative mortgage lenders next year, according to an analysis by National Bank Financial Inc.
The draft rule changes put forward by the Office of the Superintendent of Financial Institutions (OSFI) would require banks to hold more liquid assets as a buffer to help keep them stable in times of stress, The Globe and Mail reported this week. The proposals have not been made public and could still change in consultations before revisions are finalized, which could take months.
Yet, banks are expressing concerns that the changes would disproportionately harm smaller and mid-sized financial institutions, hampering competition in banking. The new rules would have the greatest impact on banks and mortgage lenders that attract most of their deposits from third-party brokers or through online channels – two types of deposits that OSFI is targeting as more risky, because they are prone to sudden withdrawals. Alternative lenders typically cater to borrowers who struggle to qualify for mortgages at major banks, such as new immigrants, self-employed workers or those with bruised credit.
A worst-case scenario outlined by National Bank analyst Jaeme Gloyn focuses on two such lenders: Equitable Group Inc., which owns Equitable Bank, and alternative mortgage lender Home Capital Group Inc., which faced a liquidity crisis in 2017 after regulatory woes sparked a run on deposits.
If the proposals are implemented without changes, it could reduce earnings per share for 2020 by roughly 10 per cent at Equitable, and 4 per cent for Home Capital, according to Mr. Gloyn’s calculations. Mr. Gloyn’s analysis does not account for the possibility that Equitable and Home Capital could adjust their funding models to compensate for any new regulations.
“Banks can deploy other strategies to offset the potential earnings and profitability drags,” Mr. Gloyn said in his research note. Those could include adjusting interest rates on mortgages and deposits or cutting costs. And some lenders, including Equitable and Home Capital, already hold more liquid assets than regulations require.
Even so, Home Capital’s share price fell 3.2 per cent on Tuesday before rebounding 1 per cent higher in early trading on Wednesday, while shares at Equitable closed 1 per cent lower on Tuesday, and fell another 1 per cent early Wednesday. Mr. Gloyn estimates that “there could be further downside” for the companies' shareholders “in line with our worst-case scenario.”
Analysts at Moody’s Investors Service Inc. said the changes would be “credit positive” for Canadian banks, including the Big Six lenders, improving their liquidity profiles by compelling them to hold more high quality liquid assets. “Although such higher liquidity will negatively impact profitability, on balance, we believe the positive improvements in liquidity and funding more than offset the profitability effect,” Moody’s said in a commentary published on Wednesday.
The new rules focus on the way banks calculate how much cash they must keep on hand as a safety net. The regulator sets what it calls “run-off rates” to estimate potential withdrawals and renewals in times of stress, which in turn determine minimum liquid assets banks must set aside. Deposits that are considered more stable have low run-off rates of 3 per cent to 5 per cent.
For less stable deposits, such as those sourced through third-party brokers, the current run-off rate is 10 per cent. But OSFI’s proposed changes would raise that rate to 40 per cent, forcing banks to keep more deposits on hand, leaving them with less cash available to lend or invest at a profit, which could also impact margins and return on equity. And the revised rules would also create a new 20-per-cent run-off rate for any deposits sourced through the internet.
“Banks get deposits from different channels now than they traditionally did, right? And so we’re thinking about whether the nature of where those deposits originated affect how ... sticky they are, how likely they are to stay in times of stress," said OSFI assistant superintendent Carolyn Rogers, in an interview about OSFI’s proposals on Tuesday, prior to the release of National Bank’s report.
But banks have complained that the rules, as proposed, would treat all digital banking activities as equally risky, ignoring important nuances at a time when banking is increasingly done online – and Ms. Rogers said OSFI is listening. “That was a big focus of ... some of the feedback we got from the banks,” Ms. Rogers said. “That’s the purpose of a consultation is to get that feedback and adjust based on that feedback."
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James Bradshaw