The U.S. Federal Reserve is preparing to release the results of beefed-up stress tests on the nation’s largest banks, and an official from the top banking regulator in the United Kingdom stated publicly Thursday that banks there are preparing for the worst, including a disorderly breakup of the eurozone.
Canadians are, by comparison, in the dark about the impact of the European debt crisis on this country’s banks — in part because of confidentiality requirements built into the act that governs Canada’s top banking regulator, the Office of the Superintendent of Financial Institutions.
“I would be surprised to hear OSFI divulging that it was asking the banks to prepare for something,” said Peter Routledge, a financial analyst at National Bank Financial. “That does not mean it is not talking to the banks about contingency plans for disorderly resolution to the European sovereign debt crisis — I’d be surprised if they weren’t,” he said, adding, “they’ll just do it quietly.”
OSFI declined to comment on specific regulatory directives regarding the European debt crisis, but a spokesperson said Thursday that “Canadian banks’ exposure to the Eurozone is manageable and banks are well aware of the risks associated with this situation.”
The Office of the Superintendent of Financial Institutions Act prohibits the prudential regulator from disclosing confidential information regarding the business or affairs of a bank, Mr. Routledge said, though there are circumstances in which the Minister of Finance can determine, in consultation with the Superintendent, that information should be disclosed.
In the absence of broad public disclosure of European risks from either the banks or the regulator, Mr. Routledge has done his own analysis of Canadian bank exposure, using statistics compiled by the Bank of International Settlements. The analyst concluded that the exposure of this country’s six large banks is minimal, and “workouts” of over-indebtedness of countries such as Greece, Ireland, Spain, Portugal or even Italy would be “immaterial.”
However, the spread of problems to the United Kingdom would pose a larger problem for Royal Bank of Canada and its smaller rivals.
“While this exposure is still quite manageable over the long term, our level of concern would rise in the remote scenario in which the debt crisis spread to the United Kingdom,” Mr. Routledge wrote in a recent note to clients.
The Canadian baning system’s largest European exposure is to borrowers from the U.K., and totals US$99-billion in gross claims, the analyst said. This compares to US$14.7-billion of exposure to the more troubled eurozone “periphery nations.”
Andrew Bailey, deputy head of the Prudential Business Unit at the United Kingdom’s Financial Services Authority, told Reuters this week that UK banks don’t have large exposures to the eurozone zone, but that they must plan for the worst.
“We cannot be, and are not, complacent on this front,” Bailey told the news agency at a conference in London. “As you would expect, as supervisors we are very keen to see the banks plan for any disorderly consequence of the euro area crisis.”
Transparency about worst-case scenarios and “stress testing” are viewed by proponents as a way to address uncertainty and calm markets by defining the downside. But opponents fear that measures such as identifying banks that could require capital injections to stay afloat will, on the contrary, exacerbate market jitters.
“Stress testing is a useful tool for regulators and risk management by banks, but there’s something to be said for not alarming people with the results of hypothetical scenarios that, by their very nature, may not be plausible,” said Guy David, a banking partner at Gowlings law firm in Ottawa who has advised on financial legislation.
He said Canada’s unique regulatory system, while arguably less transparent on some fronts, contains protections in the form of securities laws and stock exchange disclosure requirements for material information.
“All in all, the threshold for disclosure by Canadian financial institutions is quite high,” Mr. David said.
Andre-Philippe Hardy, an analyst at RBC Capital Markets, expects more disclosure about exposure to the eurozone from the Canadian banks when they report their fourth-quarter results in early December, “given the sovereign and economic issues that are in focus in Europe.”
In a report to clients earlier this month, Mr. Hardy said he expects gross exposures to be, on average, about 5% of assets.
A spokesman for the Canadian Bankers Association said Thursday that the country’s banks “are constantly following economic and financial developments both at home and abroad that may have an impact on them and revising, and adapting their risk assessment strategies to deal with these situations.”
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