Canada's banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), has announced an increase in the capital buffer requirement for the country's largest banks.

Effective November 1, OSFI’s Domestic Stability Buffer (DBS) will be raised to 3.5% from the previous 3% of a bank's risk-weighted assets. This marks the second increase in the buffer in the last six months as OSFI strengthens safeguards against potential threats to the financial sector.

OSFI is the regulatory body in Canada responsible for supervising and regulating banks, insurance companies, and other federally regulated financial institutions. It ensures the stability and soundness of the financial system while protecting the interests of depositors, policyholders, and other stakeholders.

The move aims to mitigate risks associated with high household and corporate debt levels, rising borrowing costs and global fiscal and monetary policy uncertainties.

“Today’s decision reflects our assessment that financial system vulnerabilities remain elevated and, in some cases, have continued to increase,” said OSFI superintendent Peter Routledge.

“We are in a period of rising interest rates and home prices have begun to rise again. Households and corporates remain highly leveraged, making them more vulnerable to economic shocks.”

An increase in OSFI's domestic stability buffer can potentially increase the cost of funds for financial institutions. This is because the higher capital requirements imposed by the buffer may lead banks to hold more capital, reducing their capacity to lend or invest, and potentially leading to higher borrowing costs for consumers and businesses.

OSFI had previously expanded the potential range of the buffer in December 2022 from 0 to 4% of risk-weighted assets. Additionally, the buffer was increased to 3% from 2.5%, which had been the upper limit since its introduction in 2018.

Adjusting the DSB also triggers changes in the minimum capital levels that banks are required to maintain. The common equity tier 1 (CET1) ratio, a measure of a bank's ability to absorb losses, will increase from 11% to 11.5%.

OSFI confirmed that all six of the country’s big banks currently exceed the minimum threshold.

OSFI makes adjustments to the DSB as necessary but publicly announces decisions to change or maintain the level twice a year. The buffer applies only to systemically important institutions, including Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce, and National Bank of Canada.