Drop in DSB will lead to lower capital levels, higher risk exposure for big banks.

The Office of the Superintendent of Financial Institutions’ (OSFI) decision to lower capital buffers for Canada’s big banks is a negative from a credit rating perspective, says Moody’s Ratings.

Last week, OSFI announced a reduction in the so-called domestic stability buffer (DSB) to 3% of risk-weighted assets down from 3.5%, and it reduced the range for the buffer to 0% to 3% — moves that the regulator said are intended to help free up the banks to expand their lending and investing at a critical moment for the economy.

“Overall, we view these changes as credit negative because they effectively facilitate lower capital levels at a time when these banks have already been managing toward thinner capital buffers of 100–150 basis points above minimum requirements,” the rating agency said in a new report. 

While the regulator said that its decision to lower the DSB was designed to boost banks’ ability to support the economy, Moody’s said that their recent moves to thinner capital cushions have largely come through dividend increases and share buybacks.

Moreover, the regulator’s move to lower the buffers “weakens systemwide capitalization, increasing sensitivity to earnings volatility, asset quality deterioration or market shocks, particularly in an environment of elevated geopolitical and trade-related uncertainty,” it said. It added that it also “introduces pro-cyclicality risks if banks respond by increasing capital distributions or risk-weighted asset growth late in the cycle.” 

“Over time, this dynamic could amplify vulnerabilities if credit quality deteriorates or macroeconomic conditions weaken,” it said.

In the current year, the reduced regulatory buffer “will likely result in structurally lower reported common equity tier 1 ratios across the Canadian banking system, weakening credit profiles at the margin,” Moody’s said.