Introduction

The Office of the Superintendent of Financial Institutions (OSFI) has released its annual feedback on Internal Capital Adequacy Assessment Process (ICAAP) submissions filed in 2014. The feedback relates to banks and other deposit-taking institutions that use the standardised approach to credit risk with respect to their Capital Adequacy Requirements Pillar I capital levels. The feedback therefore applies to most banks in Canada other than large domestic systemically important banks.

Although the next ICAAP report is not due until the end of 2016, OSFI provides the feedback annually so that banks may begin to incorporate OSFI's observations and concerns into their capital assessment processes.

In the most recent feedback, OSFI is continuing to press for ongoing improvement in the quality of ICAAP submissions. In particular, OSFI noted that improvements should be apparent in both qualitative assessment and risk quantification. However, OSFI also wants to see evidence that ICAAP is being used for business planning and risk management and not as a mere reporting exercise.

Leverage ratio

OSFI had four specific observations for the banks. The first two observations relate to the recent replacement of the asset-to-capital multiple with the new leverage ratio requirement. OSFI advised the banks that the maintenance of a robust target leverage ratio, in addition to risk-based capital targets, should be established as part of the capital planning process. Further, OSFI expects that a bank's capital management policy, as well as its ICAAP submission, should clearly provide that the bank will operate in accordance with the more restrictive of its risk-based target capital ratio, its new target leverage ratio and – in some cases – its regulatory minimum capital at the time of licensing. These changes may have a significant impact on the ICAAP process, particularly for smaller banks that are still dealing with the more complex rules for calculating their leverage requirement.Tax deductions

OSFI also commented on the impact of tax deductions and tax deferrals on the stress tests related to an ICAAP submission. OSFI noted that it expects the normal industry practice of calculating risk capital without assuming a tax deduction to be followed. Alternatively, if tax benefits are considered, the full impact on available capital must be included in the forecast on a basis consistent with a severe stress.

Audit requirements

OSFI also reminded the banks of the audit requirements that apply for ICAAP and Basel Capital Adequacy Requirements (BCAR) submissions. Two audits will be required.

The first is a review of the completeness and accuracy of the BCAR submission, including, but not limited to, a review of the:

  • accuracy of the categorisation of risk-weighted assets;
  • completeness of off-balance sheet amounts; and
  • accuracy of the amounts for credit risk mitigation.

The second is a full review of the institution's ICAAP, including a view on each of the following elements:

  • comprehensiveness and appropriateness of the ICAAP in the context of the institution, its operating environment, the soundness of controls underpinning it and OSFI's expectations of a rigorous ICAAP process;
  • identification of all key risks;
  • effectiveness of information systems that support the ICAAP;
  • appropriateness of the measurement methodology employed to support the ICAAP assessment and the accuracy and completeness of the data input;
  • reasonableness of the ICAAP output and the assumptions used;
  • reasonableness and appropriateness of the stress testing and the analysis of assumptions;
  • integration of the ICAAP results and risk management (eg, limit setting and monitoring); and
  • reasonableness of the capital plan and internal capital targets.

OSFI is suggesting that bank internal audit functions review their approach and methodology to ensure that their work in the 2015/2016 cycle can support the above reviews.

More detailed requirements for the 2016 ICAAP submissions will be released at a later date.

For further information on this topic please contact John Jason at Norton Rose Fulbright Canada by telephone (+1 416 216 4000) or email (john.jason@nortonrosefulbright.com). The Norton Rose Fulbright Canada website can be accessed at www.nortonrosefulbright.com/ca/en/.

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