OSFI Framework

Question 1

Discuss how the new capital framework should

1) Encourage good risk management

Answer 1

• Standards for models should be established
• Internal model approach should apply to all occurrences of that risk in a cie group
• Models should recognize cies that manage their risks properly
• Models, techniques, parameters, inputs, and assumptions for capital requirements should also be used internally for managing risk
• Leverage ratio may be useful to complement risk-based capital test

Question 2

Discuss how the new capital framework should

2) Encourage capital planning and avoid pro-cyclicality

Answer 2

• Creation of high quality capital buffers during times of profitable growth (for facing adverse circumstances)
• Minimize pro-cyclicality: tendency of a rule, such as capital requirement, to exacerbate the effect of a market phenomenon such as a business cycle
• Minimize its macro-prudential impact (effect on the financial system as a whole)
• Sufficient capital to encourage systemic stability

Question 3

Discuss how the new capital framework should

3) Consider all risks

Answer 3

• Capital requirements should reflect risk mitigates, Re, interrelationship and diversification taking account of effectiveness under normal and stress scenarios
• Risks should be aggregated (no diversification between risk categories is permitted until evidence confirms diversification will hold in a stress situation)
• Use a consistent basis for risk measurement: Assets, liabilities, capital requirement

Question 4

Discuss how the new capital framework should

4) Be practical, yet technically sound

Answer 4

• Should be a standard approach to every risk
• Standard approach
–Used by cie WITHOUT approval to determine supervisory and cie TCR
–Used by all cies to determine their MCR

• Internal models approach

• -Used by cie WITH approval to determine supervisory and cie TCR
• -Internal models should be developed with freedom to choose some but not all model inputs

Question 5

Discuss how the new capital framework should

5) Reflect existing risks on going concern basis and consider winding-up and restructuring

Answer 5

Regulatory capital available has 2 key functions:
• Absorb losses during ongoing operations
• Protects PH and creditors from loss in the event of liquidation

Question 6

Discuss how the new capital framework should

6) Use measures that are comparable across risks and products (VaR, CTE)

Answer 6

• Risk measure should be based on stat credible data
• Time horizon should be common to all institutions
• Minimum capital framework should be based on a risk measure level that is common to all institutions
• Internal capital target ratio should be established by cies because of economic cycles, desired ratings and differences in risk management

Question 7

Discuss how the new capital framework should

7) Use a Total Asset Requirement (TAR) approach

Answer 7

• Current capital level and the reserve margins should be considered on an integrated basis
• Expected losses under TAR approach should include margins for misestimation and deterioration

Question 8

Discuss how the new capital framework should

8) Ensure that capital is prudent

Answer 8

• Regulatory capital and capital requirements should be transparent
• Capital should provide a cushion against unexpected losses

Question 9

Discuss how the new capital framework should

9) Consider international principles and best practices

Answer 9

• Should be adapted to reflect the market risks and products of Canadian cies
• Capital requirements should be risk-based

Question 10

Discuss how the new capital framework should

10) Allow comparison of similar risks across financial institutions

Answer 10

• Capital framework should recognize diff in the nature of business and operating envs across the sectors
• Hold comparable levels of capital for similar products and risks, taking into account the level of conservatism in their business and BS

Question 11

Discuss how the new capital framework should

11) Be transparent, validated and based on credible data

Answer 11

• Model should be disclosed in sufficient detail so that it can be analysed and compared to those of other cies
• Credible data can be audited
• Professionals standards should be considered

Question 12

Discuss how the new capital framework should

12) Use reliable processes with assumptions sustainable in times of stress

Answer 12

• Process should be in place to make sure model applications are appropriate
• Materials changes to models will be subject to approval

Question 13

Discuss how the new capital framework should

13) Be part of intervention levels for supervisory action

Answer 13

Capital ratio level for intervention should be sufficiently high to allow supervisory action at an early stage