The Canadian insurance sector, including both property and casualty (P&C) and life insurance companies, is federally regulated by OSFI in Canada. As such, there is naturally thorough oversight of the sector’s operations.

In the recent past, OSFI undertook a rigorous review of methods for the assessment of risk in order to enhance the Minimum Capital Test (MCT) for the P&C industry. The new framework was published in 2014 and took effect at the beginning of 2015. This review led to a small decline in capital requirements for the industry as a whole. On a micro level, respective company ratios have varied given their risk profile; as such, the MCT Guideline is likely to be reviewed regularly by OSFI in order to ensure that is risk-sensitive to changes in the industry.

Looking forward, there will be an emergence of new international capital standards from the International Association of Insurance Supervisors (IAIS). The IAIS was given the go-ahead by the Financial Stability Board (FSB) to develop well-rounded and comprehensive guidelines for global systemically important insurers (G-SIIs). Such international capital standards, known as ComFrame, should be effective in 2020 for life and P&C insurance companies that have activities beyond Canadian borders. Thus far, ComFrame is likely not going to surpass the rigour of the OSFI requirements that are currently in place. However, this is something that compliance areas for insurance companies should keep their eyes on.

Reference: IAIS

What is arguably the biggest news in Canada this month is that of the Bank of Canada’s surprise cut to to its interest rate – from 1.0% to 0.75%. The Governor of the Bank of Canada, Stephen Poloz, argued that such a decrease in the rate would provide a sort of insurance against the large drop in oil prices that have been seen over the past several months. However, it is important to note that this decrease in the interest rate can also threaten to shift an imbalanced economy into one that is greatly skewed toward spending – both my individual consumers and households. The overall effect of the Bank’s move could easily have the opposite effect of the intended outcomes. More specifically, the downward move of the interest rate may easily prove to increase uncertainty across the board.

For the past four-plus years, the Bank has held the rate steady at 1% – a rate that many analysts felt was too low in itself. A rate hike was widely foreseen in future announcements – either in late 2015 or into 2016. However, this has turned into a case of negative real interest rates. This is where the cost of borrowing is lower than the gradual increase in prices over time (i.e. the inflation rate). For example, yields on some government-backed bonds fell after the announcement such that they were half of Canada’s rate of inflation.

As it stands, the Bank’s upcoming interest rate moves will certainly be closely watched. Given how unsuspecting onlookers were this month, it would almost be not entirely shocking if the Bank dropped the rate even further before finally increasing it. The implications of its monetary policy will certainly have rippling effects across the country for the coming years.

This post will briefly discuss the ethics involved with regards to financial institutions receiving emergency support from state-based actors.  Specifically, Fitch has openly condemned the rules applicable to financial institutions that revolve around disclosure of receiving emergency assistance.

The regulatory body being targeted for this condemnation is the Bank of England along with the institutions that fall under its oversight. This was in response to the quiet publication of a supervisory statement by the Prudential Regulatory Authority (PRA) which specified that disclosures related to such assistance can be waived. Such assistance could disadvantage investors and, ethically speaking, creates a clear information asymmetry that could prove to be detrimental to otherwise well-informed and financially literate investors.

In fact, it was justified by regulators that emergency liquidity assistance would be less effective if investors were to be aware of it, hence the removal of disclosure requirements. This is certainly a valid point. Ambivalent policies are not unheard of; in this case, a balance needs to be struck between the conflict of transparency to inform investors and the the need to maintain investor confidence.

Nonetheless, the lack of timely disclosure can clearly misrepresent the current liquidity position of a financial institution, which can ultimately impact the soundness of said institution if investors were to discover the occurrence of assistance.

The year has wrapped up and it seems like an appropriate time to look to the future. The role of financial regulation and financial intermediation has been continuously expanding and altering in the years since the global financial crisis. In this piece, I am not going to discuss the importance of financial regulation and how it has an impact on economic growth. This piece is going to cover how a key trend might play out in 2015 and beyond. That is, the trend of the adjustment of products and services offered by financial institutions.

There has been a very clear shift in both the scope and the intensity of financial regulation. A top central banker recently emphasized that it is not new rules which are most important, but the principles behind these rules. However, it should be further emphasized that principles-based regulation is not a panacea to global financial woes. It is something that needs to have a complementary enforcement structure that incorporates a high degree of vigilant supervision from regulatory and enforcement bodies, including both state and decentred actors. Canada is an excellent example of how such principles-based regulation can be implemented with visible success. In the Canadian financial regulatory regime, there is a comprehensive system of supervision, surveillance, enforcement, and guidance that aims to ensure the safety and soundness of the Canadian financial system in addition to encouraging growth and innovation, rather than prove to be stymying force. Therefore, the maintenance of this balance between financial safety and healthy market forces is essential for a stable economy.

In response to changing regulatory requirements, it has been evidenced that market forces have directly reacted through the adjustment of business lines by financial institutions. More specifically, business lines that are risk-heavy, either in real or perceived risks, are being dropped. The motivation behind this is to decrease the level of activities in areas where regulatory risk weights are increased.

The result of such shedding of business lines brings into question the future existence of large multinational institutions that offer a wide variety of products and services. Will such universal banks disappear entirely? In all likelihood, this will not be the case. Some are certainly simplifying their structures to decrease complexity, but will continue to exist and be successful as long as there is a demand by global clients, both individual and institutional, for their services.

A retreat from these areas by one actor naturally creates an opportunity for other actors to enter the arena. These are the forces of competition and substitution at work. Additionally, the retreat can act as a stimulant for future safe financial innovation – for example, how can products that are widely characterized by their high levels of risk be adjusted to decrease such levels?

Overall, it is often argued that financial regulation is too costly for business; that it stifles their ability to effectively compete and offer innovative products and services. However, real and perceived costs of regulation are nowhere near as material as the direct and indirect costs of large-scale global financial crises. Ex ante regulation was lacking and ex post responses are widespread. But such regulatory reform was, and is, a necessity. As discussed above, evolving financial regulation is adjusted to by businesses and market forces subsequently allow for a healthy competitive environment to continue.

In a follow-up to previous posts on payday lenders and the Financial Conduct Authority (FCA), this post will serve as an update to demonstrate financial consumer protection enforcement powers in action.

On Thursday, the FCA announced that Wonga, the oft-cited controversial payday lender, would be writing off 220 million GBP of loans to more than 300,000 customers. This serves as an excellent example of a regulator, particularly a relatively new regulator, digging deeper and flexing enforcement powers when it comes to firms that are evidently predatory towards customers. It also demonstrates how regulators have multiple and escalating levels of enforcement, not simply punitive criminal charges. In this case, Wonga entered into a voluntary requirement (VREQ) agreement that also involves measures to improve the assessments completed on customers to determine whether its services are appropriate.

For more information, please refer to the FCA’s press release.

As a follow-up to our piece on British payday lenders and regulation, this article will describe the high-level regulatory framework for payday loans in Canada.

A payday loan is a short-term loan for a relatively small sum of money. Furthermore, payday loans are typically given by non-traditional moneylenders (i.e. businesses that are not financial institutions such as banks or credit unions). It is evident that, by virtue of the existence of the payday lender, there is a clear need being met by the industry not being met by the banks and other financial institutions. However, the reality of this is that these non-traditional moneylenders are often under-regulated and this under-regulation has resulted in an industry that has become well-known for charging exorbitant rates of interest.

Generally speaking, the day-to-day activities of payday lenders are regulated provincially. The regulation of interest rates, on the other hand, is overseen on a federal level. As a result of this, under the previous framework, the provinces were largely left with an inability to regulate the price of a loan due to it being, for the most part, ultra vires – beyond their respective powers.

Upon further analysis, it was seen that this was an overall undesirable regulatory regime. What was necessary was for an increase in provincial regulation of the market. While the regime has altered slightly, the industry itself still does not come to mind when thinking about responsible corporations that treat customers fairly, particularly when it can be seen that some have track records of interest rates that have an APR in the hundreds or even thousands.

One could argue that such a business model is ethically bankrupt. Simply put, it is not a model that is sustainable for the consumer as it does not improve as the consumer’s position improves. As Schwartz and Robinson argue, the payday loan industry is focused on maximizing profit, with some individual lenders even falling in a purely economic domain and outside of the legal domain. Furthermore, the industry itself usually falls outside of the ethical domain.

However, it seems that some more traditional financial institutions may finally be waking up to fill this apparent need. For example, the Vancouver City Savings Credit Union (Vancity), Canada’s largest community credit union with over $17 billion in assets, recently added an alternative to the payday loan to its repertoire.

With far less predatory rates (ex. 19 APR vs 600 APR elsewhere), consumers can more easily break the cycle of debt. This is a clear example of a financial institution working within the regulatory regime that has allowed the payday industry to flourish to the detriment of the consumer. If this trend continues, the overall payday loan industry may see a shift towards being responsible and entering into the legal and ethical domains. It will demonstrate that businesses can expand their offerings, meet consumer needs, and still operate in an ethical fashion.

When I mention to other financial services professionals that my specialty is regulation and compliance, one of the most common reactions is that of a teasing remark, “Oh, you’re one of them.” But in this post-financial crisis world, the hand of regulation has been coming down harder, resulting in industry responses stating that it is simply too much. But is it?

Some industry leaders certainly feel that way. Douglas Flint is the current Group Chairman of HSBC Holdings plc. He is also one of several senior professionals in the banking industry to complain of a heavy-handedness to regulation. The basic argument that he and others have made is that as the regulatory burden increases, bankers are compelled to become more risk averse. The subsequent result of this is that fringe areas of the financial sector, which may be unregulated or under-regulated, pick up the slack and thus the business.

In response to such complaints, the chairman of the British parliamentary Treasury committee, Andrew Tyrie, noted simply that the industry should demonstrate specifically how business is being stifled. Furthermore, he stated what I typically say in response to an ‘Oh, you’re one of them” comment: it is not just a matter of piling on regulation that has not been thought through. Regulation must be appropriate and suitable for both the public and businesses. It is not just about box-ticking, crossing t’s, and dotting i’s. Well-reasoned regulation applied to a critical sector such banking is something that needs to be in place as the business cycle continues on. One of the best ways to achieve suitable regulation is by industry involvement. In this way, not only can regulators receive input from stakeholders, but the end result will be appropriate and relevant for the industry to implement.

Seeing as how today is Bastille Day, BanfieldConsulting.ca has decided to revisit one of its favourite topics – virtual currency – with a French twist, bien sur.

In a July 11, 2014 communique, Michel Sapin, the French Minister of Finance outlined various regulatory measures to be enforced by the end of 2014 for financial institutions and users of virtual currencies.

The catalyst for action is due to a report by Tracfin (Traitement du renseignement et action contre les circuits financiers). Tracfin is the French financial intelligence unit that targets money laundering (ML) and illicit financial networks; it is akin to FINTRAC in Canada. Tracfin released the report as part of a digital currency working group in order to make recommendations to the Minister.

The findings of the report are not surprising. Despite the fact that the increasingly mainstream use of digital money, such as bitcoin, is unlikely to cause material instability in the current financial system, there are blatant risks when it comes to illicit use. This illicit use could take the form of money laundering, terrorist financing (TF), or fraudulent activities. In this sense, the urgency to create a regulatory regime for it is clear.

The focus of the regulations will revolve around the identification and verification of users. The goal of this is to increase transparency and decrease anonymity. From the perspective of the user, this is likely removing one of the most appealing factors of virtual currencies. However, from the perspective of financial regulators, this is all about knowing your customer (KYC).

To expand on this push for increased transparency, there will also be increased scrutiny of virtual currency exchanges, requiring them to report transaction details and to verify the identity of the parties concerned in transactions. This also goes to reinforce the principles of KYC and beneficial ownership.

Talk of gatekeepers seems to be inevitable when the topic of the financial crisis arises.  Since the beginning of the crisis , this talk has primarily focused on credit rating agencies as gatekeepers. Much like other gatekeepers, such as underwriters or accountants, credit rating agencies are privy to information not generally available to the public.

A recent article from the Atlanta Fed posited that financial institutions themselves are gatekeepers, arguing that for these institutions are well-positioned to know their customers (KYC). This allows them to protect their customers from fraudulent business practices.

However, with seemingly endless additional complexities evolving in the financial sector, this is not an easy task. there is an increasing use of third parties as intermediaries for risk management and compliance functions.

The regulatory case is not as simple as having financial institutions as gatekeepers. It overlooks the classic question – Quis custodiet ipsos custodes? Who will guard the guardians? While industry involvement is important to well-rounded regulation, this question came up countless times when considering credit rating agencies as guardians and it still applies when looking at financial institutions at a broader level.

The short answer is, unsurprisingly, yes. During a recent speech at the London School of Economics (LSE), Richard Sharp of the Bank of England’s Financial Policy Committee (FPC) articulated many people’s anxieties with regards to the state of banks in the United Kingdom. Such sentiments are similarly echoed around the world.

In his speech, Sharp outlined five issues that keep him concerned for the state of the financial system in the United Kingdom. Specifically:

• The last crash occurred in part by a failure on the part of central bankers and other regulators to appropriately address glaring risks to the stability and resilience of the British and worldwide financial systems
• The economic state of the United Kingdom is still in a vulnerable stage
• While there has been a move towards more stringent capital requirements for banks, there is still a sense of undercapitalization in financial institutions
• The practice of quantitative easing on a global scale has led to the inflation of the price of assets. This can corollary lead to instability in markets. It could also have the negative impact of incentivizing investors to hoard their assets, which would lead to a drop in economic activity
• There is an omnipresent external risk to domestic economies. Sharp used the example of the United Kingdom and the rest of Europe. Noting that the European Union is the UK’s largest trading partner, the prospect of deflation could lead to corresponding effects across the Channel

Sharp ended his speech with the grim yet realistic statement that, although there have been great strides towards increased safety and soundness, “… it is perfectly conceivable that new shocks or difficulties are just around the corner.”

Source: The Financial Policy Committee of the Bank of England; an experiment in macroprudential management – the view of an external member