Canada’s top banking regulator on Friday reduced the amount of money the big banks must keep aside to absorb unexpected financial shocks for the first time in three years.

The Office of the Superintendent of Financial Institutions (OSFI) lowered the domestic stability buffer (DSB) to three per cent from 3.5 per cent and narrowed the buffer’s range by one percentage point to between zero per cent and three per cent.

OSFI requires the Big Six lenders to maintain a capital buffer so that they can continue lending to households and businesses during periods of financial stress. The DSB is measured as a percentage of the banks’ risk-weighted assets, such as mortgages or credit card loans.

The lower DSB level means the Big Six, which have consistently been posting better-than-expected profits, can now put more money into the economy through investments and loans and further support the federal government’s goal of accelerating key energy projects that require capital.

“The economy has to adjust to a very different environment, and we were concerned that, unintentionally, the very healthy buffers we had might have created a sense of risk aversion that was not going to be productive,” Routledge said during a press conference.

He also said OSFI is sending a message to the banks that there’s ample capital for deployment.

“What we’re saying to the banks is your capital in excess of the top end of the DSB range yesterday was $45 billion. Today it’s $74 billion, so green light,” he said. “Now it’s up to the banks themselves to determine how to deploy that capital.”

The big banks’ cash cushion is measured through their common equity Tier 1 (CET1) ratio, which compares a bank’s capital to its assets. The DSB, introduced in 2018, is a component of the CET1 ratio.

Canadian banks must now keep their CET1 ratio, including the DSB, above 11 per cent compared to 11.5 per cent previously. The Big Six boast an average CET1 ratio of around 13.5 per cent.

OSFI said the buffer cuts don’t mean it’s not concerned about the uncertainty in the economy, but it believes that keeping the DSB at three per cent will be sufficient to tackle any potential concerns in the future.

“While vulnerabilities in the financial system remain elevated, the conditions have been relatively stable for some time,” OSFI said in a note summarizing its decision. “Canadian household indebtedness remains high relative to income, although below historical peaks … despite trade-related headwinds, overall delinquencies, unemployment and credit losses remain within historically normal ranges.”

Typically, OSFI reviews and sets the DSB level in June and December, but can adjust it at any time if conditions warrant.

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Earlier this month, C.D. Howe’s Institute’s Domestic Stability Buffer Council recommended OSFI maintain the DSB. It said the current economic situation is worsening due to high energy prices and the ongoing trade uncertainty, but there isn’t enough evidence to suggest conditions have deteriorated enough to justify reducing the buffer.

Mario Mendonca, an analyst at TD Securities Inc., said OSFI’s move was a surprise.

“Prior messaging from OSFI pointed to the DSB as a reactionary tool to be lowered after economic risks materialized,” he said in a note on Friday. “We had not envisioned OSFI would use the DSB as a proactive capital management tool.”

He also said the reduction looks like a mechanism to support the banking system ahead of the Canada-United States-Mexico Agreement negotiations as opposed to imminent credit risks in the economy.

Mendonca said the reduction is likely to spur commercial loan growth and facilitate nation-building projects.

“Bank of Montreal and the National Bank of Canada should be the greatest beneficiaries given their higher commercial loan mix,” he said. “BMO also benefits more as its 13 per cent CET 1 ratio is the lowest among the group.”

Gabriel Dechaine, an analyst at National Bank of Canada, said investors shouldn’t expect buyback programs because of the reduction since the decision to cut the DSB is intended to support the banks’ ability to boost the economy.

“Although we welcome capital relief in the sector, the Canadian banks are already very well capitalized,” he said in a note on Friday. “For the Canadian banks to assist in the transformation/acceleration of the Canadian economy, the deregulation theme will need to be extended across all industrial sectors.”

The Canadian Banking Association, which represents about 60 banks, including the Big Six, said the decision to reduce the DSB is helpful in the current environment and will contribute to the country’s economic growth and competitiveness.

• Email: nkarim@postmedia.com