1. Office of the Superintendent of Financial Institutions Canada
OSFI’s Supervisory Framework
FSI/ SVS/ASSAL/IAIS Regional Seminar on Risk-Based Supervision – San Jose, Costa Rica
July 8 – 10, 2014

2. The Canadian System
At the federal level, regulatory oversight divided between:
OSFI (prudential regulation & supervision)
CDIC/deposit insurer (deposit insurance)
DOF (policy / legislation)
BOC (LLR & payment system oversight)
FCAC (consumer issues)
Each agency has a well-defined mandate with minimal overlap:
Limited scope for conflicting priorities within an agency
Various mechanisms to facilitate coordination, and balance trade-offs:
FISC
CDIC/deposit insurer Boards
SAC

3. OSFI’s Mandate In pursuing these objectives…
Determine whether institution’s are in sound financial condition
Take necessary corrective measures in an expeditious manner
Promote the adoption of policies and procedures designed to control risk
Monitor and evaluate system-wide events or sectoral issues that could have a negative impact
In pursuing these objectives…

4. OSFI’s Mandate (cont’d)
…OSFI shall strive to protect the interests of depositors and policyholders.
Regulated institutions can experience financial difficulties which can lead to their failure

5. Part 1 Overview of OSFI’s Supervisory framework

6. Supervision Mandate
Assess the safety and soundness of federally-regulated financial institutions and use supervisory powers to intervene in a timely manner to protect depositors and policyholders from loss.

7. General Approach Consolidated supervision Relationship Manager
Principles-based
Intensity and intervention
Board & Sr. Mgmt accountability
Risk tolerance
Reliance on external auditors
Use of work of others

8. Key Principles Focus on material risk
Forward-looking, early intervention
Sound predictive judgment
Understanding the drivers of risk

9. Key Principles (cont’d)
Differentiate inherent risks and risk management
Dynamic adjustment
Assessment of the whole institution

10. What does risk-based supervision mean to you?
Discussion Point #1
What does risk-based supervision mean to you?

11. What is risk based supervision?
Supervision is really complex judgment. Given this, it requires:
Teams and teamwork skills
Leadership that displays balanced risk-taking
Mechanisms to identify risk
A methodology that reinforces sound and round judgment
The ability to dynamically source and allocate skill

12. Core Supervisory Process
Process has been simplified into 3 main parts:

13. Core Supervisory Process
Described as a 3-stage circular process
Key documents are associated with each stage
Process is dynamic, iterative, and continuous

14. Key Concepts - The Risk Matrix
Significant Activities
Inherent Risks
Credit, Market, Insurance, Operational, Regulatory Compliance, Strategic
Quality of Risk Management
Operational Mgmt., Financial, Compliance, Actuarial, Risk Mgmt., Internal Audit, Senior Mgmt., Board
Net Risk
Direction of Rating
Importance
Activity 1
Activity 2
Activity 3
Etc.
Overall Rating
Rating
Direction
Time Frame
Earnings
Capital
Liquidity
Composite Risk
Intervention Rating

15. Knowledge of Business and Identification of Significant Activities
Environment
Economic Social Demographic Political Regulatory
Industry
Competition
Customers
Technology
Industry Products/Services Skilled Personnel
Institution’s Business Profile
Business Model
Objectives and Strategies
Organization
Develop inventory of activities and enterprise-wide processes
Identify significant activities

16. What is a Significant Activity?
Fundamental element of business model
Significant to achievement of business objectives
Based on quantitative or qualitative measures
Now or in the future
Lines of business, enterprise-wide processes, geographic units

17. Inherent Risk - Definition
Inherent risk is the probability of a material loss due to exposure to, and uncertainty arising from, current and potential future events.
A material loss is a loss or combination of losses that could impair the adequacy of the capital of a FRFI such that there is the potential for loss to depositors or policyholders.

18. Why do we identify and assess Inherent Risk?
To understand nature and extent of risks assumed.
To develop expectations as to the nature, extent and rigour of mitigation needed.

19. Categories of Inherent Risk
Credit
Market
Insurance
Operational (including legal)
Regulatory Compliance
Strategic
Six risk categories common to FIs. Appendix A of Framework booklet defines them.
OSFI’s definitions of the various categories of risk are generally consistent with those used in the industry.
OSFI’s definition of Operational risk now aligns with the Basel definition because it includes legal risk. Previously we had legal with compliance.
Next step is to determine which inherent risks contribute, then which are key.
Reputational risk is not a separate category. It is a consideration in the assessment of each inherent risk category.

20. Quality of Risk Management Operational Management (OM)
Responsible for day-to-day management
If oversight functions are deemed to be effective, we can use their work to assess effectiveness of operational management
Periodic validation via activity review

21. Quality of Risk Management Oversight Functions
Board
Senior Management
Internal Audit
Risk Management
Actuarial
Compliance
Financial

22. Determining Net Risk Significant Activities Inherent Risk Mitigated by
Quality
Of Risk
Management is
Net Risk/
Direction
of Rating
Significant
Activities

23. Net Risk - Representative Heat Map
Aggregate
Quality of Risk Management for Significant Activity
Level of Inherent Risk for Significant Activity
Low
Moderate
Above Average
High
Net Risk Assessment
Strong
Acceptable
Needs Improvement
Weak

24. Importance
Importance is a judgement of a significant activity’s relative contribution to the overall net risk
Also one of the factors in planning

25. Institution “residual risk”
Net Risk: “Residual risk” after mitigation in each Significant Activity
Overall Net Risk: The weighted aggregate of all Net Risks using the importance of each SA as the weighting factor
Institution “residual risk”
Risk Matrix
Financial Institution Risk Matrix as at…
Significant Activities
Inherent Risks
Quality of Risk Management
Net Risk
Direction of Rating
Importance
Activity 1
Activity 2
Activity 3
Etc.
Credit
Market
Insurance
Operational
Regulatory Compliance
Strategic
Operational Management
Financial
Compliance
Actuarial
Risk Management
Internal Audit
Senior Management
Board
Increasing OR
Stable
Decreasing
Low OR Medium OR High
Overall Rating
Animation: 2 clicks
NR & Direction
ONR
Capital
Earnings
Liquidity
Composite Risk
Direction of Rating
Time Frame
Intervention Rating

26. Capital and Earnings Capital Earnings Adequacy
Quantity
Quality
Capital management policies & practices
Earnings
Strength
Sustainability

27. Liquidity
Importance of liquidity to overall safety and soundness is highlighted
Liquidity assessment similar to Capital by including level and quality of liquidity and liquidity risk management

28. Composite Risk Rating
An assessment of the institution’s risk profile, after considering its earnings and capital in relation to the ONR from its S.A.s, and the assessment of its liquidity
OSFI’s assessment of the institution’s safety and soundness with respect to its depositors and policyholders

29. Institution “residual risk” Institution’s risk profile
Net Risk: “Residual risk” after mitigation in each Significant Activity
Overall Net Risk: The weighted aggregate of all Net Risks using the importance of each SA as the weighting factor
Institution “residual risk”
Risk Matrix
Financial Institution Risk Matrix as at…
Significant Activities
Inherent Risks
Quality of Risk Management
Net Risk
Direction of Rating
Importance
Activity 1
Activity 2
Activity 3
Etc.
Credit
Market
Insurance
Operational
Regulatory Compliance
Strategic
Operational Management
Financial
Compliance
Actuarial
Risk Management
Internal Audit
Senior Management
Board
Increasing OR
Stable
Decreasing
Low,
Medium
High
Overall Rating
Animation: 5 clicks
NR & Direction
ONR
CRR
Composite Risk: Overall Net Risk as mitigated or enhanced by Capital and Earnings
Institution’s risk profile
So to summarize, the Composite Risk Rating is the net result of the various assessments made throughout the supervisory process.
We aggregate Net Risk [CLICK] across all activities considering their relative importance to determine Overall Net Risk [CLICK].
We then assess the extent to which Capital and Earnings [CLICK] together act as safety nets to absorb unexpected losses arising from its ONR.
We then consider the level and management of liquidity risk [CLICK], to arrive at the Composite Risk Rating [CLICK].
In addition to assessing a level of Composite Risk, we also assess the direction of the rating as Decreasing, Stable or Increasing over a specified time frame. That assessment considers environmental and industry factors as well as the institution’s own circumstances.
So that completes Track I of the Risk Matrix.
However, there is one more thing to look at before we move to Track II
Capital
Earnings
Liquidity
Composite Risk
Direction of Rating
Time Frame
Intervention Rating

30. Part 2 SUPERVISORY RESOURCE PLANNING

31. Planning An annual Supervisory Strategy prepared for each institution
The intensity of supervisory work depends on the nature, size, complexity and risk profile of the institution
Continuum of supervisory work ranges from monitoring to extensive on-site reviews including testing or sampling

32. Planning (cont’d)
OSFI Management takes a top-down portfolio view to ensure that supervisory resources are allocated effectively to higher risk institutions and significant activities

33. Planning (cont’d) Monitoring work done quarterly
On-site review work is prioritized based on:
Risk considerations (FI specific and external)
Need to update our information
Importance of the activity
Work done by supervisory team and/or specialists, e.g., Credit Risk, Operational Risk, AML Compliance

34. Example - Prioritization
Activity
Importance
Risk Considerations
Last On-site
Priority
Individual Life Insurance
High
Moderate net risk and stable. Concerns re: prolonged low interest rates, aging population
New regulations in Jan 2014.
Sept 2013 ?
Group Life
Low
Moderate net risk and increasing. Recent purchase of large block of group business. New management in Oct 2013.
June 2011
Variable Annuity
Medium
AA net risk and stable. Exposure to capital market volatility.
May 2013

35. Part 3 Early intervention

36. What is early intervention?
Discussion Point #2
What is early intervention?

37. CRR vs. Intervention Ratings
While OSFI may stage an institution for reasons other than its CRR, there is a link between the Composite Risk Rating and OSFI’s Intervention Rating.
Low
Moderate
Above Average
High 1 2 3 4
Normal
Early Warning
Risk to Solvency
Viability Doubtful
Insolvency Imminent
Intervention Rating
CRR

38. Intervention - Overview
Assign intervention rating
Early intervention
Intervention measures are flexible
Both formal and informal powers
Consider unique circumstances of the institution
Guide to Intervention

39. Guide to Intervention Stage 1 – Early Warning
OSFI has identified deficiencies in the institution’s financial condition, policies or procedures or the existence of other practices, conditions and circumstances that could lead to the development of problems described at Stage 2 if they are not promptly addressed.

40. Stage 1 – OSFI Activities
Meet with management and board
Escalate monitoring
Conduct enhanced or more frequent reviews including by OSFI specialists
Inform deposit insurer
Meet with deposit insurer several times a year
Implement any of a number of intervention measures

41. Guide to Intervention
Stage 2 – Risk to financial viability or solvency
The institution poses material safety and soundness concerns and is vulnerable to adverse business and economic conditions. OSFI has identified problems that could deteriorate into a serious situation if not addressed promptly, although the problems are not serious enough to present an immediate threat to financial viability of solvency.

42. Stage 2 – OSFI Activities
Follow up supervisory reviews more frequently or enlarged scope
Require outside parties to review financials or actuarial reserves
Keep deposit insurer informed of results
Develop a contingency plan in consultation with deposit insurer

43. Guide to Intervention
Stage 3 – Future financial viability in serious doubt
OSFI has identified that the institution has failed to remedy the problems that were identified at Stage 2 and the situation is worsening. The institution has severe safety and soundness concerns and is experiencing problems that pose a material threat to its future financial viability or solvency unless effective corrective measures are promptly undertaken.

44. Stage 3 – OSFI’s Activities
Direct external specialists to assess
Enhance scope of business restrictions
Expand information to be submitted
OSFI staff to be present to monitor situation on an ongoing basis
Expand contingency planning
Communicate with Board re resolution options
More frequent discussions with deposit insurer

45. Guide to Intervention Stage 4 – Non-viability/insolvency imminent
OSFI has determined that the institution is experiencing severe financial difficulties and has deteriorated to such an extent that:
-it failed to meet regulatory capital and surplus requirements in conjunction with an inability to rectify the situation on an immediate basis; -the statutory conditions for taking control have been met; and/or -it has failed to develop and implement an acceptable business plan, resulting in either of the two preceding circumstances becoming inevitable within a short period of time.

46. Grounds for taking control
Insufficient assets
Failure to pay liabilities
Improper accounting of assets
Insufficient regulatory capital
Failure to comply with an order to increase capital or assets
Any other prejudicial state of affairs N.B. Power to close with positive capital

47. Stage 4 – OSFI’s Activities
Voluntary Dissolution
Monitoring of the company’s liquidation and dissolution by the Court
Take Control and Request Liquidation
Control of Assets
Control of the institution
Liquidation

48. More information is available on our website