Canada's banking regulator wants to narrow the capital gap between small and large lenders, but experts disagree on how far it should go and whether households or businesses will benefit most.
Canada’s top banking regulator says it will examine whether the capital rules applied to smaller lenders are holding back banking competition in Canada, a review that could eventually affect mortgage choice, business lending and how many new players enter a market long dominated by the Big Six. Peter Routledge, head of the Office of the Superintendent of Financial Institutions (OSFI), told a Toronto audience on Oct. 7 that the regulator will study changes to the framework smaller banks use to set aside capital against their loans.
The move builds on a faster licensing route OSFI opened in June and on targeted rule relief proposed last November. Smaller institutions see an opening. Some economists and former regulators, however, warn that easing capital requirements carries its own risks, and that the real prize may lie in business lending rather than home loans.
Why Vancity Says It Has Under-Used Its Banking Licence
Wellington Holbrook runs Vancity, one of the country’s largest credit unions, with more than $41 billion in total assets and about 580,000 consumers, most of them in British Columbia. He also leads Vancity Community Investment Bank, a Toronto-based sister company that holds a banking licence and serves a niche client base, with a focus on financing clean energy projects and social housing.
Holbrook said Vancity has not made full use of that licence because existing rules make it hard for smaller banks to compete. With Ottawa now pushing for more competition in the sector, he sees a chance to invest more in the banking subsidiary so it can offer retail services and a stronger digital experience.
“It’s making us become more ambitious in our plans to grow,” he said, adding that the organization has “big plans.”
OSFI’s 16-Month Licence Pathway for Fintechs and Credit Unions
Breaking into Canadian banking has historically been slow. New entrants can wait five years or longer to obtain a banking licence, one reason the Big Six have kept such a firm grip on the market.
In June, OSFI launched an accelerated pathway that could let certain applicants secure a licence within 16 months. It is aimed at firms with what the regulator calls “innovative or emerging banking models,” including fintech companies and provincial credit unions that already offer bank-like services in their regions.
Routledge said at the time that the goal was a smoother process without lower standards. “Done well, this can support greater competition and responsible innovation without compromising the safety and soundness of the financial system,” he said in a statement.
OSFI has not said how many organizations have shown interest. At a press conference in early October, Routledge described the number as “healthy” and said he expects more details to be available within the next six months.
Holbrook expects a fair number of companies to pursue licences, since being a bank builds trust and helps attract far more customers. He noted, though, that it depends on strategy: a business built largely on cryptocurrency, for instance, may prefer to avoid the heavier regulation that comes with a licence.
How Risk-Weighted Assets Shape Banking Competition in Canada
The bigger question for incumbents and challengers alike is capital. Every loan carries risk, and regulators require banks to hold capital as a cushion against losses. The tool that links the two is known as risk-weighted assets, or RWAs.
- Lower-risk lending: A loan to a government or an established business is considered safer, so it carries a lower risk weight and needs less capital behind it.
- Higher-risk lending: A loan to a small business may be riskier, so the bank must hold more capital against it.
- The purpose: OSFI says the system protects depositors and the wider financial system by ensuring banks have enough of their own money to absorb losses.
The catch is that smaller Canadian banks generally must hold more capital per loan than the largest banks. That limits how much they can lend from each dollar of capital, which in turn caps their growth and profits.
Standardized Rules Versus the Big Six’s Internal Models
The gap exists because large and small banks calculate their requirements in different ways.
| Feature | Large banks | Smaller banks |
|---|---|---|
| Method | Internal ratings-based approach | Standardized approach |
| Who sets risk weights | The bank, using its own models acceptable to OSFI | OSFI, using predefined weights |
| Basis | Years of loan performance data and calculation technology | The Basel Capital Accord, an international set of banking rules |
| Typical result | Lower risk factors, more lending per dollar of capital | Higher capital intensity |
Mark Zelmer, a fellow in residence at the C.D. Howe Institute and a former OSFI deputy superintendent, described the standardized framework as “simple and conservative” by design, because it serves smaller deposit-takers that lack their own tools to measure credit risk in their loan books. The result, he said, is that larger banks tend to face lower risk factors.
Routledge acknowledged the gap directly. “The capital intensity in the standardized approach is far greater than in the model-based approach,” he said at the Oct. 7 event, adding that OSFI will “do work to determine whether we can modify the standardized approach to lower that competitive imbalance.”
What Lower Risk Weights Could Mean for Mortgage Rates
Routledge offered a household example. If smaller banks lending to Canadians with strong credit scores, above 700 or 800, faced risk weights closer to those of the big banks, they could compete more effectively for those borrowers. That could give homebuyers with scores of 700 or higher more choice.
“That may bring spreads, or rather mortgage rates, down,” he said. Readers tracking borrowing costs will know that lender pricing also moves with monetary policy, as seen in our look at what Scotiabank’s posted rates reveal about the Bank of Canada interest rate decision. Any effect from capital reform would come on top of those broader forces, and OSFI has not announced specific changes.
Routledge also suggested that fixing the imbalance could draw more companies into the sector, adding to competition over time.
From Tariff Relief to “the Whole Cake”
OSFI has already taken a narrower step. Last November, it proposed changes under the standardized approach that would:
- Small and mid-sized business loans: lower the risk weight to 75 per cent from 85 per cent.
- Low-rise residential real estate: lower the base risk weight to 130 per cent from 150 per cent.
Routledge said those proposals were a response to the tariffs the United States imposed in early 2025. The new review is broader in scope. “We are not talking about an isolated problem and providing some release in a specific area,” he said. “We are talking about balance and capital intensity for competitive purposes more broadly. It’s like going from a slice of cake to the whole cake.”
Zelmer’s Warning: Prove the Rules Are Too Conservative
Zelmer called the aim of letting smaller institutions compete harder during Canada’s economic transformation a laudable one. But he cautioned that smaller lenders do not have the same capacity as large banks to manage credit risk.
“OSFI needs to prove that the current risk factors in the standardized approach are too conservative when it comes to the Canadian credit experience,” he said.
He added that if Ottawa opens the door to more competition, it must also be ready to wind down troubled institutions smoothly, without spreading damage through the system. “We have not had a bank failure in several decades,” he said. “Any failure is probably going to be rather newsworthy if it happens.”
Rempel: Business Lending Is the Bigger Lever
Mark Rempel, an assistant professor in the University of Toronto’s Department of Economics, argues that regulators should focus more broadly on business lending to make a real dent in competition.
In his view, current rules make residential lending more attractive to banks than business loans. If Canada wants more innovation and investment, he said, corporate lending has to become less expensive for banks to carry.
“Overall risk weights on the corporate side are too high relative to other assets,” Rempel said. “If you look at their portfolios, they are really heavily tilted towards real estate and away from the more productive sectors of the economy.” That critique matters for investors watching how lenders allocate capital, a theme that often surfaces as earnings season gets under way for Canadian readers.
Holbrook Sees Signals, Not Yet a Shift in Big Six Dominance
For all the momentum, Holbrook does not expect the Big Six’s hold on Canadian banking to loosen soon. What he does expect is that OSFI can lower barriers that have made it easier for the largest banks to protect their profit pools.
“We do believe that the regulatory bodies are looking at how they actually make it much more fair for smaller financial institutions to compete fairly with larger banks,” he said. “Although there isn’t a lot of evidence of that yet, there are signals that are coming and we’re certainly believing them and buying into them.”
The concrete markers to watch are OSFI’s promised update on interest in the accelerated licence pathway, expected within about six months, and any formal proposal to revise the standardized approach. No timeline for the capital review has been specified.
Frequently Asked Questions
What is OSFI reviewing?
It is studying whether the standardized capital framework used by smaller banks can be changed to reduce the competitive gap with large banks that use their own internal models.
How fast is the new banking licence pathway?
Launched in June, it could let eligible applicants, such as fintechs and provincial credit unions, obtain a licence within 16 months, compared with waits of five years or more.
Have any capital rules already changed?
OSFI proposed last November to cut the risk weight on small and mid-sized business loans to 75 per cent from 85 per cent and on low-rise residential real estate to 130 per cent from 150 per cent under the standardized approach.
Will mortgage rates fall as a result?
Routledge said closer risk weights for borrowers with strong credit scores may bring rates down, but no specific changes or rate effects have been announced.
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