Total Asset-to-Capital Ratio: Key Facts and Impact on Banks

The Total Asset-to-Capital (TAC) ratio was a leverage limit for Canadian banks, regulated by the Office of the Superintendent of Financial Institutions (OSFI). TAC was calculated by dividing total balance sheet assets and some off-balance sheet items by total regulatory capital. It has since been replaced by a new leverage ratio based on the Basel III global regulatory framework and is no longer used in practice.

Canadian banks shifted from a TAC ceiling to Basel III’s capital requirements for greater financial stability. Basel III mandates a 4.5% common equity tier-1 capital ratio, a 6% tier-1 capital ratio, and an 8% total capital ratio.

How to Calculate the Total Asset-to-Capital Ratio

The total asset to capital ratio was calculated by dividing total balance sheet assets and some off-balance sheet items related to credit risk by total regulatory capital. Canadian banks’ TAC ratio rose steadily from the early 1960s to 1980, when it peaked at about 40. Large banks were then subject to an assets-to-capital multiple of 30 from 1982 to 1991, when a formal upper limit of 20 was imposed.

This ceiling remained in effect until it was decided that banks meeting certain conditions could receive an authorized multiple as high as 23, compared with some American banks that had TAC ratios over 40 during the financial crisis.

The relatively low levels of bank leverage at the start of the financial crisis meant that Canadian banks avoided losses and faced less pressure to deleverage than their international counterparts, mitigating the downturn. Thanks to the huge levels of government-insured mortgages on their balance sheets, after a record housing boom, Canadian banks’ tier-1 leverage ratios—a gauge of banks’ ability to absorb losses—have fallen below their American and European peers.

Transition from TAC to OSFI’s Basel III Regulations

The OSFI replaced the TAC with leverage ratios in 2015, as part of its fast-track phase-in of Basel III capital rules, which have a 2022 deadline. Canadian banks are now required, as per Basel III, to maintain a common equity tier-1 (CET1) capital ratio of 4.5% of risk-weighted assets (RWA), a tier-1 capital ratio of 6% of RWA, and a total capital ratio of 8% of RWA. As a result, TAC is no longer used in practice.

Challenges with the TAC Ratio in Modern Banking

But CET1 ratios can be misleading because they depend on subjective risk weights. Because Canadian banks have been permitted to utilize lower risk weights than their U.S. peers, they are using aggressive amounts of leverage and creating more risk. The question is how all this would play out if the Canadian housing boom turns to bust, and banks are forced to hold more capital than they do presently.

For now, the OSFI has given Canada’s biggest banks more flexibility when it comes to their capital requirements. In 2018, it dropped its Basel II capital “output floor,” which limits the use of internal risk models to calculate minimum capital requirements, to 72.5% from 90%.

The Bottom Line

The Total Asset-to-Capital (TAC) Ratio, historically used in Canada, has been replaced by Basel III leverage ratios. Basel III emphasizes stricter capital requirements, aiming for greater financial stability for banks.

Canadian banks benefit from flexibility in capital requirements but may face risks if economic conditions shift. The change from TAC to Basel III indicates a move toward global regulatory consistency and adaptability in risk management. Despite the transition, however, vigilance is necessary for potential vulnerabilities in Canadian banking due to high leverage.