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People pass by the Bank of Montreal in Toronto’s financial district on Aug. 28, 2012.Michelle Siu/The Canadian Press

Start talking about the hot topic of leverage ratios and Canadian banks will argue that the country's banking regulator has long been on their case.

Though Tier 1 capital ratios have been the big focus for the past few years, the Office of the Superintendent of Financial Institutions has forced Canadian banks to abide by leverage guidelines for more than 25 years.

Whereas Tier 1 capital ratios assign different risk weightings to bank assets, and then require the banks to hold capital buffers against the riskier assets, leverage ratios treat all assets equally and require a minimum amount of capital be held against the bulk total.

As of 2018, the Basel Committee on Banking Supervision will require the banks to meet a minimum 3-per-cent leverage ratio of capital to assets.

While that might be a problem outside Canada, the Big Six argue that they already comply with OSFI's asset-to-capital multiple, which limits a bank's assets to 20 times their capital. Reverse that equation, and you get a 5-per-cent leverage ratio.

In other words, they should already exceed the coming 3-per-cent minimum, and even would be close to the 5- and 6-per-cent levels the U.S. just proposed for its own banks, depending on their size.

But it isn't that easy. The way OSFI calculates leverage and capital differs from the new Basel standards. If you update OSFI's model to abide by the new rules, our banks aren't as well off.

The key difference, according to analyst Brad Smith at Stonecap Securities, is rooted in how you classify capital. Under OSFI's model, Tier 1 and Tier 11 capital are included, whereas the Basel model has much stricter definitions. (Explaining these nuances gets incredibly wonky, but the main message is that OSFI is more lenient.)

By including Tier 2 capital, OSFI offers the Big Six a 26-per-cent leverage benefit – meaning their total capital jumps to $178-billion from just $141-billion of straightforward Tier 1 capital.

Mr. Smith also noted that OSFI's calculation strips $167-billion of estimated securitized mortgages out of the Big Six's asset exposure, lowering their asset total.

Removes these benefits and Mr. Smith calculates that Canadian banks would still meet the new Basel leverage requirements, but "fall well below" the proposed U.S. measure.

In order to meet a 5-per-cent minimum, "domestic banks would either have to reduce on-balance sheet exposure by over $700-billion (20 per cent) or add additional Tier 1 capital of approximately $35-billion even before considering the impact of off-balance sheet exposure levels," Mr. Smith noted.

The question now is how OSFI will proceed. Given that OSFI holds seats on many Basel Committees, there's a good chance the Canadian regulator will update its models to comply with the Basel standards.

But there is speculation that OSFI may go above and beyond the call of duty. For instance, the regulator could require Canadian banks to meet the 3-per-cent Basel leverage requirements by 2015, instead of the global date of 2018.

(Tim Kiladze is a Globe and Mail banking reporter.)

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