Total Asset-to-Capital Ratio – TAC Definition

The total asset-to-capital ratio (TAC), also referred to as the TAC multiple, was a regulatory limit on bank leverage placed on Canadian financial institutions regulated by the Office of the Superintendent of Financial Institutions (OSFI). It has since been replaced by a new leverage ratio based on the Basel III global regulatory framework and is no longer used in practice.

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.

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.

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 their Basel II capital “output floor,” which limits the use of internal risk models to calculate minimum capital requirements, to 72.5% from 90%.