Our File: P2830-1

January 29, 1999

To: All CEOs of Banks and Federally Regulated Trust & Loan Companies

Subject: Capital Treatment of Insured Mortgages

This letter is to clarify the treatment for capital adequacy purposes of residential mortgages insured with an entity whose claims are government-guaranteed ("Government-Guaranteed Mortgages"). OSFI has recently received enquiries concerning the appropriate risk weight for Government-Guaranteed Mortgages where those mortgages are reinsured with a subsidiary of a deposit-taking institution ("DTI").

OSFI's capital adequacy guideline states that in order to reduce the risk weight on a guaranteed loan, the guarantee must be explicit, irrevocable and unconditional and be provided by an OECD government, OECD public-sector entity, OECD bank or multilateral development bank. In addition, a guarantee by a bank's parent or an unconsolidated affiliate of a claim on a third party will not reduce the risk weight of the assets of the subsidiary bank in Canada. Mortgages insured with entities whose claims are government-guaranteed would receive a reduced risk weight provided the above conditions are met.

If a DTI's Government-Guaranteed Mortgages are subsequently reinsured with another party that is not itself government guaranteed, it is questionable whether the government guarantee can continue to be considered explicit, unconditional and irrevocable. This is because the entity to absorb losses with respect to the reinsured mortgages is not theentity which is government guaranteed but rather the entity which subsequently reinsured the mortgages.

In situations where a DTI's Government-Guaranteed Mortgages are reinsured with a subsidiary of the DTI, this subsidiary will, in the first instance, absorb losses with respect to the reinsured mortgages. OSFI is not prepared to recognize a reduced risk weight for such mortgages. Accordingly, a 50% risk weight will apply to Government-Guaranteed Mortgages on the books of a DTI if those mortgages are reinsured with a subsidiary of that DTI.

John R. Thompson
Deputy Superintendent
Regulation Sector