Shadow banking system – bank lending replaced by lending via securities markets A change in the financial environment will stimulate a search by financial institutions for innovations that are likely to be profitable Responses to change in demand conditions Responses to changes in supply conditions Avoidance of regulations
Copyright 2011 Pearson Canada Inc. 11- 1 Chapter 11 Banking Industry: Structure and Competition Copyright 2011 Pearson Canada Inc. 11- 2 Historical Development of the Canadian Banking System I Copyright 2011 Pearson Canada Inc. 11- 3 Historical Development of the Canadian Banking System II • The Free Banking Experiment • The Provincial Notes Act, 1866 • The Dominion Notes Act, 1870 – Seignorage – Gold standard • The First Bank Act, 1871 • The Bank Act, 1881-1913 • The Finance Act, 1914 – Lender of last resort Copyright 2011 Pearson Canada Inc. 11- 4 Financial Innovation and the Growth of the Shadow Banking System • Shadow banking system – bank lending replaced by lending via securities markets • A change in the financial environment will stimulate a search by financial institutions for innovations that are likely to be profitable – Responses to change in demand conditions – Responses to changes in supply conditions – Avoidance of regulations Copyright 2011 Pearson Canada Inc. 11- 5 Responses to Changes in Demand Conditions: Interest Rate Volatility • Adjustable-rate mortgages – Flexible interest rates keep profits high when rates rise – Lower initial interest rates make them attractive to home buyers • Financial Derivatives – Ability to hedge interest rate risk using futures contracts (financial derivatives) – Payoffs are linked to previously issued securities Copyright 2011 Pearson Canada Inc. 11- 6 Responses to Changes in Supply Conditions: Information Technology • Bank credit and debit cards – Improved computer technology lowers transaction costs • Electronic banking – ATM – Home banking – ABM – Virtual banking • Junk bonds • Commercial paper market • Securitization Copyright 2011 Pearson Canada Inc. 11- 7 Avoidance of Existing Regulations • Reserve requirements act as a tax on deposits • Restrictions on interest paid on deposits led to disintermediation – Money market mutual funds – Sweep accounts Copyright 2011 Pearson Canada Inc. 11- 8 Financial Innovation and the Decline of Traditional Banking • Decline in Cost advantage of Acquiring Funds (Liabilities) – Disintermediation • Decline in Income Advantage on uses of funds (Assets) • Bank Responses - No decline in overall profitability - Increase in income from off-balance sheet activities • Decline of Traditional Banking in Other Industrialized Countries Copyright 2011 Pearson Canada Inc. 11- 9 • The Big Six, together with the Laurentian Bank of Canada, the Canadian Western Bank, and another 8 domestic banks are Canada’s Schedule I banks • Until 1981, foreign banks were not allowed to operate in Canada • Schedule II banks are some domestic banks controlled by eligible foreign institutions • A Schedule III bank is a foreign bank branches of foreign institutions Schedule I, II and III Banks Copyright 2011 Pearson Canada Inc. 11- 10 Canadian Banks [...]... Separation of Banking and Other Financial Services Industries Throughout the World 1 Universal banking - No separation between banking and securities industries 2 British-style universal banking - May engage in security underwriting 3 Japanese Model - Some legal separation of banking and other financial services Copyright 2011 The Near Banks: Regulation and Structure Trust Companies and Mortgage Loan.. .Competition and Technology • Besides chartered banks, there are over 4000 financial institutions providing services, these include trust, mortgage loan companies, credit unions, caisses populaires, government saving institutions, insurance companies, pension funds, mutual funds and investment dealers • New technology and the internet have led to more competition and innovative banking in... companies 2 Automated Teller Machines -if owned by someone else, ATM not considered a branch and not subject to branching regulations Copyright 2011 Competition Across All Four Pillars and Convergence • In the past, Canada’s financial services industry was regulated by institution (banks, securities, insurance, and real estate) This approach to regulation has been known as the four-pillar approach •... Federally incorporated TMLs are regulated and supervised by the OSFI and must also register in all provinces in which they operate and conform to their regulations • The fiduciary component of trust companies is only subject to provincial legislation, even if the company is federally incorporated • CDIC and QDIB (for Québec TMLs) Copyright 2011 Credit Unions and Caisses Populaires • • • • • • • Established... Established in 1938 • Today there are 150 branches and 225 ATMs in 242 communities across Alberta, operating in three target markets: individual financial services, agricultural operations, and independent business Copyright 2011 International Banking • Rapid growth – Growth in international trade and multinational corporations – Global investment banking is very profitable – Ability to tap into the... • • • • • Established under provincial legislation Are non-profit seeking institutions Accept deposits and make loans only to members Members have voting rights, elect board of directors, which determine lending and investment policies Have their own set of institutions, including central banking and deposit insurance The main source of funds is deposits (85% of liabilities) followed by members equity... consolidation in terms not only of the number of banking institutions, but also across financial service activities 2 Banking institutions will become not only larger, but increasingly complex organizations, engaging in the full gamut of financial service activities taking advantage of economies of scale and economies of scope 3 Mega-mergers like that of Citicorp and Travelers in the U.S should become increasingly... 2011 The 2001 Bank Act Reform • • • • Bank Holding Companies Permitted Investment Ownership Rules Canadian Payments Act and Access to the Payments and Clearance System • Merger Review Policy • The National Financial Services Ombud Service • Implications for the Canadian Banking Industry Copyright 2011 ... Offshore deposits not subject to regulations Copyright 2011 Canadian Banking Overseas Copyright 2011 Foreign Banks in Canada I • Bank Act 1981 allowed foreign banks to operate in Canada • Currently hold about 8% of total Canadian bank assets – HSBC Bank Canada (national market share of 3%) • Foreign banks enter financial services industry as Schedule II or Schedule III banks Copyright 2011 Foreign... and innovative banking in Canada • 2001 changes in bank ownership laws have encouraged the establishment of new banks Copyright 2011 Comparison with the United States • 73 chartered banks in Canada and around 7,100 in the United States • The presence of so many banks in the U.S reflects past regulations that restricted the ability of these financial institutions to open branches • Many small U.S