Deposit-Taking Financial InstitutionsDeposit-Taking Financial Institutions

Banks and near banksBanks and near banks

Deposit-taking FIDeposit-taking FI

Take deposits and make loans

Profit is realized from the difference between interest charged on loans and interest paid on deposit

Engaging in other financial activities lately

Deposit-taking FIDeposit-taking FI

Banks• Schedule I Banks: The big six + two• Schedule II

Near Banks• Trust and Mortgage Loan corporations• Local Credit Unions and Caisses Populaires

Regulation of deposit-taking FIRegulation of deposit-taking FI

The Bank of Canada

OSFI

CIDC

BIS(Internationally)

The Bank of CanadaThe Bank of Canada

The heart of the Canadian banking system

Bank of Canada: HistoryBank of Canada: History

The Bank was founded and commenced operations in 1935 as a privately owned corporation

By 1938 ownership had passed to the Government of Canada and since then the Minister of Finance has held the entire share capital issued by the Bank

Bank of Canada: FunctionsBank of Canada: Functions

• Monetary policy• Central banking services• Issuance and removal of bank notes

• Administration of public debt

Monetary policyMonetary policy

Goal

To contribute to rising living standards for all Canadians through low and stable inflation.

Approach

Keep the rate of inflation inside a target range established jointly with the

government.

Since 1995, the target range has been 1% to 3%

Benchmark: CPI

Monetary policy: How it worksMonetary policy: How it works

The Bank raises or lowers the key overnight interest rate (the rate it lends money to all other banks):

• Impact on spending, production and employment through the cost of credit

• Impact on financial markets through interest rates and sometimes exchange rates

Central banking servicesCentral banking services

Market operations

• Linked to the execution of monetary policy

Client services

• Managing the accounts of the government and other financial institutions

Promoting the safety and the soundness of the financial system

• Developing of sound clearing and settlement systems in Canada. .

Issuance and removal of bank notesIssuance and removal of bank notes

The Bank of Canada is the country's sole note-issuing authority and is responsible for designing, producing, and distributing

Canada's bank notes.

Canadian banknotesCanadian banknotes

1935 series: The First Bank of Canada issue• the only $25 and $500 notes• uni-lingual notes: either English or French

Canadian banknotesCanadian banknotes

1937 series: The Bilingual series• featuring King George V and a few former Canadian PMs

Canadian banknotesCanadian banknotes

1954 series: Devil’s Head series• new look - the Queen moves sideways (this is the only time she appears on

all denomination)• the Canadian coat of arms is introduced

Canadian banknotesCanadian banknotes

1969 series: Multicolored and Wavy Pattern series• former Canadian PMs make their apparition - big time• modern security features

Canadian banknotesCanadian banknotes

1986 series: Birds of Canada series• notes readable by reading machines and electronic equipment• enhanced security features + intaglio printing• the one dollar note disappears• the last two dollar note

Canadian banknotesCanadian banknotes

2001 series: The Canadian Journey theme celebrates Canada's history, culture, and achievements. • State of the art security features• Tactile features

Bank of Canada: FunctionsBank of Canada: Functions

• Monetary policy• Central banking services• Issuance and removal of bank notes• Administration of public debt

Administration of public debtAdministration of public debt

The government raises funds through taxation and by borrowing money from the public through treasury bills and bond issues.

The Bank of Canada, acts as a fiscal agent, carrying out the government's borrowing program.

Services provided to the federal government:

• advising on borrowings

• managing new debt offerings

• servicing outstanding debt.

Chartered BanksChartered Banks

Banks operating under the Bank Act

The Bank Act• Sets out specifically what a bank may do• Provides operating rules

Chartered BanksChartered Banks

Schedule I: Most Canadian owned banks

Schedule II: Foreign owned banks

Schedule III: Foreign banks taking only wholesale deposits

Schedule I Chartered BanksSchedule I Chartered Banks

Royal Bank (Toronto)

Canadian Imperial Bank of Commerce (Toronto)

Bank of Montreal (Toronto)

Bank of Nova Scotia (Toronto)

Toronto Dominion Bank (Toronto)

National Bank of Canada (Montreal)

Laurentian Bank of Canada (Montreal)

Canadian Western Bank (Edmonton)

Schedule I Banks Principal ActivitySchedule I Banks Principal Activity

Take deposits and loan funds to businesses and consumers

The difference between interest paid on deposits and interest charged on loans is called spread

The spread provides the banks with their greatest source of revenue

Schedule I Banks: Financial Services OfferedSchedule I Banks: Financial Services Offered

• Residential mortgages• Term lending• Foreign lending to corporations and governments• Venture capital lending• Credit card lending• Participation in short term money markets

Schedule II BanksSchedule II Banks

Usually, subsidiaries of foreign banks in Canada

Became chartered as Schedule II banks in the 1980 Bank Act revision

Schedule II BanksSchedule II Banks

Commercial loans to companies

Very limited retail banking services to individuals

Schedule II BanksSchedule II Banks

Citizens Bank of Canada

Manulife Bank of Canada

HSBC Bank Canada

Credit Lyonnais Canada

ABN AMRO Bank Canada

Banca Commercialle Italiana of Canada

Amex Bank of Canada

Citibank Canada

USB Bank

etc.

Schedule I vs Schedule II banksSchedule I vs Schedule II banks

Voting shares of Schedule I banks are widely held:

Maximum 10% each investor

Maximum 25% foreign ownership

Schedule II banks may be wholly owned by nonresidents

The Widely Held Ownership RuleThe Widely Held Ownership Rule

Requires that Schedule I banks and Schedule II banks over $5 billion in equity be widely held:

- no single person may own 20% of voting shares

- no single person may own 30% of non-voting shares

WHO OWNS THE BANKS?

Canada Pension Plan Investment BoardApproximately 80 per cent of the Board's assets under management are invested in shares of major Canadian companies. Of the top 10 holdings in the portfolio, five are Canadian banks. This Board invests funds for the Canadian Pension Plan, from which many Canadians receive or will receive benefits.

Ontario Teachers Pension PlanShares of the six largest banks, accounted for 14.3 per cent of the plan’s total Canadian equity investments. This plan serves over 312,000 teachers.

Ontario Municipal Employees Retirement SystemShares of Canada's banks accounted for 14.4 per cent of the fund’s publicly traded Canadian equity portfolio. This plan serves approximately 270,000 people.

Nova Scotia Public Service and Teachers’ Pension PlanShares of Canada's banks accounted for 19.0 per cent of the total Canadian equity portfolio. This fund serves over 44,000 teachers and government employees.

Local Authorities Pension Plan - AlbertaShares of Canada's banks accounted for 15.7 per cent of the total Canadian equity portfolio. This fund serves close to 110,000 people.

Newfoundland Government Employees FundShares of Canada's banks accounted for 16.3 per cent of the total Canadian equity portfolio. This fund

serves approximately 31,000 people.

WHERE DO BANK EARNINGS COME FROMWHERE DO BANK EARNINGS COME FROM??

Interest-based income represents 48% of gross revenuesInvestments

Loans

Mortgages

Fee income represents 52% of gross revenues Trading of securities

Assisting companies to issue new equity

Financing and securities commissions

Wealth management

Personal banking service

What are service fees?What are service fees?

Banks charge fees for the services they provide to customers.

Service fees are based on the principle that customers should pay a reasonablereasonable fee for the services they use, and customers should not subsidize services they don't use.

Those with sophisticated banking needs will generally pay more than

someone with more basic banking needs.

Deposit-taking FIDeposit-taking FI

Banks

Near banks

Near BanksNear Banks

Deposit-taking FI, similar to banks, governed by specific regulation.

They’re like banks - but not exactly

Near BanksNear Banks

• Trust and Mortgage Loan corporations

• Local Credit Unions and Caisses Populaires

Trust and Mortgage Loan corporationsTrust and Mortgage Loan corporations

Chartered Banks were never allowed to act as trustees, creating a niche for trust corporations.

Trustee (Fiduciary)Trustee (Fiduciary)

A party that acts on behalf of another person in a variety of transactions: • investment • management• property distribution• will execution• receivership

• representing bondholders

A bank acting on behalf of its clients as a trustee (making discretionary decisions) +at the same time trying to make money from their funds

-------------------------------

= conflict of interest

Trust and Mortgage Loan corporationsTrust and Mortgage Loan corporations

• Sponsor mutual funds• Act as trustees for various corporate bonds and stocks• Serve as agents for real estate agencies• Act as investment managers• Act as trustees for pooled pension funds of large employers and

unions• Make mortgage loans• Make some commercial loans

Local Credit Unions and Caisses PopulairesLocal Credit Unions and Caisses Populaires

Member-owned FI, established under provincial legislation

• accountable only to its members.

• members deposit their funds and determine its lending policy

• first deposit = one vote

• most credit unions/caisses populaires are the size of a bank branch

Le Mouvement DesjardinsLe Mouvement Desjardins

First caisse populaire (credit union): 1900, Levi (Quebec),

Founder: Alphonse Desjardins

Le Mouvement Desjardins

Over 5.2 million members own:

Over 1,200 caisses populaires which in turn own:

La confederation des caisses populaires Dejardins

Le Mouvement DesjardinsLe Mouvement Desjardins

Seventh largest FI in Canada

Risk

• Credit risk refers to the risk that a borrower will default on a loan obligation or that the issuer of a security will default

• Regulatory risk is the risk of changes in regulations that will adversely affect earnings.

• Funding risk results from the mismatching of assets and liabilities with respect to their maturities. .

• Liquidity Risk

Reserve Requirements and Borrowing in the Federal Funds Market

Banks had to maintain a specified percentage of their deposits in a noninterest bearing account at the Bank of Canada and the Federal Reserve Bank. These percentages are reserve ratios, and the dollar amounts are required reserves. Reserve ratios differ by the types of deposits. Transactions deposits are demand deposits, and require a higher reserve.

Borrowing at the Fed Discount Window (US) overnight rate (Canada)

Banks temporarily short of funds can borrow from the Fed at its discount window. The rate charged is the discount rate. Acceptable collateral is necessary to borrow. Continual borrowing for long periods and in large amounts is viewed as a sign of financial weakness or as exploitation of the interest differential for profit.

Capital requirements for banks

Banks are heavily leveraged. Accordingly, their capital structure is heavily regulated. The organization that plays the primary role in establishing risk and management guidelines for banks throughout the world is the Basel Committee on Banking Supervision. This committee is one of four standing committees of the Bank of International Settlements in Basel, Switzerland.

The guidelines for capital requirements are the risk-based capital requirements. In July 1988, the Basel I Framework established minimum capital standards designed to protect against credit risk. In June 2004, the Basel II Framework incorporated a diversity of risks faced by banks in formulating risk-based capital requirements.

Deposit-taking FI: SummaryDeposit-taking FI: Summary

Take deposits and make loans

Deposits are primary source of funding

Banks: Schedule I & II

Near-banks: Trust Companies and credit Unions

Largest players: The Big Six and Mouvement Desjardins

Regulation: The Bank of Canada, CDIC, OSFI, BIS