Deposit-Taking Financial Institutions

1. Banks and near banks Deposit-Taking Financial Institutions

2. Deposit-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

3. Deposit-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

4. Regulation of deposit-taking FI The Bank of Canada OSFI CIDC BIS (Internationally)‏

5. The Bank of Canada The heart of the Canadian banking system

6. Bank 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

7. Bank of Canada: Functions • Monetary policy • Central banking services • Issuance and removal of bank notes • Administration of public debt

8. Monetary 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

9. Monetary 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

10. Central 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..

11. Issuance 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.

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

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

14. Canadian 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

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

16. Canadian 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

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

18. Bank of Canada: Functions • Monetary policy • Central banking services • Issuance and removal of bank notes • Administration of public debt

19. Administration 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.

20. Chartered Banks Banks operating under the Bank Act The Bank Act • Sets out specifically what a bank may do • Provides operating rules

21. Chartered Banks Schedule I: Most Canadian owned banks Schedule II: Foreign owned banks Schedule III: Foreign banks taking only wholesale deposits

22. Schedule 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)‏

23. Schedule 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

24. Schedule 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

25. Schedule II Banks Usually, subsidiaries of foreign banks in Canada Became chartered as Schedule II banks in the 1980 Bank Act revision

26. Schedule II Banks Commercial loans to companies Very limited retail banking services to individuals

27. Schedule 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.

28. Schedule 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

29. The 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

30. 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.

31. WHERE DO BANK EARNINGS COME FROM? Interest-based income represents 48% of gross revenues Investments 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

32. 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 reasonable 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.

33. Deposit-taking FI Banks Near banks

34. Near Banks Deposit-taking FI, similar to banks, governed by specific regulation. They’re like banks - but not exactly

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

36. Trust and Mortgage Loan corporations Chartered Banks were never allowed to act as trustees, creating a niche for trust corporations.

37. 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

38. Trust 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

39. Local 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

40. Le Mouvement Desjardins First caisse populaire (credit union): 1900, Levi (Quebec), Founder: Alphonse Desjardins

41. Le Mouvement Desjardins Over 5.2 million members own: Over 1,200 caisses populaires which in turn own: La confederation des caisses populaires Dejardins

42. Le Mouvement Desjardins Seventh largest FI in Canada

43. 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

44. 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.

45. 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.

46. Deposit-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