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Chapter 18: Learning Objectives

Chapter 18: Learning Objectives. Banking Thought Over Time A Brief History of Commercial Banking Bank Acts: Basic Features Major Milestones Performance of Chartered Banks. Evolution of Commercial Banking Thought. The concept of a bank charter: a means to protect depositors/investors

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Chapter 18: Learning Objectives

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  1. Chapter 18:Learning Objectives • Banking Thought Over Time • A Brief History of Commercial Banking • Bank Acts: • Basic Features • Major Milestones • Performance of Chartered Banks

  2. Evolution of Commercial Banking Thought • The concept of a bank charter: a means to protect depositors/investors • “Free banking”: a largely unregulated banking system. Is this possible? • Legal restrictions: government involvement in the financial system and its consequences

  3. The Development of Commercial Banking in Canada • The evolution of government note issue from Confederation: a growing monopoly • Legal restrictions on banking and the first commercial banks in Canada: limiting loans to commercial concerns but open branch banking • The key piece of banking legislation: the BANK ACT TABLE 18.1 contains a chronology

  4. Milestones in Canadian Banking • The First Bank ACT of 1871 • Revision every 10 years • Establishes “narrow” federal jusrisdiction over the financial sector • The crisis of 1907 • Recession originating in agriculture reveals the need for a lender of last resort (Finance Act 1914) • Measures to facilitate loans introduced

  5. Milestones in Canadian Banking • The 20th Century • Creation of a permanent lender of last resort: The Bank of Canada • Banks permitted to offer residential mortgages since the 1950s • Deposit Insurance since 1967

  6. Milestones in Canadian Banking • The Modern Era and the Bank Act of 1981 • Comprehensive Banking Law • Chartered Banks can acquire Trusts, securities dealers • Reserve requirements phased out beginning in 1994 • What’s in Store? Merger denials 1998, pressure from foreign competition

  7. An Important Bank Act Milestone:The BANK ACT of 1991-First Financial Sector Legislation • Abolishes the restriction of term “banking” to chartered banks alone • Still requires a revision every 10 years but mid-term reviews built-in • Brings about largest de-regulation in history • Required reserves abolished • Still requires chartered banks to be widely-held • Still places limitations of chartered banks financial activities

  8. Continuing Issues in Canadian Banking • Financial Innovations (from ATMs to Internet banking)

  9. ATMs in Canada

  10. Principal Activities of Financial Institutions

  11. Continuing Issues in Canadian Banking • Financial Innovations (from ATMs to Internet banking) • Market concentration and competition: Merger Mania • Regional concerns • Lending to big and small businesses

  12. The Bank Act of 2001 • More flexibility to enter new lines of of business • Reduce the regulatory burden • Creation of a new consumer “watchdog” agency • Promotion of lending to small & medium-sized businesses • BUT… restrictions on mergers, insurance, ownership, non-finance activities remain. Foreign banks remain “second class citizens”

  13. Evaluating Chartered Banks’ Performance: The Dimensions • Asset - Liability Composition: Tables 18.4 & 18.5 • Residential mortgages, foreign denominated become dominant, commercial loans stable • Foreign liabilities become dominant while savings deposits considerably less important over the years

  14. Assets of Chartered Banks

  15. Liabilities of Chartered Banks

  16. Evaluating Chartered Banks’ Performance: The Dimensions • Asset - Liability Composition: Tables 18.4 & 18.5 • Residential mortgages, foreign denominated become dominant, commercial loans stable • Foreign liabilities become dominant while savings deposits considerably less important over the years • Asset - Liability Management: Table 18.5

  17. Balance Sheet of Chartered Banks: NOV 2004

  18. GAP: RBC October 2003

  19. Evaluating Chartered Banks’ Performance: The Dimensions • Asset - Liability Composition: Tables 18.4 & 18.5 • Residential mortgages, foreign denominated become dominant, commercial loans stable • Foreign liabilities become dominant while savings deposits considerably less important over the years • Asset - Liability Management: Table 18.5 • Size: Table 18.6 • Top 5 all Schedule I banks • Bank Profits and Interest rates: not what you think

  20. Cahrtered Banks’ Size: Top 6

  21. Evaluating Chartered Banks’ Performance: The Dimensions • Asset - Liability Composition: Tables 18.4 & 18.5 • Residential mortgages, foreign denominated become dominant, commercial loans stable • Foreign liabilities become dominant while savings deposits considerably less important over the years • Asset - Liability Management: Table 18.5 • Size: Table 18.7 • Top 5 all Schedule I banks • Bank Profits and Interest rates: not what you think

  22. How We Got from the 1990s to the 21st Century in theFinancial Services Sector in Canada? Key Aspects Review Continuing Controversies and Problems *Supplement*

  23. The Financial Sector Today & Tomorrow • Despite all the new developments in the financial marketplace it is important to remember the the functions of banks have not changed. They still are: • institutions to clear and settle payments and facilitate transactions • institution to provide a mechanism for pooling resources • provide a means to transfer resources through time, industries and borders • assist in the management of risk • provide information to facilitate decision-making • assist in mitigating the asymmetric information problem

  24. What Has Changed? • The Manner in which services are provided, the instruments offered, and the types of entities providing financial services • This has led to: • dis-intermediation and securitization of assets • divestiture and consolidation • convergence of business lines facilitated by deregulation • increased complexity of financial services • increased pressure on bank financial performance

  25. Key Factors Affecting the Financial Sector Today • Technology • backroom efficiencies (EDP) • new instruments (derivatives, securitization, e-money…) • delivery mechanisms (ABMs, PCs, virtual banks) • software and non-financial entities acting as FSPs • Deregulation and Globalization • Demographic Factors and the Aging Population • away from credit provision toward wealth management • increased role of investment advice

  26. A Refresher on the Evolution of Banking in Canada The FOUR PILLARS story BANKS Sec. Dealers trusts insurance 1970s Banks sec. Dealers trusts insurance asset mgmt 1990s Universal banking? Future? Trust Wealth Mgmt INS Mtge Brokerage

  27. What are the Future Challenges? • Does Size Matter? • Technology is expensive/economies of scale • Globalization may also be a function of size • Providing all services requires a certain size YES • Services can be provided by different entities • Agency costs become larger • There is no correlation between size & efficiency • Dangers of monopoly power NO

  28. Challenges (Cont’d) • Economies of scale can be quickly exhausted • not everyone wants to “shop” from the same “store” • size can also mean diseconomies of scale if focus is lost (leads to divestiture) and conflict of interest • what matters to shareholders is profitability not size

  29. Fees and the Concentration Ratio

  30. Challenges (cont’d) • Does Regulation Matter? • Institutional Regulation • regulatory solvency implies a moral hazard problem • market discipline must be tempered by disclosure rules • Functional Regulation: • Regulate lines of business? But solvency is an institutional not a functional problem • Different regulators for different regulatory functions? • Potential for overlap • are functions sufficiently distinct? • Coordination problems among regulators

  31. Challenges (Cont’d) • International Considerations • harmonizing international laws (EU, BIS, WTO) • the problem of cross-border transactions • Traditional vs non-traditional Financial Service Providers (FSPs) • some regulated, some not making supervision difficult • the Holding Co. model: can regulators erect the right “firewalls” between the regulated and non-regulated parts?

  32. The Current State of Regulatory Functions in Canada • Competition Bureau: • looks at local level competition • OSFI: • conducts a prudential review • Ministry of Finance: • conducts the final policy review and makes decision

  33. What Does OSFI do? • Supervise and ensures that financial institutions comply with law and are financial sound • Advise management and require remedial action if unsound • Promote policies to manage and control risk • Monitor events that can negatively impact financial conditions • Overlaps with CDIC whose mandate is: “…instrumental in the promotion of sound business and financial practices for member institutions.”

  34. COSTS 1. Compliance 2. Operating costs of multiple regulatory regimes BENEFITS 1. “Seal” of approval 2. Lower costs as a result of 1. May lead to lower “prices” Costs and Benefits of Regulation

  35. Factors Motivating the 1991 Amendments to the Bank Act • Need to modernize legislation • Desire to break-down barriers between the “pillars” • Need to define range of business appropriate to a FSP • Need to deal with increased potential for conflict of interest arising out of financial consolidation • Need to address issues surrounding deposit insurance and supervision • Provincial legislation and the need to harmonize legislation across the country • recognition of globalization phenomenon

  36. The Task Force on the Future of the Canadian Financial Services Sector • The ISSUES: • role of the financial sector in economic activity • the state of competition in the financial sector • the state of international competitiveness of Canadian banks • the role of technology and its impact on the financial sector • the quality of financial services provided to consumers

  37. Recommendations of the Report (Sept 1998) leading to 2001 Bank Act Reforms • 1. Allow life insurance Cos., Mutual Funds and Investment Dealers to access payments system • 2. Making ABMs more functional (e.g., accept all deposits) • 3. Coop banks should be allowed to form banks • 4. Demutualize major insurance Cos. • 5. Change deposit insurance to allow other FSPs to compete or stop giving banks an edge in this area • 6. Relax closely-held vs. widely-held rules • 7. Banks should be allowed to offer insurance and auto leasing services • 8. Encourage new domestic entrants into the financial industry

  38. Summary • The history of Canadian commercial banking is a fascinating one reflecting changes in views over time about the role of commercial banks in the financial system and the role of government as a regulator • The centerpiece of financial legislation is the BANK ACT • Understanding chartered banks’ performance is complex and must be accomplished along several dimensions, including size, profitability, asset-liability composition and management

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