3. I. THE CANADIAN BANKING ENVIRONMENT
Canadian banking environment is relatively simpler and easier to understand. There are a
small number of large banks that branch across the entire country and a company will
typically have only one primary banking relationship. In Canada, the depository institutions
or banks are divided into three categories: Schedule I, II, or III. Schedule I banks are
Canadian-owned and are authorized to accept deposits and carry on a range of activities.
There are currently 22 Schedule I banks in Canada, but they are dominated by the six largest
with combined total assets of $1.8 trillion (USD) 1. The other types of banking institutions in
Canada include 25-plus Schedule II banks, which are subsidiaries of foreign banks authorized
to accept deposits and provide a ranges of services, and about 20 Schedule III banks that are
branches of foreign banks with limitations on their activities.
In Canada, the typical commercial bank account pays interest on positive balances, while
charging interest on negative balances (overdraft banking). Canadian banking customers also
have the ability to open accounts in currencies other than the Canadian dollar, which are
known as foreign currency accounts. Moreover, central bank in Canada (the Bank of Canada)
involves itself in the day-to-day activities of the chartered banks. While the roles of
supervision and “lender of last resort” are similar to those of the Federal Reserve, the Bank of
Canada does not participate in the operation of the payments system.2.
II. BANK DEPOSITS
1 Canadian Bankers Association. Canadian Bankers Association, http://www.cba.ca/en/.
2 http://gbr.pepperdine.edu/2010/08/commercial-banking-in-the-u-s-versus-canada/#_edn10
3
4. Money placed into a banking institution for safekeeping. Bank deposits are made to deposit
accounts at a banking institution, such as savings accounts, checking accounts and money
market accounts. The account holder has the right to withdraw any deposited funds, as set
forth in the terms and conditions of the account. The "deposit" itself is a liability owed by the
bank to the depositor (the person or entity that made the deposit), and refers to this liability
rather than to the actual funds that are deposited3. Thus, Bank deposits subject to check are
the claims of the creditors of a bank against the bank, by virtue of which they may, on
demand, draw by check specified sums of money from the bank. Since no other kind of bank
deposits will be considered by us, we shall usually refer to "bank deposits subject to check"
simply as "bank deposits." They are also called "circulating credit." Bank checks, as we have
seen, are merely certificates of rights to draw, i.e. to transfer bank deposits. The checks
themselves are not the currency; the bank deposits which they represent are the currency4.
III. CANADIAN MONETARY POLICY5
Monetary policy refers to any of a number of government measures undertaken to affect
financial markets and credit conditions with the ultimate objective of influencing the overall
behaviour of the economy. In Canada, monetary policy is the responsibility of the Bank of
Canada, a federal crown corporation that implements its policy decisions largely through its
ability to alter the Canadian money supply. The money supply is that portion of the financial
wealth of Canadian households which has sufficient liquidity to be considered money. At the
least it includes coin, currency, and chequing-account deposits in chartered banks, all of
which have perfect liquidity in that they represent, at face value, an immediate means of
3< http://www.investopedia.com/terms/b/bank-deposits.asp#ixzz2LMfVGRIm>
4< http://www.econlib.org/library/YPDBooks/Fisher/fshPPM3.html>
5< http://www.thecanadianencyclopedia.com/articles/monetary-policy>
4
5. payment for purchases made. Some economists broaden the money-supply definition by
including additional chartered-bank deposits (eg, savings accounts) or deposits in other
financial institutions such as trust companies or credit unions.
A. Control of the money supply
The Bank of Canada is not able to control the money supply directly, because the deposit
portion of the money supply results from decisions made within the private Banking system.
By taking deposits from individual Canadian households and firms and then lending these
funds, the commercial banks, in essence, "create" money because, in theory, the new funds
will be re deposited in the banking system. However, the money-creation powers of the
commercial banks are constrained by 2 factors.
1. If interest yields on other financial assets rise, Canadians will probably choose to hold
a relatively smaller portion of their wealth as coin, currency and (largely low-yield)
money deposits.
2. The banks are limited in loan expansion by the need to retain reserves (basically cash
in the vault, and deposits of the individual banks at the Bank of Canada) to meet
possible withdrawal needs. By altering interest rates and the level of banking reserves,
or both, the Bank of Canada can manipulate the money supply indirectly with a high
degree of precision (particularly over periods of 3 to 6 months or longer).
a. Open-market operations
One method of manipulating the money supply, termed open-market operations, involves the
trading of Canadian government securities in the secondary bond and Treasury bill markets. A
purchase of government bonds by the Bank of Canada represents an immediate increase in
the stock of money held by the general public, raises banking system reserves, and therefore
5
6. has a multiplied indirect effect on the total money supply. The added demand for bonds also
puts downward pressure on bond yields and hence on the overall level of interest rates.
Through a sequence of opposite effects, a sale of bonds will decrease the money supply and
raise interest rates.
Control of the money supply is a powerful tool for influencing the general behaviour of the
Canadian Economy. For example, simulative monetary policy (ie, a higher rate of money-
supply expansion) will put downward pressure on interest rates, strengthen business
investment and housing demand, and hence raise the overall level of demand in the economy.
During a cyclical downturn, when there is heavy unemployment and idle plant capacity, this
stronger demand should in theory lead to a rise in output and increased jobs. Reduced money
growth, on the other hand, acts as a restraining force on the economy - causing upward
pressure on interest rates and reducing both investment and total demand. At a time of high
inflation, such restraint will help reduce price and wage increases.
b. Impact on the Canadian-US dollar Exchange Rate
Because of the strong links between Canadian and American financial markets, monetary
policy also has a major impact on the Canadian-US dollar Exchange Rate. If Canadian
monetary policy is significantly more expansionary than US policy, the value of the Canadian
dollar will tend to depreciate in relation to the US dollar. A more contractionary Canadian
policy will result in the reverse effect. Canadian monetary policy, therefore, tends to work
through a combination of interest rate effects and exchange rate effects. The Bank of Canada
attempts to measure the combined impact of both through its monetary conditions index in
which a 1% decline in short-term interest rates is equivalent to a 3% decline in the value of
the Canadian dollar.
B. Limitations of the policy
6
7. Despite its important effects, monetary policy also has limitations. It cannot, for example,
simultaneously stimulate economic demand to reduce unemployment and restrain demand to
combat inflation. Nor can the Bank of Canada increase money growth rates to reduce interest
rates below US levels while at the same time successfully stabilizing the Canadian-US
exchange rate.
1. Monetary policy decisions often require painful choices ("trade-offs"). Sometimes
these trade-offs involve conflicts between the short-term and long-term effects of a
particular policy. For example, a sustained rise in money-supply growth may cause an
initial increase in both jobs and production, but eventually it will lead to a
correspondingly higher inflation rate with little or no permanent effect on
employment or output.
2. Similarly a major reduction in the rate of money-supply expansion ultimately will
reduce even strongly entrenched inflation, but this accomplishment may take several
years during which output and employment both fall.
3. These inter-temporal conflicts can be complicated by a third limitation - ignorance -
for there are still many unresolved questions concerning the mechanisms whereby
changes in monetary policy affect the economy, the nature of the interrelations
between real and financial variables, and the exact determinants of wage- and price-
setting decisions.
4. Finally, monetary policy is restricted by the impact of other government actions,
especially Fiscal Policy, ie, decisions about government expenditures and taxation.
Fiscal policy also influences overall economic demand, and if fiscal and monetary
policy are not co-ordinated, they can work at cross-purposes. In Canada the minister
of finance and the governor of the Bank of Canada consult regularly. Furthermore,
since 1961 there has been an explicit agreement that if any irreconcilable conflict
between the 2 arises, the governor must either follow the written (and publicly
7
8. released) directive of the minister or resign office. In the federal budget of 1991 the
then Conservative government and the Bank of Canada jointly agreed on a set of
inflation-reduction targets as a cornerstone of both monetary and fiscal policy. An
inflation target of 1-3% for 1995-98 was subsequently reaffirmed by Bank of Canada
and the Liberal government elected in 1993. Nonetheless, despite such evidence of
co-operation, there is also a strong tradition that, except in such acute circumstances,
the Bank of Canada should be able to set an independent monetary policy, free from
political pressures. Therefore the potential for conflicting policies does exist.
The creation of monetary policy is often a highly contentious issue. Disagreements
sometimes occur because of differing factual judgements about current economic
circumstances (eg, whether or not a recession has started), or because of conflicting value
judgements (eg, whether it is more unfair to have inflation erode the value of fixed pensions
or to have recession cause the loss of jobs). Frequently, however, debate reflects broad
conceptual differences about the appropriate strategy for monetary policy. Although there are
many alternative (and intermediate) viewpoints, 2 general approaches can be distinguished.
IV. WHAT HAVE BEEN THE OUTCOMES OF THE PRESSURES ON BANKS FROM
TECHNOLOGICAL, ECONOMIC, AND LEGISLATIVE DEVELOPMENTS OVER RECENT
DECADES6?
Over the post war period, banks gradually lost share in the deposit market, although they
recovered some of that lost share through their acquisition of trust companies in the 1990s. In
contrast, they have significantly increased their share of residential mortgage lending and
consumer lending. Their share of business credit markets has followed a cycle over the last
quarter century, rising sharply in the early 1980s and falling gradually thereafter. Overall, the
6 <http://www.banqueducanada.ca/wp-content/uploads/2010/01/tr81.pdf>
8
9. banks seem by and large to have more than maintained their position vis-à-vis other
institutions (in part by acquiring institutions in the other “pillars” since 1987). Also, as will be
seen in the course of the discussion, they have not faced the same competition from money
market mutual funds (MMMFs) or from the securitization of loans as have their American
counterparts.
A. Consumer loan market
This market encompasses virtually all loans by financial institutions to households except for
residential mortgage loans. It thus includes fixed-term, fixed-rate loans for the purchase of
automobiles, loans to finance the purchase of securities, credit card loans, and a large residual
category of other loans, which are primarily floating-rate loans 7. As noted earlier, banks were
permitted to enter this market by the 1954 Bank Act amendments, and their operations in this
market were facilitated by the elimination of the ceiling on loan rates in 1967. By providing
such loans at relatively low rates of interest, banks were able to raise their share of the market
over the 1960s and 1970s (from about one-third in the late 1950s 8 to about one-half in 1970
to about two-thirds in 1980), mainly at the expense of finance companies. The banks’ share
has flattened out at about two-thirds of the market over the last 15 years (Chart 4). Most of
the rest of this market is held by trust and mortgage loan companies not associated with the
banks (9 per cent), co-operative credit institutions (11 per cent), and finance companies (5 per
cent).
B. Residential mortgage market
7 Montplaisir, M.-C. 1996-97. “The Maturity Structure of Household Financial Assets and
Liabilities.” Bank of Canada Review (Winter): 33–46.
8 Neufeld, E.P. and H. Hassanwalia. 1997. “Challenges for the Further Restructuring of the
Financial-Services Industry in Canada.” In The Banking and Financial Structure in the
NAFTA Countries and Chile, edited by G.M. von Furstenberg, 44–106. Boston: Kluwer
Academic Publishers.
9
10. The 1954 Bank Act amendments permitted banks to lend against government-insured
mortgages. However, their operations in this market in the mid-1960s were hampered by the
ceiling on loan rates until the ceilings were eliminated by the 1967 amendments. Even more
important were the 1967 amendments that permitted the banks to enter the conventional
mortgage market and thus to make mortgage loans that were not insured.9
C. Shift towards off-balance-sheet activities and fee income
Another important trend in the operations of Canadian banks in recent years, in line with
developments in other major banks worldwide, has been the shift towards off-balance-sheet
activities and fee income. For the six largest Canadian banks, “other income” rose from about
18 per cent of total revenues in 1984 to 38 per cent in 1996. While this category includes
income from a disparate group of activities, a very significant part is associated with the
provision of services to businesses. As emphasized earlier, direct lending has been a declining
part of the banks’ balance sheet and a declining source of funds for business. The banks have
become heavily involved (though their securities subsidiaries) in the flotation of bonds and
equities by corporate customers and in the provision of backup loans on the issue of
commercial paper. In 1996, investment banking and other securities fees provided over one-
quarter of “other income” for the six largest Canadian banks. Earnings from derivatives
transactions, in which the Canadian banks are heavily involved, also contributed to this
category of income. Moreover, other new areas, such as trust activities and the promotion and
sale of mutual funds, provided another 12 per cent. The major Canadian banks, having
become full-fledged financial conglomerates, are all now in the process of developing
strategies for the next decade or two. Among the challenges to be faced are the rapid
9 The Bank Act limits conventional (non-insured) residential mortgage loans to 75 per cent of
the value of the property at the time the mortgage is issued. This ratio can be exceeded in
cases where there is private or public insurance on the amount of the loan in excess of 75 per
cent.
10
11. technological changes now impinging on the banking industry, ongoing demographic
changes, increased competition in certain of their activities from the non-regulated sector,
possibly enhanced competition from foreign financial institutions, and considerable
uncertainty about what the financial services industry will look like in 10 or 20 years 10.
Among other things, decisions will have to be made about the extent and speed of their
involvement in electronic banking, the degree of their international involvement, the areas in
which they will focus their efforts (e.g., areas in which they are most efficient and in which
they want to be significant participants), and perhaps, further mergers and acquisitions. The
next few years will undoubtedly see further important developments in banking and in the
entire financial sector.
V. AUTOMATED CLEARING SETTLEMENT SYSTEM (ACSS) AND THE LARGE VALUE
TRANSFER SYSTEM (LVTS)
While the typical business-to-business check takes from one to three days to clear in the U.S.,
checks in Canada (or cheques as they are known) are essentially same-day items. The
processing of the payments (both checks and electronic) is handled by the banks themselves
or through bank associations, such as the Canadian Payments Association (CPA) 11. The CPA
runs both the Automated Clearing Settlement System (ACSS) and the Large Value Transfer
System (LVTS). The ACSS is designed to clear both paper and electronic items and in recent
years, the trend has definitely been towards electronic. According to ACSS statistics, in 2006,
almost 79 percent of payment items were electronic, up from only 13 percent in 1990. Over
this same period, paper items declined from 86 percent down to just 21 percent. However,
Canadian companies do still tend to use cheques for large B2B payments, as the bulk of
10 Daniel, F., C. Freedman, and C. Goodlet. 1992-93. “Restructuring the Canadian Financial
Industry.” Bank of Canada Review (Winter): 21–45.
11 Canadian Payments Association. Canadian Payments Association, http://www.cdnpay.ca/
11
12. larger transactions-those over $50,000 (CAD)-are still paper-based. The LVTS is similar to
the FedWire in the U.S. and provides real-time finality of payment and guaranteed settlement.
The average value of an LVTS transaction is $8.5 million (CAD) and all transaction over $25
million (CAD) are required to use the system. The LVTS was implemented in 1999, and in
2006 over $41.7 trillion (CAD), 89 percent of all value flowing through payments systems in
Canada, was settled through the system.12
As has been the case in the U.S., Canadian banks have implemented programs related to the
creation and exchange of check images as well as the use of prevention techniques to reduce
the incidence of check fraud. However, since there is already high use of electronic payments
in Canada and all checks essentially clear the same day, there has not been a need to
implement check conversion initiatives. Canadian banks are becoming more active
participants in the U.S. markets as many of their customers either expand their businesses
into the U.S. or as opportunities to enter the U.S. banking market present themselves. When
Canadian banks operate in the U.S. under a U.S. charter they must abide by all the laws and
regulations governing financial institutions in the U.S.
VI. CONCLUSION
To summarize it can be said that the Canada seems to follow the more general developed-
country model. The Canadian companies typically have only one, primary commercial bank
relationship. Moreover, in Canada the key role of operating and managing the key payment
systems is handled by an association of banks as compared to other nations such as the U.S.
12 Canadian Payments Association. Canadian Payments Association, http://www.cdnpay.ca/
12
13. VII. APPENDIX 1
Highest Rates on Deposit Accounts in Canada13
Deposit
Account Term APY Account Details
Type
ING Direct This interest rate applies to the ING
Canada 1 1 year 1.35% GIC 'Guaranteed Investment' which is
Year GIC for 1 year and ha - CAD - Jan, 2013
Rate is for 1 year and Annual / Annual
BMO 1 Year 1.150 Compound Interest Payment Option
1 year
GIC % and $1,000 - $99,999 for - CAD - Feb,
2013
- Rate is for a Redeemable GIC and is
RBC 1 Year
1 year 1.10% for 1 to 1.5 years- Minimum deposit :
GIC
$500- Invest - CAD - Feb, 2013
This GIC interest Rate is for a term
BMO 6 6 1.000 between 180 - 269 days and is for the
Month GIC month % 'BMO Short Term Invest - CAD - Feb,
2013
13 http://canada.deposits.org/
13
14. Deposit
Account Term APY Account Details
Type
This TD Non-Cashable GIC product
TD Canada
has an interest rate that is applicable
Trust 1 Year 1 year 1.00%
for a 1 year / 12 month - CAD - Feb,
GIC
2013
Vancity 1 The interest rate indicated applies to
Year Term 1 year 1.00% the 'redeemable term deposit product'
Deposit that requires - CAD - Feb, 2013
HSBC
This CAD Interest rate is a 1 year / 12
Canada 1
1 year 0.95% month term and requires a minimum of
Year Term
1,000. This product - CAD - Nov, 2012
Deposit
Rate is for 'Long Term Non-
Scotiabank
1 year 0.90% Redeemable GICs'(Non-Registered:An
1 Year GIC
- CAD - Feb, 2013
Rate is for 'CIBC Long Term GIC'
CIBC 1 Year 0.900 account and is term is for 12 - 16
1 year
GIC % months and $1000 - $99,999 - CAD -
Feb, 2013
BMO 3 3 0.900 This BMO Guarenteed Investment
Month GIC month % Certificate interest Rate is for a term
between 90 - 119 days and - CAD - Feb,
14
15. Deposit
Account Term APY Account Details
Type
2013
Desjardins 1
This fixed interest rate product refers
Year Term
1 year 0.90% to the 'term savings' product for a 1
Savings
year at maturity te - CAD - Jan, 2013
Account
This is a TD Non-Cashable GIC short
TD Canada
6 term product and the interest rate is
Trust 6 0.85%
month applicable for a 180 da - CAD - Feb,
Month GIC
2013
This is a Non-Cashable Guarenteed
TD Canada
3 Investment Certificate (GIC) product
Trust 3 0.75%
month and is applicable for a 3 - CAD - Feb,
Month GIC
2013
- Rate is for a Redeemable GIC and is
RBC 6 6 0.750
for 180 to 269 days- Applicable to
Month GIC month %
balanc - CAD - Feb, 2013
TD Canada 1 year 0.70% This TD interest rate is for a 12
Trust 1 Year month/1 year deposit term (long term)
Term with a minimum of $1000 - CAD - Feb,
15
16. Deposit
Account Term APY Account Details
Type
Deposit 2013
- The Interest Rate is for the
RBC 3 3 0.650 Redeemable GIC Product and is for 90
Month GIC month % to 179 days or 3 month equiva - CAD -
Feb, 2013
National This 'Redeemable GIC' product for a
Bank of 12 month or 1 year term with Interest
1 year 0.65%
Canada 1 paid at maturity/annual - CAD - Feb,
Year GIC 2013
16
17. VII. REFERANCES
Canadian Bankers Association. Canadian Bankers Association, http://www.cba.ca/en/..........3
Canadian Payments Association. Canadian Payments Association, http://www.cdnpay.ca/...11
Daniel, F., C. Freedman, and C. Goodlet. 1992-93. “Restructuring the Canadian Financial
Industry.” Bank of Canada Review (Winter): 21–45............................................................11
http://gbr.pepperdine.edu/2010/08/commercial-banking-in-the-u-s-versus-canada/#_edn10. . .3
http://www.banqueducanada.ca/wp-content/uploads/2010/01/tr81.pdf.....................................8
http://www.econlib.org/library/YPDBooks/Fisher/fshPPM3.html............................................4
http://www.investopedia.com/terms/b/bank-deposits.asp#ixzz2LMfVGRIm...........................4
http://www.thecanadianencyclopedia.com/articles/monetary-policy.........................................4
Montplaisir, M.-C. 1996-97. “The Maturity Structure of Household Financial Assets and
Liabilities.” Bank of Canada Review (Winter): 33–46...........................................................9
Neufeld, E.P. and H. Hassanwalia. 1997. “Challenges for the Further Restructuring of the
Financial-Services Industry in Canada.” In The Banking and Financial Structure in the
NAFTA Countries and Chile, edited by G.M. von Furstenberg, 44–106. Boston: Kluwer
Academic Publishers..............................................................................................................9
17
