Current Legal Issues Affecting Central Banks, Volume IV.

Chapter 14 Banking Law Developments in Canada

Robert Effros
Published Date:
April 1997
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The technology-driven globalization of the financial markets has created similar problems and concerns for regulators throughout much of the world. In Canada, policymakers have responded by looking beyond national borders in search of solutions. Their perception is that it is no longer possible for any country with an open market economy to legislate and regulate in a vacuum. In an increasingly integrated marketplace for financial services, the maintenance of a stable and sound financial system, the fostering of competition, and the protection of depositors and consumers require a coordinated international approach. Banking law and regulation have evolved rapidly in Canada over the past few years, as in other jurisdictions.

In a 1985 policy paper,1 the Canadian Government enunciated nine principles that would form the basis for financial sector policy in the years to come. The principles received widespread approval. They were reaffirmed in a 1987 policy paper2 and ultimately became the basis of financial sector policy that was implemented through legislative reform in 1991.3 The principles are as follows:

  • improve consumer protection;
  • strictly control self-dealing;
  • guard against abuses of conflicts of interest;
  • promote competition, innovation, and efficiency;
  • enhance the convenience and options available to customers in the marketplace;
  • broaden the sources of credit available to individuals and business;
  • ensure the soundness of financial institutions and the stability of the financial system;
  • promote international competitiveness and domestic economic growth; and
  • promote the harmonization of federal and provincial regulatory policies.

These principles have been applied to the various types of regulated financial institutions: banks, trust and loan companies, insurance companies, investment dealers, and financial cooperatives.

This chapter will provide an overview of the Canadian financial system and then examine the legislative and regulatory framework governing four broad areas that are of general interest to central banks and regulators around the world. These are (i) the institutional structure of the financial system; (ii) foreign access to the Canadian market; (iii) financial and commercial linkages; and (iv) solvency, deposit insurance, and consumer protection.

Overview of the Canadian Financial System

Canada is in the middle of the geopolitical world, bordering on the United States to the south, Europe to the east across the Atlantic, the Pacific Rim and Asia to the west, and Russia, the Baltic countries, and the other countries of the former Soviet Union to the north across the Arctic. However, this location had little impact on the development of the financial system until quite recently.

Canada shares a long border with the United States. In fact, this border is over 4,000 kilometers long, approximately twice the distance as that from Paris to Moscow. Ninety-six percent of Canada’s 27 million people live in a narrow 200-kilometer band stretching from the Atlantic Ocean to the Pacific Ocean along this border. This population distribution more than anything else has led to development of a branch-based banking system, with a limited number of large domestic banks maintaining hundreds of branches.

Canada comprises ten provinces. It is a federal state, with powers over the financial system shared between the Federal Government and the provincial governments. This structure, too, has had and continues to have a very significant impact on the structure of the financial system and the development of banking regulation.

The Federal Government exercises jurisdiction over banks, federally incorporated trust and loan companies, insurance companies, and foreign-owned banking institutions. The provincial governments have jurisdiction over the securities industry, provincially incorporated trust and loan companies, and provincially incorporated cooperative banks (called credit unions and caisses populaires). Deposit insurance is administered by the Federal Government for both federally regulated and provincially regulated deposit-taking institutions, except in the province of Quebec, which has its own system for Quebec-incorporated institutions, and except for the credit unions and caisses populaires, which adhere to provincial deposit insurance schemes. The Federal Government also regulates the clearing and settlement system.

There are approximately 9,300 branches of deposit-taking institutions in Canada, which is more than one branch for every 3,000 people. There are also 16,000 automated banking machines, which amounts to more than two machines for every 3,000 people. Every day the clearing and settlement system processes approximately 9 million items, that is, one item for every three people. Canadians do a lot of banking. As of December 31, 1993, total assets of the deposit-taking institutions were approximately Can$850 billion, and total assets of the insurance industry amounted to approximately Can$159.3 billion. Of the total assets of deposit-taking institutions, approximately 60 percent were held by banks, 25 percent by trust and loan companies, and 15 percent by credit unions and caisses populaires.

Institutional Structure of the Financial System

“Four Pillars”

Historically, the Canadian financial industry was said to comprise four pillars: (i) the banks, (ii) the investment dealers or securities industry, (iii) the insurance companies, and (iv) the trust companies. One might also add a fifth pillar, the cooperative credit unions and caisses populaires. The industry was regulated on institutional lines, with functional and investment prohibitions aimed at preserving the distinctions among the pillars. For example, banks could not engage in the securities business or the business of insurance, and they could not undertake fiduciary activities. Likewise, insurance companies and investment dealers could not accept deposits, although the securities industry was able to circumvent this prohibition by offering various accounts to the public in conjunction with deposit-taking financial institutions. Trust companies have always been entitled to take deposits, but traditionally their commercial lending powers have been constrained.

In the most recent legislative reform, Canadian financial institutions were given a number of overlapping core powers, with some restrictions maintained for competitive, prudential, and jurisdictional reasons. The core powers are examined below.

Deposit Taking

Both banks and trust companies, as well as credit unions and caisses populaires, are entitled to accept checkable and uncheckable deposits. Insurance companies are prohibited from taking deposits, although exceptions are made for deposits that are considered to be related to insurance products, such as life annuities. However, there is an important legal distinction between bank and trust company deposits. Bank deposits are unsecured liabilities of the bank, which rank pari passu with all other liabilities, while trust company deposits are not liabilities per se, but are deemed to be held in a guaranteed trust fund that ranks ahead of the unsecured liabilities of the trust company. Because both types of deposits are covered by the same deposit insurance, this inequality does not create an advantage for the trust companies in attracting deposits; however, it creates a disadvantage for the trust companies in accessing the capital markets with other debt instruments because these market instruments rank behind the trust deposits on insolvency rather than pari passu with the deposits, as in the case of bank-issued paper.

Commercial Lending

Both banks and trust companies have access to unrestricted commercial lending powers, as do the insurance companies. However, trust and insurance companies are required to meet certain capitalization thresholds or obtain regulatory approval, or both, before engaging in unrestricted commercial lending. Financial institutions have the power to give guarantees, but these must be for a fixed sum of money; moreover, the person on whose behalf the guarantee is given must have an obligation to repay the sum guaranteed. The cooperative financial institutions have very restricted commercial lending powers, although the trend in several provinces is to increase these powers.

Fiduciary Activities

In most provinces, only trust companies are entitled to engage in fiduciary activities in-house, although banks and insurance companies may own trust company subsidiaries. However, certain provinces have extended fiduciary powers to credit unions or caisses populaires.


Banks and trust companies are prohibited from selling insurance, either directly or through networking or referral arrangements. Life insurance business and property and casualty insurance business must be carried on by separate insurance companies. The credit unions and caisses populaires have certain powers to retail—but not to write—insurance. This capacity puts them in limited competition with facets of the insurance industry.


Financial institutions are prohibited from engaging in the leasing of automobiles, household goods, and other consumer goods, so as not to compete with the retail industry, which sells or leases these products to the public. The argument has been made before legislative committees that consumer leases are essentially a financial product and a credit substitute, which financial institutions should be entitled to offer their customers. However, most financial institution legislation continues to prohibit “dealing in goods.” If one takes an economic view of leasing consumer goods, it is not clear that the prohibition of dealing in goods is sufficient to prevent the leasing of consumer goods by financial institutions. To avoid doubt, therefore, consumer leasing is specifically prohibited in many financial institution statutes.

Affiliation, Concentration, and Competition in the Financial Services Industry

In Canada, the institutional pillars have been preserved for regulatory purposes, but functional restrictions have largely been eliminated. This has been accomplished in part not only by sharing many “core” powers, as noted above, but also by permitting financial institutions to affiliate and, more specifically, by allowing the banks to own or control investment dealers, trust companies, and insurance companies. To fully appreciate what is happening, one must bear in mind that the Bank Act4 requires that domestic banks be “widely held,” that is, no single shareholder or group of connected shareholders may own more than 10 percent of the voting shares of a bank. There are exceptions to this rule for small start-up banks. Similar rules do not apply to the other “pillars” of the financial services industry. When the rule prohibiting banks from owning investment dealers was relaxed in the mid-1980s, it did not take long for most of the securities industry to be taken over by the banks. The law still requires that securities activities of banks be conducted through securities subsidiaries, but it can be expected that this requirement will become anachronistic with time and will eventually be eliminated. The only remaining factor protecting the bank-owned securities industry from extinction is that jurisdiction over this part of the financial services industry is granted under the Constitution to the provinces and not the Federal Government.5

The trend toward concentration that transformed the securities industry has also overtaken the trust companies, although there have been other contributing factors in this case. In the mid-1980s, the rule prohibiting commercial enterprises from owning trust companies was relaxed. Quickly thereafter, some of the major trust companies, which had previously been widely held, were taken over by large commercial companies. There followed the recession and the devastation of the real-estate-based loan portfolios of these companies. Under the guidance of their new commercial owners, these trust companies had invested heavily in real estate loans and, to the extent permitted, in real estate equity. Very few healthy trust companies remained after the recession, and several had already been merged with banks in order to avoid liquidation. When the rule against bank ownership of trust companies was eliminated in the late 1980s, it did not take long for the few remaining non-bank-controlled trust companies to be acquired by the banks, such that only one large independent trust company remains today.

In the 1991 revision of financial sector legislation, the power of the banks to engage in the business of insurance has been constrained to protect the insurance companies from bank competition. However, the banks have been given the power to own or control stock insurance companies. At present, the Canadian insurance industry is greatly in need of capitalization. Many of the larger insurance companies are mutual companies, owned by their policyholders rather than by shareholders. In order to capitalize to support growth, many of these companies will “demutualize,” as permitted by the Insurance Companies Act. With demutualization, one can expect that a large segment of the insurance industry will eventually be owned by the banks.

Given the permissive legislative and regulatory framework, this ongoing concentration appears unlikely to abate until the major banks control the entire financial services industry. While a domestic competitive response to the banks is not likely, there are already indications that some of the foreign bank subsidiaries will broaden the scope of their activities to compete with the domestic banks in areas that the Canadian banks now control.

Foreign Access to the Canadian Financial Services Market

Foreign ownership in the financial sector has been a long-standing issue in Canada. Although the system was opened to foreign banks in the early 1980s, most types of financial institutions continued until quite recently to be governed by legislation that restricted foreign ownership. The general rule for ownership of banks operating in Canada is that no single person or group may own or control more than 10 percent of the voting shares of the bank and nonresidents as a whole may not own or control more than 25 percent of the voting shares of a bank. However, there are two important exceptions to this rule, one applicable to foreign banks (and, more recently, to other foreign financial institutions, provided that they are widely held), and the other applicable to Canadian financial institutions. An eligible foreign institution may have a wholly owned Canadian bank subsidiary, subject to the following rules and limitations:

  • the foreign institution must be either a bank or another financial institution that is widely held;
  • the home jurisdiction of the foreign institution must offer treatment as favorable to Canadian banks operating in that country;
  • the Canadian bank subsidiary of the eligible foreign institution must be wholly owned by it;
  • the foreign institution must demonstrate that it will be capable of making a contribution to the financial system in Canada; and
  • there must be room to accommodate the new entry under the limit of 12 percent placed on the share of aggregate Canadian assets of foreign banks in the domestic banking market.

These rules came about in 1981 when Canada opened its financial markets to foreign banks, and they were further revised by the 1991 banking legislation. When the Bank Act was amended to allow foreign financial institutions to enter the Canadian market by incorporating Canadian bank subsidiaries, minimum capitalization was set at Can$2.5 million, but, in practice, Can$5 million was required. The present capital requirement is Can $10 million.6 Approval to enter the Canadian market is granted on a country-by-country and bank-by-bank basis. One of the factors to be taken into account by the licensing authority is that of reciprocity, that is, whether Canadian-owned banks enjoy treatment as favorable in the country of the foreign bank. To maintain a strong Canadian presence, a restriction has been imposed on the total participation market share of the foreign banks through individual asset and aggregate limitations. The total domestic assets of all foreign banks were initially limited to 8 percent of the domestic banking market. The cap was subsequently raised to 16 percent of the domestic market, but, under the North American Free Trade Agreement, U.S. and Mexican banks were excluded from the calculation, and the cap has been revised downward to 12 percent. At present, the total Canadian assets of foreign bank subsidiaries are between 11 percent and 12 percent of the domestic banking market.

There are now 56 foreign bank subsidiaries operating in Canada. The stated political rationale for opening the market in 1981 was that foreign competition would give customers better services at lower prices and facilitate Canadian bank access to foreign markets. While it is debatable whether markets have increased, it is generally acknowledged that the foreign banks have had a very limited competitive impact on the domestic market. This is due in part to their concentration on high-end syndicated corporate loans, commercial paper, and government securities; the foreign banks have not entered the so-called middle market of business loans, where it was hoped they would concentrate their activities. The exceptions have been banks from countries with large immigrant populations in Canada, which have concentrated on serving their Canadian ethnic communities.

Financial and Commercial Linkages in the Canadian Financial System

Holding of Bank Shares by Commercial Enterprises

Ownership policy has been one of the most effective tools in Canada for achieving public policy goals in the financial services industry. Canada has diverse forms of ownership of financial institutions, ranging from widely held institutions to closely held companies to member-owned cooperatives. To a great extent, ownership policy has been aimed at preventing takeovers of Canadian institutions by nonresidents.

Despite the belief that the Federal Government would use ownership restrictions to strengthen policies to curb self-dealing and the concentration of power, as well as to promote the integrity of the credit allocation process and Canadian control of financial institutions, ownership restrictions were, in fact, relaxed for all segments other than banks in the 1991 legislative reform.

A hotly debated topic flowing from the ownership policy is the question of financial and commercial linkages. The ownership of financial institutions by commercial enterprises raises concerns about concentration of ownership, self-dealing, reduction of competition, and conflicts of interest. However, it is not easy to answer the question of whether the existence or development of commercial links, in itself, has a bearing on the risk of insolvency of financial institutions. Many countries have structures that permit commercial links to financial institutions and allow closely held institutions to be the norm, yet their financial systems are stable. The Canadian approach has been to consider large, widely held financial institutions as the objective toward which financial institutions should strive, while recognizing the need for exceptions in a less-than-perfect world.

As noted above, foreign bank subsidiaries are one exception to the rule that no single shareholder or connected group of shareholders may own or control more than 10 percent of the voting shares of a bank.7 The Bank Act contains another exception, which applies to start-up banks resulting from either a new incorporation or a continuance (a procedure whereby another financial institution transforms itself into a bank). These institutions, which may be wholly owned by a single shareholder, have ten years in which to become widely held. Despite this exception, commercial enterprises do not have an absolute right to hold an interest in banks greater than 10 percent. The Bank Act specifies that, in exercising its discretion to permit the incorporation of a bank in which a person will have more than a 10 percent interest, the Department of Finance may “take into account any activities of the [shareholder] … of a non-financial nature.”8 The intention of this provision is to constrain, without prohibiting outright, situations in which a commercial entity will hold more than 10 percent of the shares of a bank.

The Bank Act also allows a Canadian financial institution that is not itself a bank to hold more than 10 percent of the voting shares of a bank whose capital does not exceed Can$750 million for more than ten years, provided that it controls the bank.9 The shareholders of that financial institution may be commercial enterprises, but the financial institution itself may not have any substantial investments in commercial enterprises, except those in which a bank is entitled to invest directly.

In addition to the foregoing, when the capital of a bank in which a person has a significant interest reaches Can$750 million, the bank has five years to cause not less than 35 percent of its voting shares to be listed on a recognized stock exchange and to be held by shareholders who do not have more than a 10 percent interest in the bank.10

If a bank is not able to comply with the foregoing rules, it must transform itself into a trust company.11 A trust company may be controlled by commercial enterprises or by other financial institutions. However, a trust company with capital of Can$750 million or more is subject to the requirement of a 35 percent public shareholding of listed shares (but not the 10 percent significant interest restriction), unless it is controlled by a widely held financial institution.

Investments in Commercial Enterprises by Banks

Most Canadian legislation now governing financial institutions has incorporated the “portfolio” or “prudent investor” approach. Under this approach, each financial institution must establish and adhere to investment policies, standards, and procedures “that a reasonable and prudent person would apply in respect of a portfolio of investments … to avoid undue risk of loss and obtain a reasonable return.”12 This decree is coupled with quantitative rules on the composition of an institution’s portfolio.13 However, quality tests—so long a hallmark of Canadian legislation—have been done away with.

The Bank Act and other legislation governing financial institutions prohibit these institutions from having equity investments in excess of 10 percent in the shares of any commercial enterprise.14 As noted previously, financial institutions may own or control other financial institutions operating in a different sector of the market. Financial institutions are also entitled to invest in a number of enterprises whose goods or services are more or less related to the business of a financial institution. Included in these permitted investments are corporations whose business is factoring, financial leasing, information services, investment counseling or portfolio management, mutual fund promotion or management, and property holding or management.15 However, where a bank holds more than 10 percent of the shares of any such corporation, it must control the corporation. These investments by a bank in permitted subsidiaries may not exceed in the aggregate 100 percent of the regulatory capital of the bank.16

Solvency, Deposit Insurance, and Consumer Protection

Protection for savers and depositors has been one of the major policy trends of financial institution legislation and regulation over the past ten years. This trend is the result of countless failures in all sectors of the marketplace and the ever-increasing costs to the deposit insurance system and the public purse. One might ask whether governmental protection of the solvency of financial institutions continues to be a justifiable end. Why should the taxpayer support an expensive regulatory system that ultimately protects mostly the shareholders of financial institutions? Why should the taxpayer support deposit insurance schemes that protect deposit-taking institutions and their customers from consequences that these institutions largely bring onto themselves? Does government have a responsibility to protect savings in non-deposit-taking institutions? If not, why not?

In Canada, two reasons have been advanced by the Government in support of its greater involvement with the financial sector than with other facets of the economy. First, the financial sector occupies a central place in the economy through its role in the allocation of credit and as the core of the payments system. Second, financial institutions are in a unique position of trust in handling funds belonging to the general public. These concerns, together with the experience gained from the mistakes of the past, have led to ever-increasing regulation aimed at preserving solvency, not only to protect consumers but also—and more important—to maintain the stability of the financial system as an end in itself.

Certainly, the most important lesson learned by policymakers, regulators, and the financial services industry itself from the failures of the 1980s is that deposit insurance alone is insufficient to preserve the stability of the financial system. The other lesson is that, without substantial improvement, the deposit insurance system in its present form will not survive. Canada, like many other countries, has taken measures aimed at reducing individual failures of financial institutions and thereby preserving solvency and stability. The most significant measures adopted in legislation affecting banks and other financial institutions in Canada include the imposition of the Basle Capital Accord, the implementation of controls against self-dealing and related party transactions, and adoption of the prudent investor standard for loans and investments. All of the above measures have been combined with a stricter reporting and supervisory regime.


As in most other industrialized countries, capital adequacy has preoccupied bank regulators in Canada—some would say for an inordinate amount of time—over the past few years. Variants of the Basle Capital Accord17 apply to all federally regulated financial institutions other than property and casualty insurance companies. This regime comprises (i) the defining of capital, (ii) the risk weighting of assets, and (iii) the targeting of a ratio of 8 percent of capital to risk-weighted assets.

The major Canadian banks have all achieved the 8 percent target and are on average above 9 percent. The foreign bank subsidiaries are even higher as a group. The Canadian rules are quite stringent, compared with international standards.

Some technical adjustments have been made to the Basle rules as they apply to Canadian financial institutions. The definition of capital excludes certain forms of subordinated debt in the case of trust companies. For conversion of off-balance-sheet risks, the current exposure method is mandatory for establishing the credit conversion factor. Trust companies that lack a regionally or sectorally diversified portfolio are subject to higher ratios than the 8 percent minimum capital requirement and the 20:1 ceiling on the ratio of assets to capital. Rules are still evolving for derivatives and financial instruments related to securitizations, in particular, credit enhancements of securitization transactions.

Trust companies have traditionally been regulated on an unconsolidated basis in Canada whereas banks have been regulated on a consolidated basis. Assessment of capital adequacy requirements for trust companies is migrating toward a consolidated basis. Also, banks have traditionally been assessed on a going-concern basis whereas trust companies have been assessed on a liquidation basis, in which assets of little or no liquidation value are deducted. A shift toward a going-concern assessment for all financial institutions is taking place.

The basic Basle Capital Accord framework for assessing capital adequacy, as well as the setting of parameters for market risks, is well in place with respect to federally regulated financial institutions. The provincially regulated cooperative financial institutions are gradually migrating to the Basle Capital Accord framework from evaluation based on a fixed 4–5 percent ratio of capital to deposits. Certain transitional rules include lowering the initial minimum capital ratio to 6.5 percent, allowing a lower risk weighting for consumer loans (80 percent rather than 100 percent), and suspending implementation of rules for interest rate risk exposure.

It can be expected that the entire Canadian financial system will operate under the Basle Capital Accord framework within the next few years.

Control of Self-Dealing

In the latest revision of the Bank Act and other legislation governing financial institutions, strict controls were imposed on transactions between a financial institution and persons who are in positions of influence over, or control of, the financial institution.18 Although previous legislation included controls on self-dealing, the rules were generally inadequate, and persons and entities involved in self-dealing could easily circumvent them. The new policy is based on a three-tier approach: a ban on most transactions with “related persons”;19 internal controls for some permitted transactions, which are generally for limited amounts and involve standard arrangements;20 and prior approval from the regulator for special transactions.21

The following persons are considered as being related to a financial institution:

  • shareholders who own, directly or indirectly, 10 percent or more of any class, or any series of any class, of shares;
  • directors and officers of the financial institution;
  • auditors of the institution;
  • directors and officers of corporations who own, directly or indirectly, 10 per cent or more of any class, or any series of any class, of shares of the financial institution;
  • members of the immediate family of the above; and
  • the significant business interests of the financial institution or of the persons described above.22

In addition to the foregoing, regulators can designate individuals or corporations as being related to a financial institution, and they can exempt individuals from such status.23

Other Measures to Protect Solvency and Consumers

In the latest revision of its financial institution legislation, Canada adopted a number of additional internal governance measures applicable to all financial institutions. These measures include various provisions to avoid conflicts of interest, the strengthening of the role and liability of the external auditor, adoption of the prudent investor standard, and the placing of greater responsibility on directors, who have now been given the primary responsibility for overseeing the internal governance framework.

In addition to their general duty to manage and supervise the management of the bank (or other financial institution), the directors are obliged to

  • establish an audit committee;
  • set up a conduct review committee, which must approve all related-party transactions;
  • establish procedures to resolve conflicts of interest, including techniques to identify potential conflict situations and restrict the use of confidential information;
  • designate a committee of the board of directors to monitor the conflict-of-interest procedures;
  • establish procedures to provide disclosure of information to customers of the bank to deal with complaints;
  • designate a committee of the board of directors to monitor the information and complaint procedures and satisfy itself that they are being adhered to by the bank; and
  • establish investment and lending policies, standards, and procedures in accordance with the prudent investor standard.24


The general thrust of recent Canadian legislative and regulatory policy has been to re-examine the traditional approach, so long in vogue, of assuring stability in the financial system by restricting the ability of banks to compete with other financial institutions, restricting the ability of non-bank financial institutions to compete with banks, and protecting depositors with generous deposit insurance, regardless of the risk and yield on those deposits. Although barriers remain, great strides have been made in allowing affiliation and competition among financial institutions serving different segments of the market. A price has been paid for this breakthrough in the form of greater concentration, which inevitably heightens concerns about systematic risks. To a large extent, the traditional controls have been replaced by more stringent internal governance requirements and a tighter regulatory framework.

It is not clear yet whether these developments have led to a more even playing field for the different types of institutions and to greater competition—and, hence, better service—for the customer.

The new, strengthened internal governance regime is likely to have a significant effect on the conduct of financial institutions. The Canadian courts have not yet had occasion to interpret the prudent investor test. However, experience elsewhere would lead one to conclude that the prudent investor standard—and the resulting liability of directors for failure to observe it—may be a powerful deterrent to improvident loans and investments.

Given the fast-changing nature of the financial world, some observers may ask whether the steps taken by Canadian policymakers may risk impeding the development of the kind of dynamic and efficient financial system that the economy needs to grow and prosper. Is too much being sacrificed in the name of soundness and consumer protection, thereby preventing market forces from playing their important role in shaping the financial system? Only the future can tell whether the right balance has been struck.



The two preceding chapters describe how the banking systems of the United Kingdom and Canada are confronting changes in the foreign financial services marketplace, as well as in their own domestic financial marketplaces. Even though the two banking systems are quite different in certain aspects, there appear to be some salient common themes in how each system is evolving and in the types of financial supervisory and regulatory issues that each is confronting. Some comments on the U.S. banking system would help give a broader context to the discussion and bring into clearer focus how the Canadian and the U.K. banking systems compare with another major world banking system.

At least four general themes or trends are apparent in the banking systems of Canada, the United Kingdom, and the United States. These trends have been under way for a number of years and have reached a mature state in some cases. The United Kingdom, for example, already appears to have attained self-regulation, whereas the United States and Canada are not quite so far along. In other areas, the United States or Canada has led the way.

Breaking Down Geographic Barriers

First, there has been a general breakdown of the geopolitical boundaries that formerly excluded foreign competition from national banking markets, as well as a breakdown of internal barriers to geographic expansion. This trend is evident in Canada in the increased opportunities for foreign access to the Canadian banking market, resulting from changes in Canadian law in the early 1980s, the Canada-United States Free Trade Agreement,1 and the North American Free Trade Agreement.2 In the United Kingdom, this theme is evident in the application of the Second Banking Directive of the European Community,3 which effectively creates a European banking license under which banks in the European Union can operate with ease across national boundaries. In the United States, a national treatment policy, with open access to foreign competitors operating in the United States, has long been in effect.4 The U.S. trend seems to be more internal than external. Interstate banking by bank holding companies has increased dramatically as a result of changes in the laws of the individual states. In addition, the U.S. Congress has enacted legislation that eliminates federal barriers to interstate branching.5 So, in all three banking systems, the elimination of geographic barriers to the provision of banking services seems to have been a consistent theme over the past decade.


The second theme is the consolidation of the financial services industry, that is, the combining of the banking, securities, and insurance sectors through common ownership and other relationships. This trend is evident in the changes in Canadian law in the mid-1980s that allowed banks to acquire securities firms, insurance companies, and trust and loan companies.6 In the United Kingdom, to the extent that there ever was a legal separation between commercial banks and securities firms or investment banks, this barrier was lifted in the so-called Big Bang of the mid-1980s. In the United States, the law has been interpreted to permit banks and bank holding companies to acquire securities firms and to engage in the sale of insurance nationwide through networking and referral arrangements, as well as from small towns (the so-called town-of-5,000 loophole). The United States probably has the most restrictive law, the Glass-Steagall Act,7 which historically has separated the banking industry from the securities industry. Even though this law is still on the books, however, it has failed to stop this trend.

In each of the three countries, barriers to competition among different types of financial institutions are being removed, and legal distinctions among them are blurring. In each country, nonbank financial service firms are actively engaged in lending and other credit activities. Banking institutions increasingly are involved in providing nontraditional financial services, including securities and insurance activities and leasing. The role of banks is becoming significantly broader, and the definition of “banking business” is expanding. It might be fair to refer to the “financial services industry” as a separate generic industry, rather than to the “banking industry” or the “securities industry” or the “insurance industry.” Although it has not quite occurred yet, one can expect to see in the future a continuing consolidation of the different financial sectors into a single industry.

Self-Regulatory Measures

The third trend is the increase in self-regulatory measures in the form of new emphasis on policies and procedures and the role of the board of directors of financial institutions. This trend is noticeable in Canada, the United States, and the United Kingdom, the latter of which has had a long tradition of self-regulation.

The governmental regulatory authorities in these countries are by no means relinquishing their regulatory jurisdiction. However, the consistent theme is to encourage or to require banks to create policies and procedures to deal with, for example, the monitoring and managing of risk, conflicts of interest, and money laundering, and to respond to customer complaints and strengthen customer protection through the creation of internal audit committees. Instead of requiring that loans or investments be directed to certain sectors or subject to specific limits, Canada now requires the banks to adopt policies and procedures to ensure that they invest their funds as would a prudent investor.8

This third trend represents a particularly healthy development. Rather than dictating rigid, across-the-board solutions to problems, the role of government increasingly is to identify specific problem areas and to allow or to require each bank to develop its own policies and procedures for dealing with the problems as they affect that particular institution.

The preceding three common themes in the banking systems of Canada, the United Kingdom, and the United States suggest a number of interesting issues for further discussion. For example, what type of regulatory structure is most appropriate for a consolidated financial services system? Is it functional regulation, where banking, securities, and insurance functions are regulated separately? Is it entity regulation, where a conglomerated financial services organization is regulated on a consolidated basis? Or is it some combination of functional regulation and entity regulation? This debate is unfolding in the United States. The U.S. Congress has held hearings on the regulation of bank securities activities in the marketing of mutual funds, focusing in particular on whether the Securities and Exchange Commission or the banking agencies should primarily regulate these activities.9 The banking regulators favor entity regulation, whereas the SEC favors functional regulation. What probably will continue is a combination of the two types of regulation.

Another question is, What is the role of a nation’s central bank in a consolidated financial services system? Should the central bank be the supervisor and regulator of financial conglomerates that include not only banks but also securities firms and insurance companies? The role of the central bank in the United States has been heavily debated over the past year, with the result that the central bank (the Federal Reserve System) most likely will continue to play a significant role in banking supervision and regulation. This role also will likely extend to the supervision of banks, to the extent that they engage in securities and insurance activities. The federal banking regulators have made clear that they intend to play a role, but that they will also respect the right of other agencies to regulate on a functional basis where the latter have jurisdiction.

Other questions remain. What are the implications for systemic risk of a consolidated financial services industry within a single country, as well as within the global financial market? How is each country dealing with such risk? How does each system regulate relations between banks and their affiliates? How does each system coordinate supervision and regulation of banks operating across geopolitical boundaries? What capital requirements should apply to a consolidated financial services entity?

Social Responsibility

The fourth, and final, theme is the increasing recognition that banks have a social responsibility. In the United Kingdom, a new emphasis has been placed on the responsibility of banks as owners of property under environmental protection laws. Certainly, there is also a very great focus on that issue in the United States. In fact, legislation has been pending before Congress specifically addressing the responsibility of banks and the limits on their liability for environmental cleanup costs.10 In the United Kingdom and Canada, consumer protection is increasingly emphasized.

The United States is the leader in this area. Arguably, the United States has the most stringent consumer protection laws in the world. Many banks feel somewhat overburdened by their responsibilities in this area. The United States enforces not only consumer protection laws but also affirmative obligations on banks to lend money to low-income areas.11 This is a subject to which the Administration has given some priority in its legislative agenda. Congress passed legislation in 1994 authorizing community development banks,12 and it is expected that debate will continue in the United States about the obligation of banks to allocate credit to low- and moderate-income areas.

Of final note is money laundering, an area that all banks undoubtedly will be asked to focus on for the purposes of crime control. It is a form of social responsibility, to the extent that banks are being asked to participate in crime control. There has been an increased focus on money laundering in the United States,13 as well as in the United Kingdom14 and Canada.15


It is extremely important to the continuing development and improvement of the U.S. banking system, as well as of the global banking system, to share and discuss information about banking systems around the world. The exchange of information and ideas on issues of mutual concern is for the mutual benefit of all.

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