How The Monetary System Works - And the Fraud of the Canadian Banking System

How The Monetary System Works – And the Fraud of the Canadian Banking System

How The Monetary System Works 

This article analysis the intricacies of the present monetary system.
An excellent resource on how to understand the inner workings of the monetary system has been done by Canadian activist and documentary filmmaker Paul Grignon.
Grignon has created a 3 part video series titled: Money as Debt. This article presents the information found here Grignon’s series.
Refer to the links above to be redirected to the  informative Money as Debt video series found on YouTube.
In part 1 of his series, Grignon provides an excellent account of how  money systems in the past have operated, and he cites many examples of how private financiers have taken over and dominated the economy for their selfish interests. These money systems are acknowledged below.

Forms of Monetary Systems

In the past, anything could have been used as money provided that it was portable and exchangeable for objects of real value. In this way, shells, feathers and eventually gold became a form of money used to exchange goods such as food and other resources.
In the 1600s there were goldsmiths who were able to mend the shape of gold into coins whose weight and purity were certified. The goldsmith’s skill enabled them to achieve a higher status in the society at the time.
To safeguard their gold, the goldsmiths housed their gold in large vaults, and later rented these vaults to other depositors to safeguard their own gold in exchange for claim checks.
These claim checks were receipts issued by the Goldsmith. The number on the checks represented how much gold an individual could withdraw from the goldsmith’s vaults.
Over time, the goldsmiths had learned that their depositors rarely withdrew the gold that they had deposited into the vaults. As a result, goldsmiths began to issue receipts, not only for their personal gold but also for their depositor’s gold. As a result, they earned additional interest revenue on their depositor’s gold.
In exchange for using their depositor’s gold, the goldsmiths offered interest rates to depositors similar to how banks today offer interest rates on our deposits.
Over time, goldsmiths noticed they could become even wealthier if they issued receipts on the gold they did not possess. And in fact, this is what eventually would happen.
This enabled the goldsmith’s to amass a great amount of personal wealth, and as a result of this excess wealth, many rumors spread that the goldsmith’s wealth had been based entirely on the depositors gold.
This caused depositors to doubt the reliability of the goldsmith’s promises to repay their gold and resulted in a run on the banks. Essentially this happens when depositors lose confidence in the money system and seek to withdraw all of their deposits out of the vault.
And at that time, the depositors had demanded to receive all of their gold from the goldsmiths at once. Since there were more receipts of gold than actual gold in the vaults, many depositors did not receive their gold and became outraged.
Despite this outrage, the excessive creation of gold claim checks was necessary to boost expansion. That is why, instead of outlawing the goldsmiths, the goldsmiths had been authorized to lend the gold under a fractional reserve system.
Under this reserve system, goldsmiths could lend at a fixed ratio of receipts to gold in their vaults. It was at this time that the first initial banking class had been created.
Over the next 200 years, the nature of the banking system morphed from a gold backed currency into a complete fiat currency. Fiat currency is money that is declared legal tender by the government. It is backed by the government’s promise to pay.
“Legal tender” means that the courts have the authority to enforce that any transactions be paid in fiat currency.
Thus as is evident, the nature of the manner in which commerce and money is lent and deposited had changed from things such as seashells/feathers/grains of barley, to gold and silver coins, to gold backed currency, to fiat currency, and finally to the current debt-based currency which is private banking credit.

 Present System

To the surprise of many, cash and coins only make up between 1 to 5% of the money in circulation. The rest, over 95% of the money in existence today comes into existence as bank credit created by private banks.

Bank credit, otherwise known as “Checkbook money,” is a form of money that is created when a borrower pledges an asset as collateral to take out a bank loan. The asset pledged as collateral is usually the object the borrower intends to buy using the loan.
For example, if a borrower intends to buy a car with the loan he has obtained from the bank, then the asset pledged as collateral in the event of a default, is the car itself.
It is important to distinguish the terms of the loan from the banker’s and the borrower’s perspective.
When banks hand out loans to borrowers, they accept a pledge of collateral in the event a borrower defaults on their loan, and in exchange, they offer the principal (loan) to the borrower.
When a borrower takes out a loan, they are making a “promise” to pay the bank the amount of the principal plus interest on the loan.
Some have characterized this system of granting loans as being fraudulent, since the borrower can pledge as collateral an asset he does not yet own (i.e. pledging a car you want to buy with the loan money).
The Banks are also complicit in this fraud by accepting the pledge and offering the borrower a loan.
Keep in mind that the money loaned by banks is usually not in the form of real money but rather a “promise to pay” to the borrower. This is not evident initially because the bank credit that is deposited into the borrower’s account shows an increase in the amount of the loan.
In reality, banks do not offer the borrower anything except a “promise to pay” just as the borrower has “promised to pay” the loan. This represents an exchange of promises; no real cash transfers hands.
Through this monetary system, it is possible for the borrower to buy a real good such as car without a single dollar being put up by the banks.
This then leads one to seek out the manner in which private banks create money.

Money Creation

If a borrower can buy a real good such as a car with virtual bank credit, than why don’t the banks simply buy everything and loan it out to borrowers at an interest?
Contrary to what many people believe, banks cannot create bank credit without deposits. The bank creates credit on the pledge of the borrower. If there are no borrowers, and no incoming deposits into the bank, then the bank cannot issue more money or bank credit.
The implications of this are many. With the way the private banking system operates, in periods of slow economic “growth”, banks are incentivized to favour immigration as a means of expanding their operations since immigrants deposit their money at the banks.
This helps continue the chain of the system to keep on shifting.
The excess bank credit that is created then complicates matters further.

Effects of Bank Credit

Initially, bank credit spent into existence can increase the money supply, stimulating new production by temporarily enlarging the economy.
Bank credit spent in the form of home mortgages often stimulates the residential construction industry and creates jobs for those in the real estate sector.
After this temporary stimulus however, the bank credit becomes a liability since it dilutes the money supply and devalues the purchasing power of everyone in the economy.
In that sense, bank credit is no different than counterfeiting which dilutes the real money supply with fake money if left undiscovered.
Bank credit is only extinguished when the borrower repays the bank the amount of the principal + interest. As seen below, there is a basic accounting flaw in the monetary system used by the banks.

Accounting Flaw

Banks are able to lend by creating credit from the borrower’s pledge to pay which is backed by nothing.
This pledge to pay is listed as an asset on the bank’s ledgers (a document of all the banks accounts) and is the principal of the loan + the interest.
The loan or the promise to pay the borrower is listed as a liability on the banks ledger, and represents the principal of the loan.
Already, one can see the accounting flaw on the banks ledger sheets – that the banks liabilities do not equal their assets.
Bank Ledger
Assets (Principal + Interest) =/= Liabilities (Principal).
This system is bankrupt by design as the total debts owed by the borrower (P+I) are greater than the total assets (P).
Another interesting thing to consider is that while banks create the amount of the principal in the form of bank credit, they do not create the interest.
So where does this interest come from?


In a stable monetary system, the interest needed to pay the loan should come from the banks.
Any interest revenue banks receive from the borrowers through interest payments should be redistributed in the form of;
  1. Dividends to shareholders
  2. Interest Payments on Deposits
  3. Bank Operating Expenses (Paying Bank Staff)
Since the interest is not created by the banks (yet the loan is), the interest revenue gained must in its entirety, be completely recycled through one (or more) of the above forms in order to allow people to earn it and pay the interest on their loans.
For all borrowers to be able to make their payments of principal + interest two things must be true
  1. The dollar, created as the principal of the loan, must be available to be earned by the borrower in order to make the principal payment to extinguish that dollar
  1. Every dollar the borrower pays to the bank as interest must also be available to be earned by the borrower
In Canada, as in most other countries, the two conditions are not met. The current banking system in Canada does not force banks to redistribute their interest revenue back to the people, nor does it stop banks from re-loaning or hoarding the interest revenue for its own benefit.
In order to be able to pay this interest off, the interest revenue must be spent.
If the interest revenue is re-loaned at interest or hoarded then there is an inherent shortage of money to pay off the aggregate debt. A shortage of the money necessary to pay the principal + interest results in defaults as some borrowers will not have enough money to pay the interest.
Defenders of the current monetary system argue that if all interest charges can be earned, then all loans can be repaid. If the Canadian government actually enforced that all interest revenue must be redistributed by the banks, then the above argument would hold true, but sadly it does not.
The argument is also false when one realizes that banks are not the only ones that offer loans, secondary lenders also offer loans and they can charge interest as well.
If a secondary lender manages to get a hold of money issued by the bank, then they can relend it at interest. The end result is that the same money is earning two types of interest.
So even if banks redistribute their interest revenue in a way where people could earn it, there is no guarantee that secondary lenders would not redistribute it as well.
In the event that a secondary lender hoards the money that has been first created by the banks, then the interest to pay that money will never be earned by the people, and the difference must constantly be borrowed forever resulting in a perpetual cycle of debt.

Perpetual Debt

This perpetual cycle of debt that is created has been a recurring problem that has plagued human civilization for centuries. In Ancient Rome, moneylenders had charged interest on the gold coins they had lent out.
With gold being a scarce commodity, the act of charging interest in a fixed money supply system led to enormous complications for the Romans. The act of charging interest on gold, quickly privatized the supply of gold into the hands of the moneylenders themselves.
The lack of gold placed an enormous strain on the government of Rome and eventually led to its demise.
Today, one can still see the effects of the convoluted monetary system in Canada. Banks have exerted an unprecedented amount of influence over the global economy through the practice of tightening and loosening the money supply through loan requirements.
By tightening the flow of bank credit the banks can significantly reduce the money supply causing a deflationary spiral.
Alternatively, banks can also offer massive amounts of loans to individuals at very low interest rates to spur the economy into a booming inflationary period.
In fact, the private banks operating in Canada have been adopting this practice today.
To illustrate the effects of the monetary system on inflation and deflation, we present the scenarios of deflation and inflation below;

Deflation and the Monetary System

When individuals and businesses confidence in the economy is shaken, this leads to deflationary pressures in the economy and the money supply becomes restricted since people do not want to take out loans or incur any risks.
With no incoming loans, the money supply becomes even tighter as banks cannot create additional bank credit since no deposits are coming in.
With no money, consumers are not buying and businesses have no choice but to reduce the price of goods to boost sales. The end result is that businesses are often left with excess inventory that no one wants to buy.
In such an economy, one alternative to address this,  is increased government spending (stimulus).
Governments can either create the money they spend (debt-free) as Canada has done prior to 1974 with its Bank of Canada, or they can choose to borrow money from the private banks at compound interest.
Unfortunately, since 1974, Canada has opted to borrow from private banks and the result of this decision continues to affect Canadians to this day as the net debt is over $1.1 trillion.
As another strategy, the government may also implement tax cuts to spur consumers into buying more goods and services.

Inflation and the Monetary System

When businesses and consumers have a strong confidence in the economy, this creates inflationary pressures since when businesses are seeking to expand, there is a race for loans as other businesses also seek to expand in order to keep up with competitors.
With so many loans being created, the money supply over-inflates, and the purchasing power of the public is significantly reduced.
In addition, by offering loans to people with questionable backgrounds, the bank exposes itself to the risk of defaults by the borrower.
Borrower’s that cannot afford to pay back loans must pay the bank with their collateral. If many defaults occur at once such as in the mortgage market, the price of the collateral (house) can drop significantly thus forcing heavy losses and even bankruptcy.

Banking Benefits

The moneylenders of ancient Rome enjoyed the private accumulation of gold through the use of interest charges, but what do their modern counterparts receive?
One of the most obvious benefits received to the private banks, is the interest revenue obtained from interest payments on consumer loans and mortgages. The banks can use this profit to speculate on the open market and engage in risky speculative bets in the unregulated derivatives market.
Banks can also use their excess credit to acquire large portfolios of corporate and government bonds, which allows them to heavily influence decisions that pertain to industry and government.
Perhaps the most lucrative benefit for banks is their ability to acquire real world assets such as homes and cars in the event the borrower defaults, all without ever having to spend any real money.
Even in the worst case scenario, banks can always rely on the government to provide bailouts financed through increasing tax payer debt which would affect their children’s outcomes as well.


Throughout history, the monetary system has evolved into the current system we have today. The system manifests itself through the lucrative benefits given to the bankers as well as the perpetuating debt placed onto the Canadian public.
It is clear that the monetary system is prone to failure as the assets (principal) do not equal the liabilities (principal + loan).
In a system where interest revenue is not re-spent into the economy, borrowers must fight amongst themselves in a money supply of which 95% is interest bearing bank credit.
The  monetary system also takes away more and more government revenue to pay the interest on the net debt.
This forces the government to enact difficult decisions including austerity cuts as mentioned in Part 1 of the series.
Many individuals have criticized and attacked the monetary system and the system has just recently come under fire by a 12 year old girl named Victoria Grant.
In the following video, Grant presented a speech explaining how the private banking system has worked with the government to extract the financial wealth of the Canadian people.
In her speech, Grant discussed the Bank of Canada’s historical role, and how the Canadian government neglected their right to borrow interest-free money from their central bank as was authorized in the Bank of Canada Act.
Victoria Grant explanation

The History of the Bank Fraud of Canada Part 1

The History of the Bank of Canada

This article provides a history of the Bank of Canada, and examines in detail three key events that have radically changed Canada’s fiscal position.

To begin with, the article presents the historical context of the Bank of Canada and why it was created. The key dates we examine are 1934, 1938, and finally, 1974.

It is important to note, that prior to the 1930s, Canada had no reason to create a central bank. At this time, the banking system in Canada had been comprised of several large private banks, many of which issued their own currency.

The banking system was sufficient and supplied the needs of Canadians up until the Great Depression in 1929.

Bank of Canada – 1934

The great depression devastated Canada for much of the 1930’s. At this time, hundreds of American banks had failed, yet none of the Canadian banks had failed during this time. However, there had been a huge strain on the Canadian economy because there was a contraction in the money supply, as much as 27%.

As a result of this contraction, people were not able to receive access to loans, businesses were not able to expand, and at the same time more people were seeking jobs. The intense competition in the labour market drove down the price of wages.

This period of high unemployment and economic instability forced many Canadians to question the cause of the great depression.

Canadian Jerry McGeer – a popular advocate on monetary reform – claimed that the policies of the Canadian banks had been responsible for the effects Canada felt due to the great depression.

One of the reasons McGeer, and a vast majority of other Canadians, had held the banks responsible for the great depression had been because of the failure of the Finance Act in 1923. The act granted upon the Department of Finance the power to advance dominion notes (i.e. cash reserves) to banks upon pledge of securities. The Finance Act was originally created in order to protect Canadians from situations similar to the great depression, by allowing the Department of Finance to control the cash reserves of the Canadian banks.

With the failure of the act, many Canadians wanted something to protect them from the great depression.

In accordance with the majority of Canadians, the Prime Minister of the day Richard Bedford Bennett called for a Royal Commission in 1933 in order to determine the cause of the recession.

The Royal Commission has historically been used in Canada as a major public inquiry in order to investigate the issue that is under study. In this case, it was on matters of banking and finance.

Bennett steered the Royal Commission to examine the current banking system in Canada and Bennett also wanted the Commission to consider the arguments for and against a central bank.

When Bennett had issued for a Royal Commission on the matter, he said;

The organization and working of our entire banking and monetary system [and] to consider the arguments for or against a central banking institution.

And in the summer of 1933, the Royal Commission issued its report titled The Royal Commission on Banking and Currency in Canada which examined the arguments, as well as investigating the underlying causes of the great depression.

Below is a list of the members that had been part of the Royal Commission

  1. Lord Macmillian – Former Chairman of British Macmillian Commission, also a British Jurist
  2. Sir Charles Addis – A reputable British International Banker
  3. Sir Thomas White – Canadian Finance Minister During WW1
  4. J.E. Brownlee – Prime Minister of Alberta
  5. Beaudry Leman – General Manager of the Banque Canadienne Nationale

The Royal Commission recommended the creation of a Central Bank.

Not long after, Bennett followed the report’s recommendation and established the Bank of Canada Act in 1934.

Bank of Canada Act – 1934

The creation of the Bank of Canada Act in 1934 proposed several key changes to the then banking policies.

Among the changes were;

  •  The Central bank (Bank of Canada) must keep 25% of their reserves in gold
  • The Bank of Canada (BoC) had the right to issue notes
  • The Chartered banks had to retire their note issues (money they created)
  • The BOC’s mandate was to act as the banker to the government and manage public debt
  • The Commercial banks had to keep at least 5% in reserves with the BOC either in the form of deposits or central bank notes
  • The creation of the Bank of Canada Act ultimately led to the creation of the Bank of Canada itself in 1935 as a private central bank.

The idea of a private Central bank however, was strongly opposed by several key individuals of the 1930s.

Among them was Canada’s 10th prime minister William Lyon Mackenzie King who amended the Bank of Canada Act in 1938 which led to the nationalization of the Bank of Canada.

Bank of Canada – 1938

One of the key individuals to influence King’s decision to nationalize the BOC was his advisor Gerry McGeer, a major proponent for the nationalization of the central bank.

King’s decision to nationalize the BoC demonstrated remarkable foresight as he understood that the key to a stable and debt-free economy was to have government control of currency and credit.

It was Mackenzie King himself who had once said,

Once a nation parts with the control of its currency and credit, it matters not who makes the nations laws. Usury, once in control, will wreck any nation. Until the control of the issue of currency and credit is restored to government and recognized as its most sacred responsibility, all talk of sovereignty of parliament and of democracy is idle and futile.

For many decades since 1938, the Bank of Canada provided near interest free loans to the Canadian government.

As a result of these loans, Canada had increasingly become prosperous and developed quite substantially, with the money created being used to build highways such as the McDonald-Cartier freeway, public transportation systems, subway lines, airports, the St. Lawrence Seaway, funding the universal healthcare system, and the Canadian Pension Plan.

The effects of King’s decision would last all the way until 1974, when the Trudeau government made the decision to halt the borrowing of money from the Bank of Canada, and instead, choosing to borrow from the private banks at compounded interest.

Bank of Canada – 1974

There are two major explanations why the Trudeau government decided to stop borrowing money from the Bank of Canada, and instead choosing to borrow from the private banks.

These include:

  • Popular Public Opinion by Canadians, of the Crisis in the mid-1970s
  • International Basel Committee’s Recommendations

In the first explanation, the public  in the mid-1970s Canada was facing an oil crisis along with many of the other nations in the west.

The public misattributed the economic effects of stagflation as having been created out of the Bank of Canada This stagflation had little to do with the Bank of Canada and more to do with the rising prices of energy as well as the stagnation of wages.

In fact, the energy crisis that gripped Canada’s economy had much to do with the Oil and Petroleum Exporting Countries (OPEC) oil embargo. The OPEC’s oil embargo resulted in the quadrupling in the price of oil and the cost of this increase required Canadians to spend more of their income on energy.

The rise in oil prices had also been accompanied by an increase in the unemployment rate as new and existing workers were seeking more jobs to pay for the increase in the price of goods. The increase in unemployment naturally drove down the cost of wages since competition in the labour market was fierce.

In addressing the second explanation, the government borrowed from private banks based on the recommendations of the Basel Committee. The Basel Committee is an international think-tank type of organization that is composed of the central bank governors of the G-10 countries.

A prime objective of the Basel Committee had been to maintain monetary and financial stability. To achieve this goal, the Committee had discouraged governments from borrowing money from their respective central bank and instead, encouraged governments to borrow money from the private banks.

The Committee’s rationale had been that borrowing money from the central banks would create inflationary pressures and cause the value of the currency to drop.

Previous finance minister Paul Martin has agreed with the Basel Committee’s view of the Bank of Canada as a cause of inflation. During an interview in the documentary movie Oh Canada: Our Bought and Sold Out Land! Paul Martin claimed that printing interest-free money would “drive inflation through the roof”.

Regardless of which explanation is used, we can see clearly that Canada’s net debt rose significantly beginning in 1974.

It was at this time that the Government had borrowed from private banks. The growth of Canada’s national debt is indicated below.

From the graph, one can see that after 1975, Canadian federal debt grew for the next 12 years at more than 20 percent per year. Currently, Canada’s national debt stands over $1.1 trillion and taxpayers are forced to pay over $30 billion in interest on the debt every year.


Thus as one can see, the private banking system has been a prime facilitator in the indebtedness Canada is currently in. 


It is inevitable, based on how the money system operates as indicated in Part 2 of the series, that more and more money will have to be spent to pay the interest of the net debt.

This leads to a situation where governments have less money to spend on education, infrastructure, and social programs and as a result, leads them to implement ineffective tax cuts and austerity measures in order to save money.

To address Canada’s economic health, many prominent academics have begun to speak up on the issue calling for monetary reform. We address these leaders in part 4.

Download the PDF File Click Here

Historical Content - Canada’s Deregulated Financial Industry Part 2
This article digs into the historical context for deregulation – a process which had been on-going for a number of decades.

Pillar System

The full extent of the financial deregulation process began in the 1980’s.
It was at this time, that financial deregulation through government policies, allowed for the banks to diversify and expand their financial activities.
By then, the Canadian financial services sector was not divided into distinct “pillars” of specific financial institutions such as banks, insurance companies, brokerage firms, and trusts.
From the 1930s until the 1960s, Canada’s financial institutions were regulated according to the “pillar” system.
Under the pillar system, Canada’s financial system operated under 4 distinct pillars: chartered banks, insurance companies, trust companies, and investment dealers.
Each of these were regulated as separate financial institutions. Each pillar carried out functions that were separate and distinct from that of the other pillars and virtually no overlap among the pillars was permitted.
The Great Depression of the 1930’s brought grave concerns of the solvency and stability of the banking system, which prompted a wave of bank failures (particularly in the United States) during the Depression.
This motivated Canada to move towards this form of regulation, which was designed to guarantee the independent functioning of each sector and to minimize the possibility of negative spillover from one pillar to another.
In this pillar system, an individual would save their money or receive a loan from a bank.
An individual would purchase stocks and bonds from a broker. An individual would buy insurance from an insurance agent. And an individual would buy mutual funds from a mutual funds sale representative.
However, due to government changes in regulation, this pillar system was eventually disbanded and financial consolidation within the big banks was allowed and this led to a convergence of financial power, and versatility, where most of an individual’s financial services and products could be obtained through a handful of financial institutions.
Until the 1950’s, the core functions performed by each pillar remained quite separate and distinct. The main reasons for separation were to ensure stability and to avoid conflicts of interest. So for example, under a pillar system, a bank providing loans to a given firm and underwriting and selling that firm’s securities would face a potential conflict of interest.
And as it stands today, in this increasingly fiscally liberalized era, much consolidation was committed between the ‘Big 5′ Canadian banks, and brokerage firms and trusts. The shape of Canada’s financial industry today has become dominated by a small handful, of large, diversified financial conglomerates functioning on a transnational scale.
To truly understand just what was deregulated in the financial services, it is important to learn what was regulated in the first place; in attempts to make for a more sound and stable banking system. These factors are looked in depth below.

Biggest Regulatory Changes


Also in this year, the 10/25 rule was introduced so as to reduce foreign ownership of Canadian banks.  Under this rule, no single investor could hold more than 10 % of a bank’s voting equity, and foreigners in aggregate were prohibited from owning more than 25 %. This 25% rule would require banks to be widely held to help ensure the separation of financial and commercial activity and prevent the possibility of questionable self-dealing between a financial institution and its major shareholders.
While the provisions limiting foreign ownership were phased out by the Canada-US Free Trade Agreement, NAFTA, and GATT,  the banks are still required to be widely held.


Also in 1980, foreign banks were permitted to establish banking subsidiaries in Canada, however they were classified as Schedule II banks. Provisions were included in the bill, to prevent Schedule II institutions from competing in certain markets.
However, a ‘ceiling’ limit was placed on the size of the total foreign banking sector, equal to 8% of total banking assets in Canada. Amendments were introduced to bring foreign-owned banks under federal regulatory control. Previously, foreign owned banks were provincially regulated.


Also in 1992, when the pillar system was removed, another major reform was introduced. Until this time, the chartered banks were required to hold reserves with the Bank of Canada. Reserves were intended to serve as protection against insolvency and allowed the central bank to influence the money supply by adjusting reserve levels.
However, the banks had complained for years, that reserves constituted an unfair ‘tax’ that placed them at a competitive disadvantage compared to other financial institutions. Thus bank reserves were quietly phased out over 2 years starting in 1992. This major concession to the banks was enacted by the Mulroney government with little public debate or awareness
Also permitted under the amendments, financial institutions were granted permission to own corporations that carry out related financial services, such as the purchase and sale of accounts receivable. Furthermore, financial institutions were permitted to own up to 25 % of shareholders’ equity or 10 % of voting shares of non-financial corporations.
As a result of these revisions to the federal Bank Act and other legislation’s, there has been a substantial breakdown of the pillar system and many of the barriers to entry in the financial services industry have been either eliminated or reduced.
As a result, the focus of financial service regulation has shifted from concerns about solvency to a focus on competition.


With the permission to allow foreign banking subsidiaries in 1980, the federal government took additional steps to open the financial services sector to foreign interests in the late 80s.
The Canada-US  Free Trade Agreement (FTA) deal was crucial in its inclusion of services including financial services, in a trade liberalization agreement.
Through the signing of the Free Trade Agreement, US interests were excluded from the limits on foreign ownership of specific Canadian banks, which is the the 25% rule brought about in 1992, as well as the foreign ownership of the Canadian banking sector as a whole.
With the signing of the North American Free Trade Agreement (NAFTA), Mexican interests were also excluded from the regulatory limits as well.
Through the Uruguay Round of GATT and the development of the General Agreement on Trades in Services (GATS), these limits were removed altogether in 1994.
As has been presented above, since the 1980’s, successive Canadian governments have encouraged, and nurtured the increasing consolidation of financial power.
Public policy on all levels has also followed on the recommendations made by the major banks and the corporate boards of Canada. Thus, looking back, it can be said the Federal Government’s open embracing of neo-liberalism has generously benefited the Canadian banks.
The Banking Empire Deregulation of Canada's Financial Industry Part 3
The Banking Empire Deregulation of Canada’s Financial Industry Part 3
As Canada Deregulated Financial Industry examines, the “Big 5″ Canadian Banks: Royal Bank of Canada, TD-Bank, Scotia Bank, CIBC, and Bank of Montreal have increasingly benefited and profited from deregulation and market liberalisation.
This piece examines the effects deregulation has had on the big 5 Canadian banks.
The internationalization of financial markets since the late 70’s, coincided with the deregulation of Canada’s financial industry which began in the early 80’s.
Since deregulation policies were introduced, Canadian banks significantly expanded their domestic and international operations.
Yet even as they grew larger, their relative size and importance in comparison to competitors in other markets made them look weak and ineffective.
Their international ranking based on assets had declined relative to other international banks.
In 1970, three Canadian banks were amoung the 25 largest banks in the world ranked by assets.
By the 1990s, Canada’s largest bank (RBC) was ranked approx 50th in the world. The chart below depicts the trend.
Even with the presence of deregulation, Canadian banks were still losing ground in the international markets.
Realizing the implications of impending foreign competition, the major big 5 banks called for greater market liberalisation with open arms.


Financial deregulation by the federal government allowed the banks to diversify and expand their financial activities.
The Canadian financial services sector was no longer divided into distinct pillars characterized by specific financial institutions and their core business activities, namely banks, insurance companies, brokerage firms, and trusts.
In this liberalized environment, the banks diversified and took over many domestic firms. Entire sections of Canada’s financial industry, in particular the independent brokerage firms and trusts were merged with, or bought out.
The marketplace became dominated by a small number of large, diversified financial conglomerates functioning on a transnational scale.
Successive Canadian governments, whether Liberal or Conservative, encouraged and facilitated this growth and consolidation. Occurring roughly in the same time frame, public policy at all levels also closely followed the recommendations of the major banks and the rest of the corporate elite.
In the decades past, Canadian regulators favoured safety and soundness over competition in the financial sector. Domestic firms were protected from foreign competition and oligarchies of large national firms were encouraged.
In order to expand abroad and make foreign acquisitions, Canadian banks argued they must consolidate and gain size in their home market.
Being focused on foreign expansion, the Canadian banks “banked” on a trend toward international liberalisation, and in order to gain access to foreign markets through bilateral and multilateral trade negotiations, the Canadian state was required to facilitate increased foreign access to the Canadian market.
Of course, Canada’s big banks were quite happy to concede foreign access of the domestic market in which their dominant position is well entrenched (thanks to existing regulations), in order to gain access to larger foreign markets.
The Canadian banks have then proceeded in arguing that the foreign ‘threat’ requires further domestic consolidation. Thus they have used a double-ended strategy in order to secure their interests.
The amendments introduced to the Bank Act in 1987 and 1992, granted chartered banks and insurance companies permission to own trust companies. And the banks went to acquire trust companies very aggressively. Canada’s Deregulated Financial Deregulated Industry  looks at these specific regulatory changes in greater detail.
The examples of RBC, TD Bank, and Scotia Bank prove that the financial institutions were seeking further consolidation to amass more profits for their shareholders and for their executive bonuses.
RBC bank spent almost no time at all, having quickly acquired Dominion Securities, Voyageur Insurance Company, and finally Royal Trust in the years between 1988 to 1993.
Scotia Bank purchased National Trust some 5 years later, in 1997, and TD Bank completed a merger with Canada Trust in 2000.
The Canadian banks also have numerous agencies running operations in the United States, Latin America, the Caribbean,  Europe,  Asia and all over other parts of the world.  Almost half of the earnings made by these banks are generated outside of Canada. Scotiabank alone, has operations in some 50 countries and continues to be a leading bank in the Carribean and in Central America, with operations in 25 countries within the region.
Out of everything that was happening in the past few decades, one thing was clear. The liberalization and expansion of financial markets around the world increased the power of financial interests relative to governments, non-financial corporations and communities.
Thus, financial claims demonstrated real authority on their owners. Stockholders demanded receiving higher profits, and this kept corporations downsizing and outsourcing operations even during the best of times. Bond holders also pressured state and local governments to trim their budgets, and bankers and bondholders, along with global state institutions such as the IMF, forced severe economic restructuring on debtor countries.
This is clearly apparent today with the prime examples of Greece and Ireland.
While the deregulation of financial services has been a common theme since the 1980s’, the Canadian state retains a prominent role in shaping and supporting the financial services sector.
And though the state has liberalized market activities, still, some significant restrictions remain on foreign businesses in the form of corporate organization and patterns of ownership.
Regulatory structures have been consolidated and their mandates and roles have been formalized to respond to a more competitive marketplace.
As a result, the state continued to play a vital role in providing consumer protection, ensuring prudential stability, and acting as a lender of last resort.
Paul Martin’s rejection of two large bank mergers in 1998 was an example of the continuing relevance of the state.
However, the insatiable appetite for more profits, and greater growth, led to even more fiscal consolidation.
This monolithic vision by the big banks eventually led them to announce proposals for bank mergers, that, had they succeeded, would have profoundly changed the outcome of the Canadian economy as it stands today.

 The Proposal for Mergers

These were to be mergers between TD Bank and CIBC, and between Bank of Montreal and RBC. At that time, the Council of Canadians launched a well publicized cross-country campaign to convince the federal Finance Minister Paul Martin to reject the proposed mergers and bring greater accountability to the banking industry.
At that time, the Competition Bureau also became alarmed and sent out a series of letters to the respective banks on the course of action to take. The Competition Bureau is an independent agency with a mandate to protect and promote competitive markets and enable informed consumer choice.
While the Bureau lacked the regulatory authority to allow or disapprove of mergers, its role had been to review the proposed merger for its impact on competition and make the results of its review known to the Banks.
The Bureau sent a copy of the letters to the Minister of Finance who had the ultimate authority to approve the merger under the Bank Act.
And on December 14, 1998 Paul Martin had ruled against the mergers of the big banks.
However this didn’t just end here.
The debate over bank mergers re-emerged just a few short years later.
In 2002 the Federal govt committed another public review, through the House of Commons Standing Committee on Finance and the Senate Committee the year after.
These reports began looking into some of the policies that governed bank mergers.
A report based analysis of the two reviews were conducted by the Public Interest Advocacy Center (PIAC) with funding from Industry Canada.
The report was titled: Bank Mergers and the Public Interest.
The report concluded (just as many before it), that there was no persuasive evidence that consumer choice and access to banking services would be enhanced by large bank mergers and no evidence that the cost of banking services wold be reduced under a bank merger. The report argued that in the public review that was done, there was little representation from the public or consumers, to the legislative committees that were tasked with this public review. Rather, there was significant representation and input by banks.
Indeed, this turned out to be true. Evidence of this can be found in the Standing Senate Committee on Banking, Trade, and Commerce report, as found in Appendix 4.
The Committee heard from or received submissions from 23 banks and only 2 public interest groups.
The situation of consultations wasn’t much different in the House of Commons Standing Committee on Finance.
Found in Appendix C & D of the report titled: Large Bank Mergers in Canada. The House of Commons Committee heard from or received submissions from 12 banks and 4 public interest groups.
Some of the testimony heard included words from several high ranking individuals at the financial institutions.
Before the Standing Senate Committee on Banking Trade and Commerce on November 25th, 2002, CEO of the Bank of Nova Scotia Peter Godsoe said,
You merge for only one reason, in my view. There is one overwhelming reason that can be given to the Canadian people, which is the overall scale of our equity base. Why do you need the size? It is to grow and expand outside of Canada faster.
And before the Standing Committee on Finance on Feb 4, 2003, former Chief Economist with TD-Bank Douglas Peters said,
Bank mergers are about raising prices and reducing service to the public and concentrating economic power in the hands of the few.
A member from the Competition Bureau was also present at the House of Commons Committee in which they summarized their findings.
So what did we find in 1998? We found that the barriers to entry or expansion were high. There is a need for a large branch network. They represent large sunk investments. Customer inertia is high. Market share does not change very much except by acquisition. The banks built up significant brand names through decades of advertising, which was reinforced by large numbers of branches throughout the country. Technology is an important factor here, but we found that in some ways it was more of a complement than a substitute, and in some ways it can actually make changing banks a little more difficult…In terms of the effect of competition, at that time, given the four merging banks, what you had left was the Bank of Nova Scotia and some regional niche players, which were important to some parts of the country but not all. Foreign competition for the products we were most concerned about, personal banking and SME (Small and Medium sized Enterprises) products, was minimal.Obviously there was also the removal of two vigorous and effective competitors
The banks were not successful in a bid for mergers in 1998 when the fed government blocked this decision.
Having diversified their business activities quite extensively already, there was little room left for the big banks to grow in Canada.
They were tired of competing for market share and the big banks hoped to grow through teaming up with each other through mergers.
Even more important to the big Canadian banks were the opportunities offered by foreign markets, especially in the US.
Unlike Canada, the US had many mid-sized and small state and local banks.
As consolidation proceeded in the US, the Canadian banks wished to expand their presence in the US market by acquiring some of the smaller US firms.
However, while the banks were looking at expansions south of the border, there still remained the question for competition at home.

Increasing Financial Competition

The Standing Committees at both the House of Commons (HoC) and the Senate also heard that more needed to be implemented in order to increase competition in Canada.
Both Committee put forward recommendations that urged the Government to do more on this.
The HoC Finance Committee recommended that the Government review the legislative and policy framework to ensure that barriers to entry and expansion were eliminated.
The committee suggested in its report that greater foreign competition might occur if regulatory barriers to entry for branches of foreign banks were lowered.
It recommended that the Government take immediate steps to remove any impediments to the emergence and growth of credit unions in Canada.
The Senate Banking Committee recommended that the Government undertake a review of barriers to entry into the financial services sector – including tax changes – that would foster competition.
It also noted that divestitures of assets could be used to foster the growth of existing and new competitors in the financial services sector in Canada, in the context of a particular transaction.
In the late 90’s and early 2000’s, the Government introduced a number of measures to increase competition in Canada.
In 1999 the Government allowed foreign banks to operate directly in Canada through a branch of the parent bank.
Furthermore, foreign banks wishing to operate in Canada were permitted to have the same range of investments as Canadian banks. They were allowed to establish more than one branch and could own more than one bank. And like the domestic banks, they benefited from the streamlining introduced into the approvals system.
Since 2001 the financial sector framework (through Bill C-8) encouraged new firms to enter the financial services market, making it easier to start a bank, trust and loan company or insurance company, by lowering the minimum capital required to begin operations and allowing a small institution to be held by a single shareholder.
Bill C-8 strengthened the credit union system, helping the credit unions to implement their plan to make themselves stronger and more competitive nationally.
The Government also opened access to the payments system to life insurers, securities dealers and money market mutual funds, so that they could offer Canadians a broader range of options for managing their money.
With respect to the Senate Banking Committee’s concerns about taxation, the 2003 Budget announced that the federal capital tax that applied to all industries (including the financial services sector), would be eliminated in stages over a period of five years.
This would serve to illustrate why the corporate tax rates were reduced in the subsequent years following this announcement.
The reduction of the corporate tax rate can be seen in the Canadian Labour Congress study: Big Businesses Party Profit, eat more cake with less investment and jobs: study finds
The economic crisis in 2008 served a wake up call for those in the financial community.
Out of the crisis, throughout the western world, it was the Canadian banks that performed best.
The shocks in the system were absorbed well.
This even led to former Chief of the US Federal Reserve Paul Volcker to comment back in 2009, that the system he was arguing for “looks more like the Canadian system than the American system.”
Banks Prudently Regulated to Teeth – Deregulation of Canada’s Financial Industry addresses the assumptions made by the world financial community, as well as whether Canadian banks were actually as “prudent” as claimed, and whether they are actually “safe”.
Banks Prudently Regulated to Teeth - Deregulation of Canada's Financial Industry Part 4

Banks Prudently Regulated to Teeth – Deregulation of Canada’s Financial Industry Part 4

In Into the Boiler Room: Deregulation of Canada’s Financial Industry , a general overview from an academic context on the state of deregulation in Canada is provided. It’s important to note that such significant changes such as those made in our banking sector, have taken place over a period of many decades. Thus it is hard to root out one sole cause when in fact, another root lies deeper down below it.
Canada’s reputation for strong regulation and prudent banks around the world began with policies implemented and enforced nearly a decade ago. Indeed, a change in the landmark decision in 1998 could have decided the fate of the Canadian banking system as we know it today, and could have radically altered the economic conditions.
The Banking Empire Deregulation of Canada’s Financial Industry began an introductory look into the bank merger proposals.  The two large bank merger proposals in 1998 required review by two regulatory bodies; the Competition Bureau and the Office of the Superintendent of Financial Institutions (OSFI). The two proposed large bank mergers announced were direct challenges to the perceived Canadian Government merger policy of “big shall not buy big”.
Of course, this policy has been an informally cautious one, that does not allow for big companies to buy other big companies, out of concern for consolidation at the detriment of the consumer.
Had the bank mergers succeeded, they would have fallen into the category of in-pillar mergers, which involve merging parties offering the same or similar products. A key motivation for an in-pillar merger as argued by executives at the big bank, has been on efficiencies of scale and profitability.
However, a bank and an insurance company merging together would be a cross-pillar merger, referring back to: Historical Context – Deregulation of Canada’s Financial Industry when the pillar system of financial services was adopted in the earlier parts of Canada’s financial services history. This cross-pillar merger was allowed by the Canadian regulatory framework, and the most notable examples would be the mergers between RBC and Royal Trust; Scotia Bank and National Trust, and TD Bank and Canada Trust.
 Timeline of Events
On June 1, 1992 the federal government proclaimed its new legislative framework for federally regulated financial institutions: banks, trust and loan companies, insurance companies, and the national organization of the credit union movement. The new legislation changed the landscape within which federally regulated financial institutions operated, by introducing new powers, making changes to the ownership regimes, and instituting new prudential safe guards.
On December 18, 1996 the Minister of Finance at the time had announced the mandate and composition of the Task Force on the Future of the Canadian Financial Services Sector. The Task Force was asked to advise the government on what needed to be done to ensure that the Canadian financial system remained strong and dynamic. It examined a number of substantial policy issues that were not dealt with by the 1996 Government White Paper on Financial Institutions.
In September 1998, the Task Force released it’s final report which will be detailed below, which contained 124 recommendations dealing with 4 major themes: Enhancing competition and competitiveness; Improving the regulatory framework; Meeting Canadian’s expectations; and Empowering Consumers
Two separate parliamentary committees – the House of Commons Standing Committee on Finance, and the Standing Senate Committee on Banking, Trade, and Commerce had both scrutinized the Task Force’s report. Both Committees issued their respective reports in December of 1998.
Following the reports from the Parliamentary Committees, Council of Canadians documents, Competition Bureau’s assessments, and the MacKay Task Force, the Minister of Finance at the time (Paul Martin) had reached a decision on denying the merger of the Big 4 banks. The mergers proposed were between BMO and RBC; and TD and CIBC.
In June 1999, the Minister of Finance released the Government White Paper: Reforming Canada’s Financial Services Sector: A Framework for the Future, which outlined the Government’s vision for the future of the financial services.
MacKay Task Force
On September 15, 1998 the Task Force on the Future of the Canadian Financial Services Sector published their report titled: Task Force Report on Future of Canadian Financial Services Sector
The Report presented a curious blend of 1990s global competitiveness concerns and 1970s government social activism.
The Report tried to balance three main objectives for the financial sector:
  • meeting global competition,
  • ensuring safety and stability in the system, and
  • meeting its social obligations (as defined by the government).
The MacKay Task Force found, that the current financial services framework was not as effective as it should be, in reducing the information and power imbalance between institutions and consumers.
For consumers, the MacKay Task Force report was a god send. It recognized  that making sure financial services accessible to all Canadians was an important public value, and that fairness to consumers was consistent with a healthy marketplace, not , as the industry had long argued, was counter to competition. The Task Force offered 124 recommendations that addressed the 4 broad themes of the report:
1) Enhancing Competition and Competitiveness
2) Empowering consumers
3) Canadian expectations and corporate conduct
The report argued, “Our recommendations will increase competition and choice for Canadians. They will also ensure that the marketplace works more fairly and responsibly.
An interesting and remarkable difference between the attitudes of the American and Canadian financial system were emphasized by Pierre Ducros, Vice Chairman of the Task Force, who said it was important to understand that the relationship between consumers, financial institutions, governments and regulators was an interactive one.
He wrote in the report, “More than ever before, to work truly well, the four must be in harmony. Each must better understand the needs of the other and the challenges they are facing. Our conclusions and recommendations are designed to be a cohesive blueprint of how to meet that reality.
The report called for life insurance companies, mutual funds, and investment dealers to be given access to the payments system, the network that allowed banks to cash each other’s cheques. By opening up the payments system, consumers could use, for example, an automatic bank machine in order to make a withdrawal from a money-market fund.
The report also called for more flexible federal rules on the ownership of smaller banks, both to encourage new banks to start up and let existing ones forge strategic alliance with other companies.
Out of 124 listed recommendations, only a handful are listed here for space saving purposes.
List of Recommendations:
  •  Legislated privacy regime that will assure consumer protection of sensitive personal information
  •  Stronger and broader ban on coercive tied selling than now exists
  •  Better assurance of access to basic banking services for low-income Canadians
  • A regime for financial institutions to issue regular Community Accountability Statements that discuss contributions to the community and identify emerging community needs
  •  New powers for credit unions and credit union centrals to make them more effective, including the power to become or form cooperative banks,
  •  Integration of deposit insurance for banks and compensation plans for life insurance companies, to reduce the competitive advantage that banks now enjoy
  • Strengthening the Office of the Superintendent of Financial Institution’s (OSFI) governance structure and reducing regulatory overlap by transferring the regulatory responsibilities of the Canada Deposit Insurance Corporation (CDIC) to OSFI
  • Public Interest Review Process for large mergers, with a Public Interest Impact Asssessment that examines the public interest costs and benefits, and legislated power for the Minister of Finance to accept enforceable undertakings from merger proponents with severe sanctions for non-compliance
The Task Force proposed the implementation of a public review process involving the Competition Bureau (with respect to competition matters), the Office of the Superintendent of Financial Institutions (with respect to prudential matters), the Canadian public (with respect to “the public interest”) and the Minister of Finance (with respect to the federal government’s interpretation of “the public interest”). Although lukewarm on the actual need for bank mergers, the Task Force Report concluded that if a proposed merger met competition and prudential standards, it should be approved unless there were overriding public interest concerns.
The report explicitly said, “While it is not in our mandate to pass judgement on the proposed mergers between major Canadian banks, we did thoroughly examine the merger policy and process issues…The Task Force recognized that mergers can be a valid business strategy…there should be no absolute ban on mergers amoung large banks, insurance companies or other financial institutions. However, no such mergers should take place if it is not consistent with the public interest.”
The Task Force report was supported by five background papers that discussed in detail, the reasoning that led to the conclusions of the Task Force, as well as 18 research studies it commissioned.
The Task Force Report formed the basis of the 1999 Department of Finance White Paper entitled Reforming Canada’s Financial Services Sector: A Framework for the Future.
Thereafter, many of the recommendations of the Task Force Report and the White Paper were included in Bill C-38, which contained a massive update of the Bank Act and other federal financial institutions legislation. The Bill died in the chopping block, as a federal election was called for the fall of 2000. When the Liberal government was re-elected, the bill was reintroduced as Bill C-8 in February of 2001 and enacted in June 2001, as the Financial Consumer Agency of Canada (FCAC) Act.
2001 changes to the Bank Act and related federal legislation implemented some important safeguards and protection, particularly for retail consumers. These measures included mandatory low-cost accounts, branch closures requiring advance notice and public hearings, cashing government cheques without charge, and related basic services required from banks. These were to be monitored by FCAC.
The tabling of Bill C-8 on February 7, 2001 followed the issuance of a government press release that contained, as a two-page annex to a brief summary of the legislation, the federal government’s long-awaited Merger Review Guidelines for large banks (those having more than $5 billion in equity).
The Guidelines described a three-stage public review process that must be followed for large banks to merge, and it was not much different from those measures outlined in the 1998 Task Force Report.
Merger Review Guidelines
  • Stage 1 – Examination of the Proposal.  The first stage of this process commences with the submission of a written application for permission to merge. The application is to be accompanied by a comprehensive Public Interest Impact Assessment (“PIIA”) prepared by the applicants. Among other things, the Guidelines require the applicants to address the rather toxic issues of job losses, branch closures and access to credit for small and medium-sized businesses.
  • Stage 2 – Minister of Finance Decision. After stage 1, initial reviews of the merger application and the PIIA are then carried out by the Competition Bureau, OSFI, the House of Commons Standing Committee on Finance and the Standing Senate Committee on Banking, Trade and Commerce, with the latter two bodies expected to hold public hearings on the merger application. The results of these various reviews are then communicated to the Minister of Finance for the second stage of the process, which the Guidelines describe as follows: “Using the reports of the Competition Bureau, OSFI, the Finance Committee and the Senate Committee as inputs, the Minister of Finance will render a decision on whether the public interest, prudential and competition concerns are capable of being addressed. If not, the transaction will be denied and the process stopped at this stage.”
  • Stage 3 – Negotiation of Remedies. The third stage, if ever reached, consists of negotiations on any steps required by the Competition Bureau, OSFI and the Minister of Finance to remedy specific problems created by the proposed merger.
Here is a diagram of the regulatory framework for the Merger Proposal from Banks.

The issuance of the Merger Review Guidelines did not stimulate a new round of bank merger announcements. Instead, these guidelines drew criticism from banks and other interested parties, who concluded that the “public interest” was still code for the perceived “political interest” of the Liberal government.The criticism centered on the fact that although the Guidelines purported to create an objective and transparent review process, the final decision would still be made by the Minister of Finance on an ill-defined, and malleable “public interest” basis.
I argue it was wise, and very prudent, of the Minister of Finance to not allow either merger proposals to occur. The differences in the merger between TD Bank and Canada Trust (Bank + Trust Company) were completely different than that presented between TD Bank and CIBC. The latter, had different implications.
The approval of the merger between TD Bank and Canada Trust in early 2000 demonstrated an important point, that it was not a “merger of equals” amoung large banks that was permitted but rather it was a “Cross-pillar” acquisition that was allowed. This would serve to demonstrate to naysayers, that the Government was open to large institutions merging in the Canadian financial services sector, just not “inter-pillar” between two existing big banks. 
It is also important point to note that when the TD – Canada Trust transaction occurred, for the permission to the granted, the Government was assured by TD Bank that it would be raising its service levels to levels of Canada Trust as well as handling the employment issues during the integration phase.
Also, certain branch divestitures were required as an anti-competition remedy for government approval of T-D bank acquiring Canada Trust.
Some witnesses at the committee hearings noted that mergers can enhance competition by providing an opportunity for new competitors to emerge or for existing participants to increase market share, including foreign and small Canadian banks, co-operatives and credit unions, and single-product financial service providers. Divestitures, which involve the sale of assets (including branches of banks) of the merging parties to a third party, have provided the potential for an opportunity, not only to ensure that sufficient competition has continued to exist following a large merger, but also to add a significant competitor either by allowing existing institutions to expand or by creating new ones.
The divestiture of bank branches, for example, is widely considered among industrialized countries as a successful approach for addressing concerns arising from a bank merger. In the Canadian context, divestitures have helped provide an opportunity to enhance the competitiveness of other competitors such as credit unions or smaller banks.
In summary, this article has sought to emphasize, that at least on a regulatory stage, it wasn’t the characteristic of prudent banks, but prudent regulators and ultimately the Finance Minister, that decided the denial of the bank mergers. This quite perhaps may have been the single largest incident that saved the Canadian banking system, and the economy, from a significant crash.
Some great regulatory oversight can be credited to the Competition Bureau, the antitrust regulator/watchdog for Canada. Back in 1998, the Competition Bureau’s, Konrad von Finckenstein, told Maclean’s he expected MacKay’s analysis to have a major influence on his findings, especially in assessing the competitive impact of new technology. He was reported to have said, “The best view we have of some of the market developments, some of the pressures, is the MacKay task force.” However, von Finckenstein was not bound in echoing MacKay’s call for allowing mergers.
Unlike MacKay, as per his mandate, von Finckenstein had to apply and enforce strict rules. If either of the two merged banks commanded more than 35 % of a certain local market for a financial service, such as credit cards in one city or home mortgages in another, the bureau’s guidelines and models had assumptions that competition might be seriously threatened. According to it’s own framework, as part of sound regulatory policy, it would also consider any situation in which any four banks having more than 65 % of a particular market to be too much concentration.
Testimonies from Both Sides of the Divide – Deregulation of Canada’s Financial Industry will attempt to further analyze the comments provided by bank executives, and those of public service personnel.
Testimonies from Both Sides of the Divide- Deregulation of Canada's Financial Industry Part 5

Testimonies from Both Sides of the Divide- Deregulation of Canada’s Financial Industry Part 5 

Back in 1998, the Parliamentary Committee on Finance published their report and included below were the results.
The Committee argued that the mergers of large federally regulated financial institutions posed a significant policy dilemma to the country. The Committee was against large banks and large insurance companies from buying each other out.
The reasons for their decision was, “driven by the Committee’s belief that if the major insurance companies and banks merged, it would result in too much concentration of economic power in too few hands. The Committee is very uneasy about reducing the financial services sector to only four or five companies. The Committee believes that in a pluralistic society, it is essential that there be a multitude of powerful decision makers. Moreover, allowing excessive concentration across the full range of financial services could well create a level of systemic risk that would be unacceptable. This can create the conditions for what is commonly referred to as the moral hazard problem of “too big to fail.”
Indeed, looking back to the 2008 crash, `too big to fail`was a significant problem among the big Wall St firms which resulted in them receiving a TARP bailout to the detriment of the population that had to bear the costs associated with it.
Full Re-Cap from Previous Articles
The legislative changes in 1992 to the Bank Act had drastic changes for the financial services sector leading to the near elimination of the independent trust company sector. Similarly, the independent investment dealer sector was quickly dominated by the banks, after the Ontario government removed the restriction on investment in securities dealers by other financial institutions in 1987.
The Parliamentary Committee described that the same should not be allowed to happen with respect to the life insurance sector (as emphasized above).
However, the Committee did not recommend restrictions be placed on banks from buying small insurance companies; indeed that was something banks could already do. Rather, the Committee’s recommendations stated that large institutions should not be able to buy another large institution from another pillar.
However, most financial services CEOs who testified before the Committee said that their primary interest was in consolidation within their own industry rather than across pillars. Their testimonies made it very clear that it was intra-pillar consolidation that yielded the greatest efficiencies and cost reductions, not inter-pillar mergers. 
MacKay Task Force
The Task Force was of the view that the Bureau, with minor modifications to the Mergers Enforcement Guidelines (MEGs), was appropriately positioned to examine the potential anti-competitive and abusive dominance implications of proposed mergers in the financial services sector. The Task Force also identified OSFI as the appropriate agency to advise the Minister with respect to the incremental systemic risk, if any, posed by specific business combinations.
The most significant thing, is that the Task Force argued that OSFI should not be attempting to ensure that financial institutions never fail; and that in considering mergers of large financial institutions, OSFI should focus on the doctrine of “too big to fail.
This was significant, and the Parliamentary Committee criticized this because they understood, that allowing excessive concentration across the full range of financial services could well create a level of systemic risk that would be characterized as “too big to fail.”
Testimonies in Parliamentary Committee Report
Found in the House of Commons Parliamentary Committee report, here were some of the submissions of testimony among bank executives. It should be noted that these individuals were in favour of the MacKay report. This serves to provide some context into their line of thought, and their perceptions of the regulatory climate at the time.  Witnesses who favoured a “big buy big” policy generally commented on the validity of mergers as a business strategy.
On October 7, 1998, Peter Godsoe testified, “Clearly, mergers represent a valid business strategy. In-market mergers are a classic response where companies wish to increase market share and reduce costs through elimination of duplicate networks. That is clear. I have no problem with this in principle…
On September 29, 1998 John Cleghorn testified, “the Royal Bank is in full agreement with the [MacKay] report’s conclusions that mergers among institutions are a viable business strategy and should not be prohibited outright. We also fully support the report’s proposals for the case-by-case merger review process.
One witness cautioned that the regulatory process must remain strong and that larger banks are stronger.
Group Chief Executive of Barclays Bank of London, said, “What if one fails? Again, you must look at the anatomy of why banks fail. In many respects, history indicates that too small to survive is a bigger problem than too big to fail, if the history of bank failures since the 19th century is any indication. To give you an example, a major bank has not failed in Canada since 1920, which means Canada came through the 1930s without a major bank failure. We have an outstanding supervisory and regulatory regime in the country. The two institutions involved are AA rated. They would have a combined capital base of $25 billion before you would ever get anywhere close to there being a loss. I argue that when you combine banks that are strong to begin with you reduce the risk of failure.
In a separate statement, Barrett felt that the decision of the bank mergers was becoming politicised. He was reported to have said, “It’s purely political and not about concentration…I think it’s a disgrace.” This is found in the document titled: Depoliticization of Bank Mergers Must Occur
Since he is speaking from a banker’s perspective, I hope you can begin to understand, that he was absolutely wrong, in that averting systemic risk is sound policy, not pandering to political objectives.
The Superintendent of Financial Institutions, on the other hand, indicated that the evidence on bank size and financial solvency was inconclusive.
John Palmer former Chief of OSFI testified, “As a general matter, however, I think it is very hard to determine the simple answer as to whether risk increases, decreases, with things like size, geographic scope, participation in particular business lines or other business lines. I think that the sort of experience on this internationally does not support a conclusion one way or another.
However, some witnesses felt that, at the large end of the size spectrum, bank mergers pose a significant risk in that the remaining institutions are not likely to be able to pick up all the pieces of a failed large bank without taxpayers having to make a contribution.
Peter Godsoe, CEO of Bank of Nova Scotia testified, “With regard to “too big to fail,” if one of the five of us went under, could the other four, the government, insurance companies, et cetera, subdivide it and, as we have done since 1920, work this out without costing the taxpayer one cent? Probably not.
Here Godsoe is attempting to reinforce, that the Canadian banks are already too consolidated and centralized, and in the event of a systemic collapse, a public bailout would probably be required since it is baked into the cake. And infact, as will soon be revealed in an upcoming article, the big Canadian banks did require a certain amount of ‘liquidity injection’ from the taxpayer which was provided by the Federal Government. Of course, this is not called a ‘bail out’ by the Government, but you may decide for yourself what you feel about it.
When evaluating a merger proposal, the OSFI Chief said,
We then tend to try to look at whether the quality of the risk mitigants, the risk control systems, the capital levels, the reserving levels are appropriate for the kind of inherent risks in the activities, and a balance of those two, so that the net risk, if you will, is manageable from the point of view of the overall safety and soundness of the institution. Clearly, for example, there are lot of cases in which expansion of geographic scope can actually reduce risk because it diversifies risk. There are other examples in which expansion of scope can lead to control problems if not managed appropriately and lead to surprises that have occurred, and there is experience of that internationally.
In conclusion, for the most part the House of Commons (HoC) Parliamentary Committee report supported the recommendations of the MacKay report. In it’s conclusions, the HoC found that if two financial institutions proposed a merger, then 3 different categories of issued would need to be addressed:
  1. competition policy issues, [by the Competition Bureau]
  2. prudential issues, and [by the Office of the Superintendent of Financial Institutions]
  3. stewardship issues (the Task Force calls these latter issues “public interest” issues).   [by the Finance Minister]
At the time, the Committee believed that these issues should be addressed sequentially. Also, the Committee report found that the requirement of the Competition Bureau be satisfied that a proposed merger is not anti-competitive, and that OSFI be satisfied that it posed no prudential problems, would be necessary prerequisites to any merger proceeding. “Until the necessary conditions are met, it is meaningless to address the additional set of stewardship issues that apply to financial institutions,” the report read.
At the time, the Finance Minister took much heat not just from banking lobbyists, but also from the opposition party. The Conservatives blamed the governing Liberals as “politicizing” the bank merger process. The Conservative Finance Critic Scott Brison, compiled a scathing report attacking the Liberal government’s delays of the bank merger process. The report of the document was titled: De-politicization of Bank Mergers Must Occur.
This process laid out here describes the process and efforts that went into the bank merger decision. It is important to note that each body had it’s own purpose to fulfill; OSFI, Competition Bureau, HoC/Senate Parliamentary Committees, and the Finance Minister.
Looking back, it can be said that the prudence of our regulators and Finance Minister are to be applauded for. Thus, I argue that the denial in allowing the bank mergers was one of the main reasons for maintaining the perception of Canadian banks as safe, and stable as they are known today. However, the story doesn’t end there. Life insurance companies were the only remnants of the old big-4 pillar remaining; considering that independent trust companies and brokerage firms were quickly overtaken by the big 5 banks.
The reason the banks proposed a merger in the first place, as they stressed, was on a need to combine forces in order to withstand against new foreign competition. Indeed, this is plainly obvious when one reviews the testimony given by numerous bank executives to the Parliamentary Committees. If one were to step back and examine the events taking place in the 1970s and 1980s, one would observe that the trend towards market liberalisation caused this state of affairs.
The Bank of Nova Scotia, part of the Big 5 Banks, and the only bank without a merger partner, attacked the merger deals for concentrating banking clout in its rivals’ hands. Comments from a bank executive from Nova Scotia, as well as others can be viewed in The Banking Empire Deregulation of Canada’s Financial Industry of this series.
Also, Life Insurance Companies demanded greater powers to compete with the banks, even if Ottawa decided to block the mergers. This is discussed in more depth in The Life Insurance Industry and Banks Woes – Deregulation of Canada’s Financial Industry Pt 6 as consolidation in the Life Insurance also was part of the deregulations that took place within Canada’s financial industry.
The Life Insurance Industry and Banks Woes – Deregulation of Canada’s Financial Industry Part 6

The Life Insurance Industry and Banks Woes – Deregulation of Canada’s Financial Industry Part 6


The Life Insurance Industry and Banks Woes – Deregulation of Canada’s Financial Industry Part 6

If you’ve been reading the past 5 parts of this series, then you have realized, that on the bank mergers, the Finance Minister claimed to have rejected it on the grounds that it would lead to an unacceptable concentration of economic power, along with a significant reduction in competition and reduced policy flexibility for the government to address potential future prudential concerns. The Minister based his decision on the reports from the Competition Bureau and the OSFI As well as public opinion polling of Canadians, who were against the idea of a bank merger.
The Competition Bureau found that the proposed mergers would result in, “a substantial lessening or prevention of competition that would cause higher prices and lower levels of service and choice for several key banking services in Canada.” (Competition Bureau, 1998a and 1998b).
The Superintendent of Financial Institutions gave suggestion, that if one of the merged banks ever faced insolvency, it would represent a huge challenge to regulators and the Canadian economy (OSFI, 1998).
The mergers were also opposed by other groups such as by Peter Godsoe, Chairman of the Bank of Nova Scotia (the only remaining big 5 bank without a merger partner), the Canadian Federation of Independent Business, the Retail Council of Canada, the Council of Canadians, the Canadian Community Reinvestment Coalition, the NNDP political party, and many of the Liberal caucus.
A survey done by the Conference Board of Canada in 1998 also suggested that corporate boards across Canada did not favour the bank mergers. And the Canadian Bankers Association, and the Business Council on National Issues, were weakened by the split in their ranks.
Life Insurance Companies
So what role did deregulation play in the efforts of  the Life Insurance Companies of Canada? Well, at the time of the bank mergers, Paul Martin declined on the merger proposal, he stated, “Whereas the merger proponents wanted the mergers to be allowed in order to change the status quo, we believe the status quo must be changed before any merger can be considered…The government will not consider any merger among major big banks until the new policy framework is in place.”
At that time, Martin was referring to the demutualization of the major insurance companies and the removal of the ban on branches of foreign banks in Canada. These were key aspects of the deregulation.
In 1998, the Acting Assistant Deputy Director of Investigation & Research, Richard Taylor, gave a speech to  to the Canadian Life Insurance National Conference titled: Evaluating the Impact of Consolidation on the Life Insurance Industry
He said, ” In a limited number of instances, competition issues arise from a merger as a result of there being too few existing competitors left to discipline the market, and minimal likelihood of new entry doing the same due to the presence of significant barriers to entry or expansion in the market. While one of the great strengths of a market economy is its ability to adapt to change, there is a need in mixed economies to ensure that the regulatory framework which oversees the market remains adaptive, effective and clearly focused on achieving its intended objectives.
He also makes a crucial point on the issue of regulation vs competition and I believe this is quite insightful.
From a competition policy perspective, competition should act as the fundamental driving force of our economy. Competition within markets provides a much better vehicle than regulation for creating the incentives that encourage the development of new products, services and the methods of delivery to consumers. Competitive market forces drive the prices of goods and services toward their relative costs of production. This minimizes the misallocation of resources in the economy which in turn enhances economic welfare. This is not to say that market intervention and regulatory oversight is not sometimes warranted. In some instances, market forces alone cannot be relied upon to meet public policy objectives. And, in these instances, the reality is that achieving these public policy objectives may come at the expense of competition.
The subject of much debate happens to be on whether market intervention and regulatory oversight is actually warranted. However this point will be addressed in a subsequent article.
In 1999, the federal government also passed legislation allowing large federally regulated mutually owned life insurance companies to convert into publicly listed shareholder owned companies, a process known as demutualization. This measure was intended to grant them access to an important source of financing, as well as giving them greater organizational flexibility.
This also meant that for the following two years, government mandated a breathing period for demutualized firms, with no permission for mergers or acquisitions. The Five largest mutual life insurance companies at the time; Manulife, Sun Life, Canada Life, Mutual Life (renamed Clarica and Industrial-Alliance) then demutualized and issued shares in 1999-2000.
Shortly after the ban of mergers on demutualized insurers had ended (after the two year period), the life insurance sector saw a large wave of consolidations as well.
In 2002, Sun Life acquired Clarica (formerly Mutual Life), for 7.3$ billion.
In 2003, Great-West Lifeco Inc, part of the Power Corporation empire, struck a $7.3 billion deal to buy Canada Life.
In 2004, Manulife acquired The Maritime Life Assurance Company and this was based on Manulife’s acquisition of Maritime’s parent company, Boston-based John Hancock Financial Services, Inc.
With this in place, the life insurance space was dominated by three large players; Manulife, Great-West Life, and Sun Life. Assisted by deregulation, demutualization, and the consolidation within the Life Insurance Industry helped to strengthen the largest life insurance companies as diversified financial groups in order to become solid competitors to the banks.
This was also said by Yvon Charest, CEO of Industrial Alliance, which a is mid-sized Life Insurance company. He presented a report titled: Consolidation in the Life Insurance Industry.. How Does David Compete in a World of Goliaths?
He acknowledged as well, “the life insurance industry has had the reputation…of being the most boring sector in Canada (one of the reasons being that it’s full of actuaries, like myself)…the life insurance industry is going through a major restructuring process. The industry has gone through more changes in the past five years than it has in the past 100 years. Five of the country’s largest life insurers have demutualized and the consolidation has accelerated to the point where the three largest life insurers now control more than half of the Canadian market.
He went on to say,
While the life insurance market used to be quite fragmented, with well over 100 companies operating in the marketplace, it’s not evolving quickly towards an oligopoly, like the banking sector.
His report is an excellent insight into the way several mid-sized Life Insurance Companies felt about the consolidation that was occurring within the industry.
This “oligopoly” in the Life Insurance industry was seen as a way to combat and curb the big banks and keep the system churning. As we’ll see, this presented some interesting challenges for the banks.
Banks being challenged
From here, the major banks argued that with the domestic competition among themselves, along with regulatory protections for the Life Insurance companies (remember the two year breathing period), they faced increasing competition from foreign entrants to the Canadian market.
Their argument was simply untrue, and the number of foreign bank subsidiaries in Canada was only 27 (OSFI, 2005) compared to 59 in 1987. This demonstrates the level of consolidation that actually took place over the years which led to a severe reduction in banking subsidiaries.
As you could clearly see from the figures at the time, one could conclude that the threat to domestic banks from foreign competitors was not warranted nor justified. The big five banks had feared that foreign competitors would focus on lucrative sections of the Canadian market. An example is MBNA, which is a large American bank that entered the Canadian credit card market. Another would be ING Bank, a subsidiary of an immensely large Dutch financial services conglomerate that developed a ‘virtual bank’ in Canada, and specialized in higher interest rate savings accounts.
The greatest challenge to banks came not from foreign competitors, but came in investment and corporate banking. The big five banks role as supplier of large corporate loans declined as a result of corporate access to international capital markets, securitization, and the emergence of new suppliers of the funds.
This was highlighted in the MacKay report, saying, “there is a clear trend for large businesses to look for their needs to many banking suppliers, and increasingly to foreign financial services providers, who are seen as more innovative and more capable internationally. The traditional relationships of large Canadian businesses with domestic banks have clearly been replaced with more discriminating and more critical ones.”
Thus, foreign, and primarily American firms, were playing a major role in underwriting international equity and debt issues for Canadian companies and were advising on mergers and acquisitions. This undoubtedly represented a significant loss for the Canadian brokers, as they missed out on the biggest and most lucrative deals. Their size, expertise, and access to American capital markets made the largest American firms extremely tough competition for the Canadian brokers.
However, this does not imply that Canadian banks were being squeezed and could not make ends meet.
During this time frame, new forms of corporate finance, such as syndicated loans, securitized instruments, and credit derivatives became increasingly important. For example, the Canadian syndicated loan market developed in the 1990s, allowing for Canadian borrowers to rely relatively less on the US market.
For the Canadian banks, the dominant form of securitization in the country was asset-backed commercial paper (ABCP), which emerged only in the late 1990s, but was worth $63.7 billion at the end of 2002.
This asset-backed commercial paper will be quite significant later on so keep this point in mind. The big banks accounted for 90% of the outstanding asset backed commercial paper in Canada, and three of them (BMO, CIBC, TD) accounted for over 75%.
All this meant that bank profits were starting to grow as a result of a more diverse range of economic activities. The percentage of bank profits obtained through non-interest based activities grew.
In 2004, interest income accounted for only 46% of the total bank profits for the big five banks (CBA, 2004b).
Changes in 2001
The 2001 gave way for an increase in the OSFI’s supervisory powers. These powers increased the consequences for any institution that failed to meet certain regulatory or supervisory requirements. OSFI was given the power to remove directors and senior officers from office in certain circumstances, such as in instances of misconduct.
2001 also brought about new consumer protection legislation for the financial sector and consumer and community protections provided through either legislation or guidelines. This included:
-Guaranteed consumer access to a banking account with basic identification
-Access to basic low-cost banking services
-The right to cash a government cheque without paying a fee
-Requirement for annual public accountability statements by all financial institutions with equity above $1 billion
-Creation of a new federal agency – Financial Consumer Agency of Canada (FCAC)This agency was established in October 2001 to oversee consumer protection measures and promote consumer awareness.
Some individuals have viewed the Liberal’s implementation of regulations and guidelines, as merely a ploy used by the then-Liberal government as a political strategy. A strategy used in order to illustrate to the people their social responsibility and good corporate citizenship. And that with these prudent measures in place, the government could argue that it has in place the prudential regulations and consumer protections in order to allow future consolidations  to occur within the sector.
This is evident because as indicated near the beginning of this article, Paul Martin had stated that the status quo must be changed before any bank mergers could be considered.
  Deregulation in Ownership Limits
In order to create common ownership regulations for both banks, and demutualized insurance companies, a new size based ownership set up was also established by the federal government in 2001.
Small financial institutions with equity under $1 billion had no obligation to be widely held.
Medium sized financial institutions with equity between $1 billion and $5 billion are allowed to be closely held with only a requirement of floating 35% of shares on the market. These provisions would allow a domestic or foreign commercial enterprise to purchase or establish a small or medium sized bank.
Along with allowing small banks to be closely held, the federal government also reduced the amount of capital needed to apply for a charter from 10 billion to $5 million. These moves were designed to facilitate the creation of new financial institutions.
The first of these new institutions was Bank West, a subsidiary of Western Financial Group, which opened for business in 2003. Other such banks that were created under these rules were the Canadian Tire Bank and Sears Bank.
As indicated earlier, some have viewed all these steps as part of a political strategy. The allowance of foreign bank branches through deregulation, reduced barriers in creating new banks, and all of this has been portrayed by the federal government as increasing the competition within the Canadian banking sector. It is argued that the state and the banks would like to use this argument in order to permit the bank mergers.
For those large financial institutions with over 5$ billion in equity, the 10% ownership limit per single shareholder can be increased to 20% of voting shares and 30% of non-voting shares.
Changing the 10% rule was intended to offer the banks greater flexibility to enter into joint ventures and strategic alliances with other firms.
Some critics had warned however, that the change to 20% made little sense, and would actually rise the possibility of control, while maintaining the fiction of being widely-held.  The widely-held rule was applicable to the big 5 Schedule I banks that have been discussed in depth in this series. The widely-held rule at the time meant that no more than 10 % of any class of shares of a bank could be owned by a single shareholder, or by shareholders acting in concert. Throughout the decades, this rule was a key instrument in addressing the prudential concerns relating to banks. Having widely-held financial institutions was seen as one way to limit the risk of self-dealing.
Widely held rules precluded upstream commercial links, which were traditionally perceived to increase the risk of inappropriate self-dealing, including distortions in credit allocation. Widely held banks were also subject to a high degree of market transparency and oversight, something that tended to enhance governance and moderate the riskiness of management decisions. over the many years.
Part 7 will address the impacts, and Canadian banks in expanding overseas thanks to the deregulations that had occurred.
Outward Expansion – Deregulation of Canada’s Financial Industry Part 7

Outward Expansion – Deregulation of Canada’s Financial Industry Part 7

Banking Expansionist Empire
In academia, the risks in financial collapse can arise due to two market failures. One of these market failures is asymmetric information. On this line of reasoning, depository institutions are better informed about the characteristics of investments they make with depositors savings then the depositors.
The characteristics of financial firms, such as their high leverage position, has enhanced the risk of bankruptcy, and each time a bank fails, it creates a lack of confidence in the system, which can lead to a contraction in the process of inter-mediation, leading to further failures…despite the prudence by other banks.
The Canadian approach to guarding against bank failures has been to protect the industry from competition. This has encouraged an oligopoly in the domestic market. The manner in which it works, is that when competition is lacking, firms earn economic profits that keep them above the break-even point.
The central debate has been, whether an environment allowing for the concentration of economic profits is likely to experience failures among financial enterprises.
However, reducing competition creates another market failure since firms with market power do not allocate resources efficiently.
Thus, there is tension between the risk of bank failure (i.e. too big to fail) and the risk of a non-competitive financial sector and this tension has been evident in the regulations of the Canadian financial sector.
The recent trend has been towards a relaxation of regulation that was previously designed to enhance the stability of the industry. As a result, Government policy towards competition in banking has been more stringent than in the past.
Competition policy, and merger law, has been concerned with ensuring efficiency by examining the potential anti-competitive effects of proposed mergers.
In Canada, the Competition Act and the Bank Act govern bank mergers. The Competition Act is administered and enforced by the Competition Bureau, which is specialized in interpreting the Competition Act and representing the government with regard to competition issues. It also assists the public in understanding how Canadian law is concerned with competition and how potential mergers will be dealt with. To achieve these goals, the Competition Bureau created the Merger Enforcement Guidelines which were a non-legislative and more practical interpretation of the Competition Act. There were also a special set of merger guidelines for banks.
As emphasized in Historical Context – Deregulation of Canada’s Financial Industry Part 2, Canada had traditionally limited it’s financial institutions to participate in just one of the following “pillars”: commercial banking, trust and mortgages, cooperative credit unions, insurance, or securities. Ownership limits were inspired by the desire to hold Canadian ownership of financial institutions and prevent links with non financial firms.
Until 1967 revision of the Bank Act, banks were prohibited from offering mortgage loans and there was also a ceiling on interest rates that further restricted the banks’ ability to offer consumer loans.
A sunset clause was introduced in revisions of the Bank Act requiring the re-evaluation of regulations every 10 years. This clause has reflected the Government’s recognition of banking as a dynamic industry with very quick changes, thus the government has been committed to act accordingly.
Out of a response to the steady efforts at deregulation, the banks expressed a strong desire to engage in mergers and acquisitions in order to “compete” (as they would argue). This is covered extensively in Banks Prudently Regulated to Teeth – Deregulation of Canada’s Financial Industry  Part 4 of this series.
Market Trends
To completely understand the impact deregulation has had on competition, it’s useful to outline the market trends that have also influenced the financial sector. The globalization effects that affected the financial industry allowed savers and borrowers to go into world markets to find the services they demanded. So, for businesses looking to obtain direct external financing, world capital markets were attractive because they may have provided for cheaper financing options.
Before the changes in regulation, the banks’ loans were made up of few mortgage and consumer loans compared to the other institutions. A large part of the mortgages in Canada were now offered by the banks. The banks share of mortgage grew from 10% in 1970, to 55% in 1996 (Freedman, 1992, p. 22).
National banks had an advantage over mortgage companies in the absence of restrictive regulations.
Consumer loans also moved towards banks as well and this was evident from the increased share the banks had of consumer loans, increasing from approx. 50% in 1970, to 70% by 1996. This all boiled down to one thing, banks wanted to grow even more, and seek even higher profits. This is why expansions were the second way at attempting growth, once mergers and acquisition strategies were employed. 
The major Canadian banks and insurance companies have been active internationally, and have long been an important source of Canadian direct foreign investment abroad (CDIA). In 2001, within the financial services sector, Canadian direct investment abroad was worth more than 3 times the value of foreign direct investment in Canada.
Altogether, Canadian direct investment abroad in financial services doubled, between 1995 – 2001 as a percentage of Canada’s GDP; while foreign direct investment in Canadian financial services remained constant.
Thus as you can see, Canadian Direct Investment Abroad as a % of GDP almost tripled between 1995 – 2001, and this was occurring thanks to the deregulation of the financial services industry, and the international expansion of the banks.
During the latter part of the 1990’s, 4 of the 5 major Canadian banks focused on North American strategies. The Bank of Nova Scotia was the exception, as it built on its traditional base in Latin America and the Caribbean. It continued to follow this pattern, as shown by it’s acquisition in 2004 of the fourth largest bank in El Salvador. The other major Canadian banks focused their foreign strategies on the American market.
This graph also depicts, how the composition of stock of Canadian Direct Investment Abroad was growing more heavily on the finance and insurance industry. The successive wave of deregulation not only improved banks own earning capacity, but it also made it more lucrative to invest in the finance and insurance industry. This would come at the detriment to other, more productive parts of industry such as energy and metallic minerals, and wood and paper.
The Liberalization of the American banking sector to allow inter-state banking, and the combination of commercial and investment banking both opened up opportunities for Canadian banks to engage in consolidation within the US.
Here is a chart showing some of the findings of acquisitions in the U.S.
These acquisitions help illustrate the aggressive nature of the banks in seeking to expand.
However, in the event of the 2008 US financial collapse, Canadian banks have received a badge of honour, for being labelled as prudent and safe. I would like to contend that they are not quite as safe or prudent as one would be led to believe. Although assessing and critiquing Canada’s banks will occur in another article, the Canadian banks had their hands dirty in many fraudulent practices.
The collapse of the stock market bubble and the bankruptcies of such previous large conglomerates such as Enron, Global Crossing, Adelphia, and WorldCom, demonstrated a large revelation about highly fraudulent business practices and snake accounting procedures that were often perpetrated with the complicity of auditors and bankers
This was because of an intense pressure to boost short-term shareholder value, and the prevalence of stock options as a method of executive compensation encouraged aggressive business practices and “creative accounting”. The banks were under similar pressure to make the big deals and sustain the stock market bubble.
Former Vice President and Chief Economist of the World Bank, Joseph Stiglitz wrote,
in the 90s’, the banks became so eager for short-term profit that there was a race to the bottom. Each bank knew that its competitors were engaging in similar practices, and if it didn’t compete, it would be left behind; and each banking officer knew what that meant: smaller bonuses, perhaps even being fired…The banks must surely have known that when the bubble burst, many of the loans that they had made would fail. Thus the banks’ loan portfolios depended on keeping the stock market bubble going.
American Losses Inflicted on Canadian Banks
By 2005, the biggest deal made by a Canadian financial institution was Manulife’s $15 billion takeover of John Hancock Financial Services, including Maritime Life. Through this deal, Manulife became the largest publicly traded firm in Canada, the second largest life insurance company in North America and the 5th largest in the world measured by market capitalization.
Also, Canadian bank executives, for the most part, defended their goal of domestic consolidation on the basis that they needed a larger capital base to expand abroad, particularly in the US.
Therefore it is ironic, that foreign mischief in recent years played havoc with the Canadian banks’ balance sheets.
For example, during the 2001-2002 financial crisis in Argentina, Scotiabank faced angry protests after it closed its subsidiary Scotiabank Quilmes. Ultimately, Scotiabank took a $540 million write-down and sold the subsidiary.
In the US, there were meltdowns and scandals in the North American telecommunications and energy sectors that hit TD and CIBC.
The problems experienced in the US market, especially with the high-tech meltdown, led to a $2.9 billion loan-loss provision and an annual net loss for TD in fiscal 2002. This has been a rare event for one of Canada’s major banks.
To respond, TD slashed its corporate lending portfolio and restructured the international division of its discount brokerage and its US equity options trading business.
Also occurring in 2002, CIBC closed down its American electronic banking unit, Amicus, and faced a $366 million write-down in the process, including selling off its Oppenheimer brokerage. It also scaled down its US investment banking services.
In 2004, RBC was also hit with difficulties. RBC spent $8 billion over 4 years to expand its American presence but had little return on investment. Also in late 2004, RBC announced it would cut 1,600 jobs and RBC Centura was forced to scale back expansion plans.
Even with the troubles the Canadian banks faced in the US, they were certainly able to rely on their retail banking operations in Canada, which provided them with a steady income year after year.This effective banking oligopoly kept them relatively safe.
In conclusion, Canadian Direct Investment Abroad (CDIA) and Foreign direct investment (FDI) trends indicate that Canadian companies started becoming more globally oriented.  The Canadian investments abroad included those such as Alcan’s acquisition of Pechiney, the French aluminum giant, and Manulife Financial’s $15‑billion takeover of John Hancock Financial, a U.S.-based financial services company.  On the flip side, foreign entities have also likewise pursued direct investment opportunities in Canada.  Examples include the acquisition, in 2000, of Ottawa-based Newbridge Networks by Alcatel, a French telecommunications giant, and the 2001 acquisition of Laval-based BioChem Pharma by Shire Pharma, a pharmaceutical company based in the United Kingdom.
The deregulation in the financial industry outlined the growth in outward-bound Canadian direct investments in the past 20 years, was a trend fueled largely by the financial services industry.  This led to Canada increasingly becoming a net direct investor abroad.  This phenomenon was driven in large part by financial services, where Canada traditionally enjoyed a competitive advantage because of historical factors.
The deregulation in the financial industry took on a life of it’s own, starting with the 2006 Conservative Party’s minority government. This will be explored in Part 8.

Download PDF Click Here


Risky Mortgages – Deregulation of Canada’s Financial Market – Part 8

Risky Mortgages – Deregulation of Canada’s Financial Market – Part 8

In the previous segments,much focus has been placed on the banks, life insurance companies, and others in the financial space. However now, we’re going to slowly move on forward to the mortgage market, because this is inherently where the greatest risks to the Canadian economy lie.
In a nut shell, financial deregulation has occurred throughout all countries in the west, and has, to some extent or another, led to an increasing centralization of power. Deregulation during the 1980’s, and into the 1990’s, allowed banks to lower their interest rates, and made it easier for companies to receive large loans, even if they knew it would be impossible to pay. With the current events of Europe today, their financial market has only buried itself deeper and deeper into debt. In many of the Eurozone countries, massive amounts of loans were given out and during a financial crunch such as now in 2012, the effects can plainly be seen on Portugal, Ireland, Italy, Greece, and Spain. These countries have been the most affected, and the worst off.
In this part, we look into the expansion of deregulation that occurred when the Conservative government received their first minority after a decade.
Included in the Budget Plan for 2006, titled: Canada’s New Government, Turning a New Leaf, there were many measures stated to be implemented.
However, the new changes as outlined on page 83, would
allow new players entering the mortgage insurance market to gain access to that facility, and will be increasing the amount of business that can be covered under the Government’s authority from 100$ billion to 200$ billion in order to keep pace with the increase in housing prices and the growth in the mortgage market. These changes will result in greater choice and innovation in the market for mortgage insurance, benefiting consumers and promoting home ownership
The Canadian Government’s proposed solution was a radical change in fostering competition in the Mortgage Insurance Market.
At the time before the Budget was written, the Government promoted mortgage financing through a program that provided a government guarantee for companies that insure mortgage loans. This program did contribute to a competitive mortgage insurance market and for more affordable housing for Canadians.
The keywords in the sentence were “promoting home ownership” and “innovation” because this is exactly what the U.S. Government was intending on as well.
The strength in U.S. house prices was due to an artificial bubble that was created. Rising house prices stimulated housing construction and boosted employment in housing related industries. Households with the willingness and ability to spend had accumulated housing wealth through equity withdrawals and mortgage refinancing were the major contributors to the ‘growth’ that was seen in consumer expenditures.
But it wasn’t just a housing boom, the US financial crisis also involved “predatory loans” that the banks had engaged in, as well as over leveraged positions through derivatives trading, repeal of regulations such as Glass-Steagall Act that separated commercial banking from investment banking, collusion between the major Wall St banks and the rating agencies that were supposed to mark on the health of their debts, and collateralized debt obligations through subprime housing loans.
To begin, the graph below depicts the charting of real house prices between 4 nations:
As can clearly be seen, it was around the year 2000 that housing prices started their upward hill. This was hot on the heels of the crash that sent the Nasdaq tumbling. Many have argued that policies enacted in 2000 went on to fuel yet another bubble but this time in the mortgage insurance markets.
The rise in housing prices in the US was due to several key significant reforms which were aimed at deregulating the market, including the repeal of the Glass Steagall Act. There was also the Commodities Modernization Futures Act that was passed on financial markets as well.
In comparison to the other nation’s, Canada’s housing rise was much more modest, which explains it’s prudent regulations at the time.
So what caused the housing boom in the US? One factor was because of low long-term interest rates that boosted house prices and consumption in the U.S., which in turn pushed the personal savings rate down. The US was also carrying a trend of negative trade deficits.
The challenges present in the Canadian scenario were different than that experienced in the US, and this is because the regulatory framework was much stricter, and more conservative. Yet even these standards were opened up in favour of competition. This created a shift in mortgage insurance standards, which are described below.
Brief History of Mortgage Insurance Market
Mortgage insurance was concocted as a strategy in the 1930s by the U.S. government’s Federal Housing Administration in order to promote home ownership during the Great Depression. The effects of it, proved to be a major factor behind the North American housing boom that occurred in the postwar era. Because banks and other lenders would shy away from borrowers with less than a 25% down payment as higher risk clients, mortgage insurance thus gave people with smaller down payments an improved risk profile.
If a homeowner were to default on their payments with the lender facing a loss following foreclosure, mortgage insurance would cover the difference and turn a high risk customer into a zero-risk customer. Due to this, “potential” homebuyers that received a steady income would still have been able to own a home much sooner, even if they had little in savings.
The mortgage insurance concept came to Canada in 1954 when its exclusive provider was the precursor to CMHC. The Crown corporation had the mortgage insurance business to itself until the 1970s, when several private-sector firms tried and failed, over the next 20 years, to establish themselves. In 1995, private mortgage insurer Genworth entered the Canadian market, and since then, has been an able competitor. In 2006 when the Conservative Government came to power, it advocated for more deregulation by promoting competition in the mortgage insurer’s market, which allowed for another entrant to enter as well.
In 2007, AIG United Guaranty, a subsidiary of New York-based American International Group (AIG) Inc., made its entrance, offering a product for buyers who could essentially place 3% of the homes purchasing price. And the payments would have been able to have been spread over 30 or 40 years. Before this time, Genworth Mortgage Insurance Canada was the CMHC’s sole competitor, with CMHC commanding roughly 70% of the market and Genworth holding the other 30%.
Since April 2007, all mortgages with less than a 20% down payment have been considered as High-Ratio Mortgages. Thus they require High-Ratio Mortgage Insurance, and in the 40 years before April 2007, the downpayment requirement was set at 25%. High-Ratio Mortgage Insurance has protected lenders from borrowers who may otherwise default on their mortgages.
High-ratio mortgages account for slightly less than half of all mortgages originated in Canada, and are a major reason why Canada has had one of the highest home ownership rates in the world.  Mortgage insurance premiums have been paid by the homebuyer on the amount of the downpayment, not on the basis of creditworthiness or geographic location.
Government policies in favour of more competition were initially intended on establishing better rates on High-Ratio Mortgage Insurance for borrowers and better terms as well. However, the unfortunate consequence of this “Race to the bottom” competition, was that it also allowed for many Canadians to receive access to Mortgage Insurance with 0% down. This meant that many Canadians received loans they would not have otherwise been able to have received if the lending practices were kept prudent, and it also helped to boost housing prices. Some pundits have argued that the by product of the competition in the mortgage insurance market has led to a reigniting of a housing bubble, and as with all bubbles, will be due for a readjustment in value soon. This part of the debate will be explored in a future discussion.
The Players
Canada’s mortgage insurance industry is not entirely government-run  but it has certainly been government-controlled. The Canada Mortgage and Housing Corp. (CMHC), a federal Crown corporation and government agency, has commanded more than two-thirds of the mortgage insurance business in Canada and has protected lenders against borrower default by guaranteeing home loans. Its’ mandate has always been to ensure affordable home ownership for all Canadians.
Their private-sector competition has come from Genworth Financial Canada, (part of the General Electric conglomerate) and AIG . And since it is managed by only 3 players, the profits have been very good. According to the federal Bank Act, every mortgage from a federally regulated institution with a down payment of less than 25% is required to carry mortgage insurance. Last year, 45% of all homebuyers, or 500,000 Canadian families, were required to buy a total of $1.6 billion worth of mortgage insurance.
From a lender’s standpoint, there’s an incentive to allocate a portion of their insurance business to private insurers. For one, it keeps CMHC further from monopoly status. In addition, having multiple insurers gives lenders options when a file doesn’t meet one insurer’s guidelines.
The issue
An investigation done by Jacque McNish and Greg Mcarthur in March 2009 into banking and insurance sources found, that new mortgage borrowers signed up for an estimated $56-billion of risky 40-year mortgages, and more than half of the total new mortgages approved by banks, trust companies and other lenders during that time. These sources also estimated that 10 % of the mortgages, worth about $10-billion, were taken out with no money down.
Former CEO of private mortgage insurer, Triad Guarantee Inc., was the one who spearheaded his company’s aborted push into Canada, and said that the proliferation of high-risk mortgages could have been mitigated if Ottawa had been more watchful. He said,
There was a lack of regulation around the expansion of increased risk.
Indeed, there was significant risk. This high-risk mortgage lending had been rampant throughout 2007, up until early 2008 when the Government finally reined in on this policy. 
The Globe investigation had revealed that AIG’s Greensboro, N.C., mortgage subsidiary launched a quiet lobbying campaign in 2004 with senior U.S. executives and a former CMHC official to push open the doors to Canada’s mortgage insurance market, where some of the world’s highest insurance rates are charged. On May 1, 2006, AIG’s mortgage insurance division had registered with the lobbying commissioner’s office and this was coincidentally the day before the federal budget revealed that new players would be allowed into Canada.
When the 40 year amortization periods were offered, certain banking and insurance officials were very concerned. One bank executive had warned the Bank of Canada’s chief financial stability officer, Mark Zelmer, in a meeting that “the government has got to put an end to this.”
Another U.S. insurance executive who asked not to be named had told the Globe, “Quite honestly I was surprised [the 40-year mortgage] was seized upon so eagerly by the Canadian banks and borrowers.”
You hear all the usual excuses: ‘It’s a cash-flow management tool, people will pay off their mortgage ahead of time.’ But in reality it just becomes a mechanism for borrowing more than you probably should have. 
An important change mentioned in the 2006 budget was when Finance Minister Flaherty announced that not only would Ottawa guarantee the business of U.S. insurers, but that it would double the guarantee to 200$ billion, up from $100 billion. This would mean that if there were an event where the mortgage insurers faced a liquidity crisis, the Canadian Government would have double the allocated Government capital to assist them, directly from taxpayer funds.
This could have unintended consequences. The last thing the Canadian economy would need, would be a taxpayer bailout of mortgage insurers.
Race to the Bottom
The policy recommendations as outlined in the Conservative budget encouraged new players into the market, however they had serious unintended consequences. The competition that occurred in the mortgage insurance market created what I would term, a ‘race to the bottom’ effect in the mortgage market. Below are examples of this
  • On February 25, 2006 the CMHC kicked things off when they announced intentions to offer homeowner mortgage loans amortized up to 30 years as part of a pilot project to improve access to home ownership and choice for Canadians as part of a ‘pilot’ project, intended to last 4 months.
  • On March 16, 2006 Genworth had also announced that they would be raising amortization periods from 25 year periods to 30 and 35 year periods.
  • On June 28, 2006 the CMHC was Canada’s first mortgage loan insurer to eliminate homeowner high ratio mortgage insurance application fees. The 35 year amortization was also offered as a mortgage product.
  • On October 23, 2006 Genworth had announced that it would insure mortgages with amortizations up to 40 years
  • Effective as of December 15, 2006 the CMHC had extended amortization periods available up to 40 years
As evident in just a span of 11 months, a massive race had already begun to take shape between CMHC, Genworth, and AIG. This was a significant change at the time and one that would come to haunt the Canadian economy many years later.
Back in 2006 when the 40 year amortization period was announced by CMHC, their vice-president Mark McInnis said, “We’re the third guys coming up to the plate with these products. AIG has done it, GE has done it. We’re just doing something that’s in the marketplace.
In an interview with the Globe in 2009, CMHC vice-president Pierre Serré repeatedly pointed to the behaviour of his competitors when asked about the agency’s riskier products, explaining that CMHC’s rivals were the first to introduce the 40-year products.
When asked if he thought that the new U.S. insurers pushed CMHC into riskier policies, Mr. Serré paused. “It’ s a tough one for me to answer. In retrospect you can look at all the individual things happening and you can link them together, but it’s a hard one to tell. We think we’ve done a prudent job of introducing these products and managing these products,” he added, and he had declined to explain how many 40-year and zero-down mortgages the CMHC had on its books.
Unfortunately, unlike in the United States, such figures are not made publicly available in Canada.
The CMHC’s willingness to ease mortgage lending practices against private competitors, especially since being a Crown corporation and funded by taxpayers, has raised considerable criticism.
John Williamson, federal director of the Canadian Taxpayers Federation at the time advocated for privatizing CMHC. He said CMHC’s move to compete with private sector insurers demonstrated the need to privatize the Crown corporation, which made a profit of $1-billion last year. “If this company wishes to be involved in the competitive market, they should be freed to do that by being privatized.”
And David Dodge, then-govenor of the Bank of Canada also criticized the CMHC’s policy. In a letter obtained via freedom of information, Dodge weighed in on his opinion of the June 28 2006 announcement by the CMHC to announce up to 35 year amortization periods for mortgages.
He addressed his concerns to Karen Kinsley, then-CEO of CMHC and he wrote, “I read with interest and dismay-that CMHC would offer mortgage insurance for interest-only loans and for amortization of up to 35-years.” He added, “Particularly disturbing to me is the rationale you gave that ‘these innovative solutions will allow more Canadians to buy homes and to do so sooner.”
Dodge called the new lending policies as steps that would contribute in driving up home prices making them even less affordable and he called the CMHC’s actions as ‘unhelpful’. I would agree with his  opinion, because when mortgage lending standards are lowered with longer amortization periods, it not only increases inflationary pressure, but it also can have unintended consequences such as inviting housing speculators.
To give credit to the Canadian regulatory system, housing speculation is curbed somewhat, due to the loans being  full recourse mortgage loans. This means a homeowner cannot walk away from a mortgage loan. If an individual were to try, the bank that issued the loan would have legal rights to come after the homeowner including garnishing future wages to pay off the loan.
If the homeowner cannot afford the house any longer and the bank forecloses, than they would sell the house and chase the homeowner for the remainder of the balance on the loan that remains unpaid. The only way to get out of the problem completely would be to declare bankruptcy and have all their assets liquidated to pay the loan.
In present day today (March 2012), there has been significant debate into whether the CMHC’s policies in recent years helped to re-ignite a housing bubble in this country, much the same way Fannie and Freddie had done in the U.S. This debate will be addressed in a future article.
Finally, in July 2008, the Conservative Government did step in to seal the door on risky mortgages. Mortgage amortizations were limited to 35 years, and buyers were required to place a down payment of at least 5%. However the move has been seen as too little, too late, as now the housing market is largely due for a correction in value.

Pin It on Pinterest