Canada has a mature, competitive and centrally regulated banking system. The Canadian banking sector is composed of domestically owned banks, subsidiaries of foreign banks operating in Canada as Canadian chartered banks (foreign bank subsidiaries), full-service branches of foreign banks, branches of foreign banks with limited access to Canadian source funding (referred to as lending branches) and foreign bank representative offices. The six largest Canadian banks by assets and market capitalisation are Royal Bank of Canada, the Toronto-Dominion Bank, The Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank of Canada, each of which has been designated by the Office of the Superintendent of Financial Institutions (OSFI), the Canadian federal bank regulator, as a domestic systemically important bank (D-SIB). These six banks account for more than 90 per cent of Canada's total banking assets. In addition to these domestic banks, as of 2 April 2015, there were 22 other domestic banks, 24 foreign bank subsidiaries, 26 full-service branches, three lending branches and 25 representative offices.
Canada also has an active public debt market in which domestic and foreign securities dealers assist clients in issuing and placing a wide variety of corporate and institutional commercial paper, medium-term notes, bonds, debentures and hybrid instruments. Many of the securities dealers are bank-owned. However, the banking sector is the dominant source of capital for those seeking conventional financing. Canadian banks also dominate the residential and commercial mortgage market. Canada does not have a deep market for second-lien loans, mezzanine or venture capital finance, and merchant banking financing is relatively limited when compared with other competitive financing jurisdictions. Canada also has an active credit union and non-bank financial sector.
The Canadian banking sector is regulated by the federal government under the auspices of one regulatory authority, OSFI. OSFI regulates all Canadian federally incorporated financial institutions (FRFIs), including banks, insurance companies, trust and loan companies, and credit unions. However, banks are the only financial institutions that fall exclusively within the regulatory purview of the federal government; all other forms of financial institutions can be incorporated and regulated at the Canadian provincial and territorial level. In many cases, the provinces and territories have ceded jurisdiction on a de facto basis to the federal regulator to avoid the inefficiencies of regulation by two levels of government.
Canadian banking regulation is characterised by prudential regulatory concerns and a focus on depositor protection. In general, OSFI has adopted a very conservative approach in the regulation of the Canadian financial services sector, and the banking sector in particular. Canadian regulatory requirements often impose higher capital requirements and lower leverage than has been allowed in other jurisdictions. In addition, Canada has not adopted the concept of universal banking, keeping distinct differences in focus among the Canadian banking, insurance, auto leasing and securities dealing sectors of the financial economy.
This approach served the Canadian financial services sector well during the economic downturn from 2007 to 2010. During this period (and throughout the subsequent period to date), Canada did not experience any bankruptcies or failures among FRFIs. Further, the government did not have to bail out any FRFIs or the Canadian financial services sector generally. Actions taken by the government and the Bank of Canada to ease credit in the Canadian financial services sector were taken to maintain the competitiveness of Canadian financial services companies and to respond cooperatively to initiatives taken in the United States and Europe, with a view to stabilising the international financial services sector, promoting open markets and maintaining a level playing field and fair competition across the integrated global banking sector.
II.THE REGULATORY REGIME APPLICABLE TO BANKS
I. OSFI as regulator
OSFI was established under the Office of the Superintendent of Financial Institutions Act (Canada). OSFI works in conjunction with the Bank of Canada, which monitors and controls the money supply, and provides overnight and short-term lending facilities to banks; the Canada Deposit Insurance Corporation (CDIC), which provides deposit insurance to the general public on certain kinds of Canadian dollar-denominated deposits placed with member institutions; and the Financial Consumer Agency of Canada, which acts as a consumer protection watchdog with respect to the activities of banks in Canada as they pertain to consumers.
OSFI has very broad powers and oversight in regulating the activities of domestic and foreign banks in Canada. Its multifaceted mandate includes ensuring prudential regulation of FRFIs generally and the banking sector in Canada in particular, protecting depositors, and maintaining the integrity and stability of the Canadian financial services sector.
To achieve these objectives, OSFI has been given the authority, and exercises control, over the commencement and operation of business by banks in Canada and their leverage and capital requirements. OSFI also monitors and ensures prudential and responsible corporate governance. OSFI regularly publishes guidelines, directives and bulletins on all of these subjects, and regularly meets with Canadian banks and other FRFIs to ensure compliance with OSFI requirements.
At present, the activities of securities dealers and other participants in the securities market are regulated at the provincial and territorial level by the provincial and territorial securities commissions. The federal government has been engaged in the process of working with provincial and territorial governments to establish a centralised single national securities regulator. However, recent attempts to implement a national securities regulatory regime have been struck down by the Supreme Court of Canada on constitutional grounds.
ii. Bank Act (Canada) (Bank Act)
A bank may carry on business in Canada as a licensed Canadian chartered bank or a branch of a foreign bank, or by opening a subsidiary to carry on a financial service or other business. A bank may also maintain a marketing presence in Canada through the establishment of a representative office. All domestic banks in Canada and foreign bank subsidiaries, foreign bank branches, foreign bank representative offices and subsidiaries of foreign banks established to provide limited financial services or to carry on another business in Canada are subject to regulation under the Bank Act.
Incorporation under the Bank Act is subject to the discretion of the Canadian Minister of Finance (Minister) and to obtaining permission from OSFI to commence carrying on business. Canadian chartered banks may be owned and controlled by a bank holding company incorporated under the Bank Act. In such cases, the capital adequacy regime normally applied by OSFI to the balance sheet of a Canadian chartered bank is applied at the bank holding company level. As such, Canadian banks have not seen any benefit in adopting bank holding company structures similar to those seen in the United States and Europe.
The application processes for the establishment of a Canadian chartered bank or for the establishment of a foreign bank branch in Canada are relatively similar. In both cases, the application must be filed with OSFI, together with an extensive amount of information about the bank's primary shareholders or the bank itself (in the case of the opening of a branch) together, without limitation, with a detailed business plan (including pro forma financial statements and projections) with respect to its proposed business in Canada, and a list and the CVs of those persons who will serve as directors or primary officers of the Canadian bank or branch. Such individuals typically undergo a security review and background check by the Royal Canadian Mounted Police, Canada's federal police agency and, where applicable, the Canadian Security and Intelligence Service. In general, it can take anywhere from nine months to a year to incorporate a Canadian chartered bank and open for business, and up to six months to establish a foreign bank branch in Canada, from the time application materials are first submitted to OSFI. OSFI has published administrative guidelines to assist applicants in preparing materials in support of applications to be submitted for review and consideration.
iii. Foreign banks
As a general rule, but with some limited and rarely utilised exceptions, regulated, licensed or self-identified foreign banks and entities associated with foreign banks (i.e., entities within the subject foreign bank's group or control that are not incorporated or existing under the laws of Canada or a province or territory of Canada) are prohibited under the Bank Act from carrying on any business in Canada, owning a position in a Canadian enterprise above a prescribed threshold, or taking legal or de facto control of any Canadian enterprise. Foreign banks cannot undertake such activities directly or indirectly through an agent or nominee. The Bank Act regulates the activities and investments of foreign banks and entities associated with a foreign bank in relation to both banking and non-banking services in Canada.
The concept of a foreign bank is broadly construed under the Bank Act to include, inter alia, an entity called a bank that engages in the provision of financial services, whether or not it actually maintains a bank licence, and an entity that is a bank or is regulated as a bank or deposit-taking institution according to the laws of its incorporating jurisdiction or any place in which it carries on business. An entity is associated with a foreign bank if it controls, is controlled by, or is under common control with, a foreign bank.
Canada does not apply its banking laws extraterritorially to foreign banks. Accordingly, foreign banks are free to carry on business with Canadians and to solicit business from Canadians without offending the Bank Act as long as such activities are undertaken by the foreign bank from outside Canada. In addition, foreign banks may access the Canadian capital markets from offshore as long as they do not retain an agent for the placement of such securities in Canada and they comply with other restrictions imposed by OSFI and the Bank Act.
OSFI is vigilant in monitoring any illegal activities of foreign banks in Canada and publishes a list of offending foreign banks. OSFI also pursues such offending banks with a view to having them comply with the Bank Act or cease their activities in Canada. Foreign banks are permitted to carry on business in Canada with the permission of the Minister. The Minister has the authority to issue orders permitting a foreign bank to carry on business in Canada through the incorporation of a foreign bank subsidiary, the establishment of a branch or the ownership or control of Canadian enterprises. The Minister also has the authority to exempt a foreign bank from the application of the Bank Act. To our knowledge, no such blanket exemption order has been issued under the Bank Act to date.
Where a foreign bank establishes a foreign bank subsidiary, such a subsidiary is incorporated under the Bank Act and is subject to the same regulatory regime and capital requirements, and has the same powers and market access as domestically owned and controlled Canadian chartered banks.
A foreign bank may establish a full-service branch or a lending branch. In either case, the foreign bank is permitted to carry on the same business activities in Canada through its branches as the Canadian chartered banks. However, branches of foreign banks are not permitted to accept retail deposits in Canada. Retail deposits are measured by a formula contained in the Bank Act, but can be loosely interpreted as deposits of under C$150,000. Lending branches differ from full-service branches in that they cannot access the Canadian capital markets or take any deposits in Canada. Foreign bank branches are exempt from regulatory capital rules applied by OSFI to Canadian chartered banks on the assumption that the capital of such foreign banks is regulated by the regulator in their home jurisdictions. In lieu of the application of Canadian regulatory capital standards, full-service branches are required to maintain a capital equivalency deposit equal to 5 per cent of their Canadian branch liabilities on deposit with a Canadian financial institution. Lending branches are only required to maintain C$100,000 on deposit.
Representative offices maintained in Canada by foreign banks are not permitted to carry on business or provide financial services in Canada. Their sole function is limited to the promotion to Canadians of the foreign bank's business outside Canada, and to acting as a liaison between the foreign bank and Canadians in respect of the business between them that is conducted outside Canada.
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Originally published in The Banking Regulation Review, Sixth Edition, June 2015
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