1 Overview of the financial services industry

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1 Overview of the financial services industry

Role of the financial services industry

The financial services industry, which includes a plethora of institutions such as banks, trust companies, mutual fund providers, insurance companies, investment houses, and credit unions, is a vital and dynamic component of the Canadian, and indeed of any industrialized economy. Its importance to the Canadian economy cannot be understated. In 1997 alone, the industry as a whole maintained assets in excess of $2 trillion with profits exceeding $15 billion.1

Beyond its sheer size relative to the economy, the financial services industry is an importance facilitator of economic activity. The primary function of any financial institution, whether it be a bank, a trust company, a brokerage house, an insurance company or a mutual fund company, is to facilitate the exchange of financial resources between savers and borrowers. The financial services industry, therefore, has a dual function that is often viewed only from the side of the borrower. Financial institutions offer a variety of financial products for borrowers--from mortgages to demand loans to equity offerings to lines of credit. These and a host of other products provide customers with the ability to consume and invest today even though they do not currently have the necessary financial resources. Borrowers and investors are able to use funds today in exchange for a stream of payments (principal and interest or capital appreciation and dividends) in the future.

This exchange exists because, at any particular time, there are individuals that possess excess financial resources (savings). Financial institutions exist in order to facilitate the exchange of financial resources from these savers to borrowers. All too often the focus is placed solely on the borrower, or user, side of the ledger. In order for financial institutions to function as lenders they must attract the necessary financial resources. Financial institutions, therefore, offer a variety of products for savers--guaranteed income certificates, personal financial accounts, and mutual funds--so as to attract as much excess financial resources as possible.

A healthy financial services industry can facilitate economic growth by channeling financial resources to their most productive uses.2 Similarly, a healthy and vibrant financial services industry can increase both individual wealth by promoting savings, and individual utility by allowing for current consumption based on future income.

The financial services industry and the banking sector

A common mistake made when discussing financial services is to focus solely on the banking sector. This error in analysis is understandable since the banking sector dwarfs the other segments of the industry. Table 1 presents selected 1997 information about the various sectors of the financial services industry that are regulated by the federal government.3

The banking sector dominates the financial services industry based on asset value and profitability. Measures of size, or market power other than assets and net income also indicate the dominance of the banking sector. For instance, the banking sector maintains 55.13 percent of the equity of the federally regulated financial institutions and pays 63.49 percent of the total salaries in the sector.4

Schedule I and Schedule II chartered banks

There is an important differentiation to be made within the banking sector. There are two types of chartered banks in Canada: Schedule I and Schedule II. The key difference between the two is the ownership structure.

All chartered banks are regulated according to the rules set forth in the federal Bank Act. Until 1980, bank charters could only be obtained by a special Act of Parliament. Since 1980, it has been possible to obtain a bank charter via letters patent from the Minister of Finance. Schedule I institutions must be owned primarily by Canadians and must be widely held--no individual or group of associated shareholders can own more than 10 percent of any class of shares in a Schedule I bank. Further, no more than 25 percent of the shares of a Schedule I bank can be held by non-residents.5 In contrast, Schedule II institutions are not subject to such ownership restrictions.

Table 1: 1997 assets and net income for federally regulated financial institutions

Type of Institution

Assets(in thousands)

Percent of Total

Net Income(in Thousands)

Percent of Total

Chartered Banks

Thrust Companies

Loan Companies

Cooperative Credit Associations

Life Insurance*

Societies*

Property Casualty Companies*

1,224,314,345

37,264,018

159,874,500

7,115,649

279,768,607

6,903,037

52,280,245

69.26

2.11

9.05

0.40

15.83

0.39

2.96

7,954,176

358,717

1,385,746

28,973

2,764,362

63,520

1,866,333

55.15

2.49

9.61

0.20

19.17

0.44

12.94

*Includes both foreign and domestic firms.

Source : calculated by the authors from data in Canada, Dep't of Finance Office of the Superintendent of Financial Institutions 1998.

Appendix A lists the various Schedule I and Schedule II banks in Canada. There are eight Schedule I banks in Canada; all of the ``Big 5'' banks--the Royal Bank of Canada, the Canadian Imperial Bank of Commerce, the Bank of Montreal, the Bank of Nova Scotia, and the Toronto-Dominion Bank--are Schedule I banks. There were 50 Schedule II banks in Canada in 1997, consisting mainly of subsidiaries of foreign banks and banking subsidiaries of widely held non-bank financial institutions such as mutual fund, insurance, and trust companies.

In order to understand the structure of the Canadian banking system, it is necessary to recognize the differences between Schedule I and Schedule II banks. The differentiation between the two types of banks effectively means that Canada has both a national banking system constituted by the Schedule I banks and a much smaller, regional or niche-based banking sector constituted by the Schedule II banks. Table 2 presents selected information on the Schedule I and Schedule II banks in Canada.

The Schedule I banks eclipse the Schedule II banks in every criteria presented in table 2. What is not explicit in the data, however, is that the Schedule II banks are mainly regional or niche banks. The Schedule II banks' assets and operations are much more concentrated than those of the the Schedule I banks. Take, for instance, the largest Schedule II bank in Canada, the Hongkong Bank of Canada. Table 3 presents specific financial information for the Hongkong Bank of Canada.

The Hongkong Bank of Canada is clearly a marginal player on the national level when compared to the Schedule I banks. On a regional basis, however, the Hongkong Bank of Canada represents a material participant both in the banking sector and in the larger financial services industry. Table 4 presents specific information concerning the geographic concentration of the Hongkong Bank of Canada based on the distribution of branches.

The Hongkong Bank of Canada's high concentration of operations in British Columbia and specifically within the greater Vancouver region is indicative of its regional focus. Like the Hongkong Bank of Canada, other Schedule II banks are competitive with the Schedule I banks and, indeed, with all financial institutions within specific product markets and geographic regions. For example, both the Amex Bank of Canada and Citicorp focus almost exclusively on credit card products in Canada. The Schedule II banks represent a significant competitive threat to the Schedule I banks in particular regions and product lines, a threat that is not evident when analyzed on a national or broad product-line basis.

There are, thus, two distinct types of banks operating in Canada, offering two unique types of competition. The Schedule I banks compete with one another on a national basis while the Schedule II banks compete with the Schedule I banks within specific geographic regions or product lines. The varying nature of competition among the chartered banks also characterizes the larger financial services industry as depicted in table 1. There are a variety of financial institutions competing for the financial business of individuals and firms in Canada.

In addition to the various federally regulated financial institutions, there are a number of important provincially regulated firms such as brokerage houses and pension managers. The common characteristic of all these financial institutions is that through a variety of means they facilitate the movement of excess financial resources from savers to investors and borrowers.

Table 2 : Select data for Schedule I and Schedule II banks

	Schedule I bank		Schedule II bank
	Value(In Thousands)	Percent of Total*	Value(In Thousands)	Percent of Total*
Total Domestic Assets Equity Net Income	1,131,286,519 49,690,947 4,530,283	92,50 90.98 94.92	93,027,826 5,007,662 254,025	7,50 9.02 5.08
* Percent of the total banking sector, not of the larger financial services industry. This percentage is used to gain a relative comparison between Schedule I banks and Schedule II banks within the banking sector. Source : calculated by the authors from data in Canada, Dep't of Finance Office of the Superintendent of Financial Institutions 1998.

Table 3 : Financial data for the Hongkong Bank of Canada

Category

Total Value(In Thousands)

Percentage of Banking Sector

Percentage of Schedule II Banks

Assets

Deposits

Equity

Net Income

23,909,957

20,114,507

671,247

138,288

1.95

2.45

1.23

1.74

26.02

33.77

13.61

34.22

Source : calculated by the authors from data in Canada, Dep't of Finance Office of the Superintendent of Financial Institutions 1998 and from the 1997 annual report of the Hongkong Bank of Canada.

Table 4 : 1997 branch information for the Hongkong Bank of Canada

Region /City

Number of Branches

Percent of Total Number of Branches

Canada*

British Columbia

Alberta

Ontario

Greater Vancouver

Metro Toronto

117

52

12

33

36

16

98.32

43.70

8.40

27.73

30.25

13.45

* The HongKong Bank of Canada also has two branches in the United States.

Source : calculated by the authors from data in the 1997 annual report of the Hongkong Bank of Canada.

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Last Modified: Wednesday, October 20, 1999.