© 2008 Pearson Education Canada10.1 Chapter 10 Banking Industry: Structure and Competition

© 2008 Pearson Education Canada10.2 Canadian Financial and Banking System

© 2008 Pearson Education Canada10.3 Evolution of the Banking Industry A change in the financial environment will stimulate a search by financial institutions for innovations that are likely to be profitable –Responses to change in demand conditions –Responses to changes in supply conditions –Avoidance of regulations

© 2008 Pearson Education Canada10.4 Responses to Changes in Demand Conditions: Interest Rate Volatility Adjustable-rate mortgages –Flexible interest rates keep profits high when rates rise –Lower initial interest rates make them attractive to home buyers Financial Derivatives –Ability to hedge interest rate risk –Payoffs are linked to previously issued securities

© 2008 Pearson Education Canada10.5 Responses to Changes in Supply Conditions: Information Technology Bank credit and debit cards –Improved computer technology lowers transaction costs Electronic banking –ATM –Internet Banking Commercial paper market/Junk Bonds Securitization

© 2008 Pearson Education Canada10.6 Avoidance of Regulations: Loophole Mining Reserve requirements act as a tax on deposits Restrictions on interest paid on deposits led to disintermediation –Money market mutual funds –Sweep accounts

© 2008 Pearson Education Canada10.7 Decline of Traditional Banking Decline in Cost advantage of Acquiring Funds (Liabilities) Decline in Income Advantage on uses of funds (Assets) Bank Responses - No decline in overall profitability - Increase in income from off-balance- sheet activities – “A significant incease in risk”

© 2008 Pearson Education Canada10.8 The Big Six, together with the Laurentian Bank of Canada, the Canadian Western Bank, and another 8 domestic banks are Canada’s Schedule I banks Schedule II banks are some domestic banks controlled by eligible foreign institutions A Schedule III bank is a foreign bank branches of foreign institutions Schedule I, II and III Banks

© 2008 Pearson Education Canada10.9 Canadian Banks

© 2008 Pearson Education Canada10.10 Competition and Technology Besides chartered banks, there are over 4000 financial institutions providing services, these include trust, mortgage loan companies, credit unions, caisses populaires, government saving institutions, insurance companies, pension funds, mutual funds and investment dealers New technology and the internet have led to more competition and innovative banking in Canada 2001 changes in bank ownership laws have encouraged the establishment of new banks

© 2008 Pearson Education Canada10.11 As of 2005 there were 68 chartered banks in Canada and around 7500 in the United States The presence of so many banks in the U.S. reflects past regulations that restricted the ability of these financial institutions to open branches Many small U.S. banks stayed in existence because a large bank capable of driving them out of business was often restricted from opening a branch nearby It was easier for a bank to open a branch in a foreign country than in another state in the U.S. Comparison with the United States

© 2008 Pearson Education Canada10.12 Comparison with the United States

© 2008 Pearson Education Canada10.13 Comparison with the United States

© 2008 Pearson Education Canada10.14 Response to Branching Restrictions in the U.S. Response to Branching Restrictions 1. Bank Holding Companies 2. Automated Teller Machines

© 2008 Pearson Education Canada10.15 Competition Across All Four Pillars and Convergence In the past, Canada’s financial services industry was regulated by institution (banks, securities, insurance, and real estate). This approach to regulation has been known as the four-pillar approach Recent legislative changes allowed cross-ownership via subsidiaries between financial institutions As a result, Canada’s traditional four pillars have now converged into a single financial services marketplace

© 2008 Pearson Education Canada10.16 Bank Consolidation 1.The way is now open to consolidation in terms not only of the number of banking institutions, but also across financial service activities 2.Banking institutions will become not only larger, but increasingly complex organizations, engaging in the full gamut of financial service activities taking advantage of economies of scale and economies of scope 3.Mega-mergers like that of Citicorp and Travelers in the U.S. should become increasingly common

© 2008 Pearson Education Canada10.17 Three Basic World Frameworks 1.European Universal Banking - No separation between banking and securities industries.. Japanese Model - Hybrid between 1 and 2 2.British-style Universal Specialized Banking - traditionally strongest separation between banking and securities business - Recall how this has changed over time in Canada (and U.S.)?

© 2008 Pearson Education Canada10.18 Near Banks Trust Companies Mortgage Loan Companies Credit Unions Government Savings Institutions are all interesting FYI only, not enough so for tests or exams.

© 2008 Pearson Education Canada10.19 International Banking Rapid growth –Growth in international trade and multinational corporations –Global investment banking is very profitable –Ability to tap into the Eurodollar market

© 2008 Pearson Education Canada10.20 International Banking International Loans Market = Eurocurrencies Market International Bonds Market Eurobonds Market cf. Foreign Bonds International Equities Market Mature equities market Emerging equities market

© 2008 Pearson Education Canada10.21 Eurocurrencies Market Mostly dollar-denominated deposits held in banks outside of the U.S. Most widely used currency in international trade Offshore deposits not subject to regulations

© 2008 Pearson Education Canada10.22 Canadian Banking Overseas

© 2008 Pearson Education Canada10.23 Foreign Banks in Canada

© 2008 Pearson Education Canada10.24 The 2001 Bank Act Bank Holding Companies Permitted Investment Ownership Rules Canadian Payments Act and Access to the Payments and Clearance System Merger Review Policy The National Financial Services Ombud Service