mishkin_money_3ce_ch10

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Chapter 10
Banking Industry:
Structure and
Competition
10.1
© 2008 Pearson Education Canada
Evolution of the Banking
Industry
• Financial innovation is driven by the
desire to earn profits
• 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
10.2
© 2008 Pearson Education Canada
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
10.3
© 2008 Pearson Education Canada
Responses to Changes in Supply
Conditions: Information Technology
• Bank credit and debit cards
– Improved computer technology lowers transaction costs
• Electronic banking
–
–
–
–
ATM
Home banking
ABM
Virtual banking
• Junk bonds
• Commercial paper market
• Securitization
10.4
© 2008 Pearson Education Canada
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
10.5
© 2008 Pearson Education Canada
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-balancesheet activities
10.6
© 2008 Pearson Education Canada
Schedule I, II and III Banks
• 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
10.7
© 2008 Pearson Education Canada
Canadian Banks
10.8
© 2008 Pearson Education Canada
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
10.9
© 2008 Pearson Education Canada
Comparison with the United States
• 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.
10.10
© 2008 Pearson Education Canada
Comparison with the United States
10.11
© 2008 Pearson Education Canada
Comparison with the United States
10.12
© 2008 Pearson Education Canada
Response to Branching
Restrictions in the U.S.
Response to Branching Restrictions
1. Bank Holding Companies
2. Automated Teller Machines
10.13
© 2008 Pearson Education Canada
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
10.14
© 2008 Pearson Education Canada
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
10.15
© 2008 Pearson Education Canada
Three Basic World
Frameworks
1. Universal banking
- No separation between banking and
securities industries
2. British-style universal banking
- May engage in security underwriting
3. Japanese Model
- Some legal separation of banking and other
financial services
10.16
© 2008 Pearson Education Canada
Trust and Mortgage Loan
Companies (TMLs)
•
•
•
•
10.17
Operate under a charter issued by either the
federal government or one of the provinces
Federally incorporated TMLs are regulated and
supervised by the OSFI and must also register in
all provinces in which they operate and conform
to their regulations
The fiduciary component of trust companies is
only subject to provincial legislation, even if the
company is federally incorporated
CDIC and QDIB (for Québec TMLs)
© 2008 Pearson Education Canada
Credit Unions and Caisses Populaires
•
•
•
•
•
•
•
10.18
Established under provincial legislation
Are non-profit seeking institutions
Accept deposits and make loans only to members
Members have voting rights, elect board of
directors, which determine lending and investment
policies
Have their own set of institutions, including central
banking and deposit insurance
The main source of funds is deposits (85% of
liabilities) followed by members equity (7%)
Asset portfolio made up largely of mortgages (55%)
© 2008 Pearson Education Canada
Government Savings
Institutions
Province of Ontario Savings Office
• Established in 1921
• Today only lends to the Treasurer of Ontario for
provincial government purposes
Alberta Treasury Branches
• Established in 1938
• Today there are 150 branches and 225 ATMs in 242
communities across Alberta, operating in three target
markets: individual financial services, agricultural
operations, and independent business
10.19
© 2008 Pearson Education Canada
International Banking
• Rapid growth
– Growth in international trade and multinational
corporations
– Global investment banking is very profitable
– Ability to tap into the Eurodollar market
10.20
© 2008 Pearson Education Canada
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
10.21
© 2008 Pearson Education Canada
Canadian Banking Overseas
10.22
© 2008 Pearson Education Canada
Foreign Banks in Canada
10.23
© 2008 Pearson Education Canada
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
10.24
© 2008 Pearson Education Canada
Implications for Canadian
Banking Industry
• The financial consolidation process will increase
with the 2001 legislation as the way is open to
new mergers and acquisitions, strategic alliances,
partnership and joint ventures
• Financial groups will become larger and
increasingly complex, engaging in a full gamut of
financial activities
10.25
© 2008 Pearson Education Canada
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