1.4.1 Chartered Banks

Overview

In Canada, the primary function of chartered banks is to accept and safeguard deposits from individuals and businesses. They then lend or transfer those funds to users in various forms, such as mortgages, car loans, business loans, and other lending instruments.

All chartered banks in Canada operate under the Bank Act and must function within its regulatory framework. The Bank Act is the federal legislation that sets out operating rules and restrictions for banks and is updated regularly, usually through five-year revision cycles.

Under the Bank Act, banks are designated as Schedule I, Schedule II, or Schedule III. Each designation has unique rules and regulations surrounding the banks’ activities. Most Canadian-owned banks are designated as Schedule I banks, whereas foreign-owned banks are either Schedule II or Schedule III banks.

Schedule I Chartered Banks

Definition

Schedule I banks are banks that are not a subsidiary of a foreign bank and are considered domestic banks even if they have foreign shareholders. There are currently more than 30 domestic Schedule I banks operating in Canada.

Canada’s Big Six Banks

Canada’s Big Six Banks dominate in asset size and have established an extensive network of retail branches and automated teller machines (ATMs) across the country. They are:

• Bank of Montreal (BMO)
• Canadian Imperial Bank of Commerce (CIBC)
• National Bank of Canada
• Royal Bank of Canada (RBC)
• Scotiabank
• Toronto-Dominion Bank (TD Bank Group)

These banks have also expanded their international operations by acquiring or investing in foreign international financial institutions.

Ownership Regulations

• Large Schedule I Banks: Voting shares must be widely held. Control is restricted to no more than 20% by any single shareholder or group of shareholders.
• Medium-sized Banks: A single shareholder can own up to 65% of the voting shares, while the remaining 35% must be publicly traded.

Stat: Medium-sized banks have shareholder equity between $2 billion and $12 billion.

• Small Banks: A single person or organization can fully own banks with shareholder equity of less than $2 billion.

Services Provided

Canadian banks offer a wide variety of consumer and commercial banking products and services, including mortgages, loans, accounts, and investments. Savings deposits are eligible for deposit insurance provided by the Canada Deposit Insurance Corporation (CDIC).

Banks also offer financial planning, cash management, and wealth management services—some directly and some through subsidiaries.

Within the banking groups, subsidiaries also handle services such as investment dealer activities, self-directed investing, and the sale of insurance products.

Example: A customer opens a self-directed investment account through an investment dealer subsidiary of their bank branch. The bank branch does not have access to the investment account information, and vice versa, due to information sharing limits known as firewalls.

Income Sources

One major source of income for banks is the activity of lending funds at an interest rate higher than the rate they pay on deposits or other borrowings. This difference, known as the interest rate spread, covers operational costs and provides a margin of profit for the bank.

Schedule II and Schedule III Banks

Schedule II Banks

Schedule II banks are incorporated and operate in Canada as federally-regulated foreign bank subsidiaries. They may accept deposits eligible for CDIC insurance and can engage in business similar to Schedule I banks.

Examples of Schedule II Banks:

• AMEX Bank of Canada
• Citibank Canada
• UBS Bank (Canada)

Schedule II banks derive most of their revenue from retail banking and electronic financial services.

Schedule III Banks

Schedule III banks are federally-regulated foreign bank branches authorized under the Bank Act to perform banking activities in Canada. They focus on corporate and institutional finance and investment banking.

Examples of Schedule III Banks:

• Barclays Bank
• Comerica Bank
• The Bank of New York Mellon

Benefits of Foreign Banks

The presence of foreign banks in Canada benefits domestic Schedule I banks by facilitating their international operations. Additionally, foreign-owned banks enable the investment of foreign capital in Canada, providing alternative borrowing sources for Canadian corporate borrowers.

Glossary

Bank Act: Federal legislation setting out the operating rules and restrictions for banks in Canada.

Canada Deposit Insurance Corporation (CDIC): Federal Crown corporation that provides deposit insurance to depositors in Canadian banks.

Firewall: Barriers that inhibit information sharing across different business units within the same banking group.

Interest Rate Spread: The difference between the interest rate banks charge on loans and the interest rate they pay on deposits.

Key Takeaways

• Chartered banks in Canada function primarily to accept deposits and then lend or transfer funds through various lending instruments.
• They must operate under the Bank Act, which is revised every five years.
• Schedule I banks are domestic banks not subsidiaries of foreign banks; Schedule II banks are foreign subsidiaries, and Schedule III banks are foreign bank branches.
• Ownership regulations for Schedule I banks are differentiated by bank size: large, medium, and small.
• The primary income source for banks is the interest rate spread.
• Subsidiaries within banks provide diverse services like investment dealing and insurance sales, regulated by information-sharing firewalls.
• The presence of foreign banks enhances international reach and diversifies capital sources for Canadian enterprises.

Frequently Asked Questions (FAQs)

Q: What is a Schedule I bank? A: A Schedule I bank is a domestic bank that is not a subsidiary of a foreign bank.

Q: How often is the Bank Act updated? A: The Bank Act is typically updated every five years.

Q: Are deposits in Schedule II banks insured? A: Yes, deposits in Schedule II banks may be eligible for insurance provided by the CDIC.

Q: What is the primary income source for chartered banks? A: The primary source is the interest rate spread, which is the difference between the interest rate charged on loans and the interest paid on deposits.

Q: What are firewalls in banking? A: Firewalls are barriers preventing the sharing of customer information across different business units within the same banking group.