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Canada’s Financial Services Sector

The Canadian Financial Services Sector

June 2002

Overview

• The Canadian financial services sector is made up of banks, trust and loan companies, credit unions and caisses populaires, life and health insurance companies, property and casualty (P&C) insurance companies, securities dealers and exchanges, mutual fund companies and distributors, finance and leasing companies, as well as independent financial advisors, pension fund managers and independent insurance agents and brokers.

• There is a significant level of product convergence occurring within the financial services sector, resulting in the emergence of large “financial groups.” The groups, which are particularly prevalent in the banking and life and health insurance sectors, offer a wide variety of financial services such as deposit taking, insurance and wealth management both directly and through subsidiaries. At the same time, there has been the emergence of “monoline” companies focusing on one or a few business lines.

• The financial services sector is a significant contributor to Canada’s economic growth, employing over half a million Canadians in 2000 with a yearly payroll of about $24 billion. The sector represented over 5 per cent of Canada’s gross domestic product in 2000 and contributed approximately $9 billion in taxes to all levels of government.

• Banks represent the largest portion of the Canadian financial services sector, reporting $1,080 billion in domestic assets in 2000, or over half of the sector’s total assets in Canada. Mutual fund companies and life and health insurers were next in terms of asset size, reporting $419 billion and $267 billion in domestic assets respectively in 2000, followed by the credit union sector at $122 billion and P&C insurers with domestic assets of $58 billion.

• Canada’s banks and life and health insurers are significant participants in international markets. The six largest banks generated 45 per cent of their net income from foreign sources in 2000, while 55 per cent of the life and health insurance sector’s premium income was derived from foreign sources.

• Banks and life and health insurers both reported an average return on equity (ROE) of approximately 14 per cent in 2000. The credit union sector reported an ROE of 8.4 per cent, while P&C insurers reported an ROE of 7.2 per cent, reflecting their considerable claims growth in recent years.

• The federal and provincial governments share jurisdiction over the financial services sector. The federal government has sole jurisdiction for banks while credit unions/caisses populaires, securities dealers and mutual funds are largely regulated by provincial governments. Both levels of government regulate insurance and trust and loan companies.

• There is increasing consolidation occurring within the financial services sector as firms respond to challenges posed by technological innovation and globalization.

Introduction

The financial services sector plays a critical role in a market economy, providing the means of channelling savings into various investment opportunities and driving economic growth. It provides the capital necessary for the growth of existing businesses and the start-up capital needed for new businesses. Governments also use the financial services sector to finance new debt issues and support programs and services. The sector also provides the means for Canadians to carry out their everyday financial transactions, including chequing, savings and wealth management, and to insure against risk and unexpected events. The financial services sector can be seen as the “engine” of a market economy, meeting the financial needs of governments, businesses and individual Canadians.

The financial services sector is a significant contributor to Canada’s economic growth, employing over half a million Canadians with a yearly payroll of about $24 billion. In addition, the sector represents over 5 per cent of Canada’s gross domestic product and contributes approximately $9 billion in taxes to all levels of government.

Table 1
Overview of the financial services sector, 2000

Structure of the Industry

The financial services sector is made up of banks, trust and loan companies, credit unions and caisses populaires, life and health insurance companies, P&C insurance companies, securities dealers and exchanges, mutual fund companies and distributors, finance and leasing companies, as well as independent financial advisors, pension fund managers and independent insurance agents and brokers.

The deposit-taking institutions include banks, trust and loan companies and credit unions and caisses populaires. The banking sector is made up of 14 domestic banks, 33 foreign bank subsidiaries and 16 foreign bank branches. However, the 6 largest Canadian banks account for about 90 per cent of total bank assets. Canada’s banks operate through an extensive network that includes over 8,000 branches and close to 17,000 automated teller machines across Canada. Canada’s banks also provide a range of services beyond deposit taking and lending. They are now major players in the securities sector, helping governments and private companies raise equity and debt financing, and in the mutual fund sector. Indeed, 3 of the 10 largest mutual fund companies and all of the large securities dealers are bank-owned.

Trust and loan companies offer similar services as banks, including accepting deposits and making personal and mortgage loans. However, trust companies can also administer estates, trusts, pension plans and agency contracts, activities that banks are not permitted to undertake directly. The largest trust companies are subsidiaries of the major banks.

Canada’s credit unions and caisses populaires (the latter operating primarily in Quebec) differ from banks in that they are co-operative financial institutions that are owned and controlled by their members. Their ownership and corporate governance are based on co-operative principles, and each individual credit union and caisse populaire maintains a separate identity. Because of their autonomous local structure, credit unions and caisses populaires are generally much smaller in terms of asset size than are other deposit-taking institutions. They also differ in that they do not operate outside of provincial boundaries. As of 2001 Canada’s credit union sector consisted of about 700 credit unions and almost 1,100 caisses populaires, with more than 3,600 locations and 3,900 automated teller machines. As with the banks, credit unions and caisses populaires are increasingly active in the provision of wealth management services.

The life and health insurance sector comprises about 120 companies providing group and individual life and health insurance, as well as annuities such as group retirement plans and individual retirement products. While the sector is not as concentrated as the banking sector, the four largest companies account for about 60 per cent of the sector’s domestic general assets. Wealth management products, including annuities and segregated funds, are assuming an increasing prominence in the sector. For example, while annuities accounted for 19 per cent of the sector’s premium income in 1970, by 2000 this had increased to over 50 per cent.

The diversity and competitiveness of the P&C insurance sector is reflected in the large number and wide variety of industry participants, with about 230 insurers actively competing in Canada. Canada’s P&C market has attracted considerable interest from foreign companies, and 6 of the 10 largest insurers are foreign-owned. Product lines generally include automobile, property and liability insurance, with a few companies selling a limited amount of sickness and accident insurance.

The mutual fund sector can be divided into the manufacturers of mutual funds and the distributors, although there are companies involved in both segments of the business, notably those owned by the banks and the credit unions/caisses populaires. In Canada there are currently 80 mutual fund companies sponsoring over 1,800 mutual funds, and 144 firms involved in the sale of funds. The majority of mutual funds are either managed by the manufacturers (50 per cent) or by bank-owned companies (31 per cent).

The securities sector plays a key role in assisting corporations and governments to raise capital, as well as offering individuals an opportunity to invest in stocks, bonds and other securities. It is made up of institutional, retail and integrated firms, with institutional firms providing services exclusively to institutions, such as insurance companies and pension funds, and retail firms offering services to individual or retail investors. Integrated firms offer services that cover all aspects of the industry, including raising debt and equity capital for companies, helping governments raise debt to fund their operations and serving retail investors. In 2000 there were about 190 securities firms operating in Canada, with 7 large integrated firms accounting for about 70 per cent of total industry revenue.^[1]

The finance and leasing sector allows for the financing of equipment and vehicles primarily by way of lease, but also by secured loan or conditional sales. The leasing company retains the ownership of the leased equipment or vehicle until the end of the lease, at which time the lessee can purchase the equipment or vehicle or return it to the lessor without further obligation. While many finance companies are subsidiaries of manufacturers, or “captives,” assisting in the financing of their parent company’s products, more recently there has been significant growth in the number of independent companies.

Assets and Revenue

As shown in Chart 1, banks represent the largest portion of the financial services sector in Canada in terms of asset size. In 2000 they reported $1,080 billion of assets held in Canada, or 55 per cent of the sector’s total assets. Mutual fund companies and life and health insurers were next in terms of domestic asset size, reporting $419 billion (22 per cent) and $267 billion (14 per cent) respectively for 2000.

As shown in Chart 2, the banks also have the greatest revenue share, accounting for 52 per cent of the sector’s total revenue, up from 41.5 per cent in 1993. The banks’ increasing share of industry revenues reflects their acquisitions of trust companies and securities dealers during the 1990s.

The International Dimension

Canada’s banks and life and health insurers are significant players in international markets. The six largest banks are particularly active in the United States, Latin America, the Caribbean and Asia, generating 45 per cent of their total net income from foreign sources in 2000, up from 27 per cent in 1990. The Canadian life and health insurance sector is even more internationally oriented, with branches and subsidiaries in more than 20 countries. Life and health insurers’ share of total premium income from foreign sources increased from 37 per cent in 1990 to 55 per cent in 2000 (see Chart 3).

As shown in Table 2, Canadian-owned banks and life and health insurers are also strong in the domestic market. Canadian-owned banks account for over 90 per cent of the domestic revenue of this sector, while Canadian-owned life and health insurers have a 71-per-cent domestic market share. In addition, Canadian mutual fund companies and securities dealers account for the vast majority of the domestic asset share in these sectors. However, foreign firms are increasing their share of the mutual fund sector, with three foreign fund companies now managing 20 per cent of total mutual fund assets in Canada.

Table 2
Domestic market share of Canadian and foreign financial institutions, 2000

The P&C insurance sector has a much higher involvement of foreign companies than do the other sectors: 6 of the 10 largest P&C insurers are foreign-owned, and foreign P&C insurers account for about 66 per cent of net premiums earned in Canada. Given the governance structure of the credit union sector (i.e. it is made up of member-owned co-operatives), it is 100-per-cent Canadian-owned.

Return on Equity

As shown in Chart 4, banks and life and health insurers both realized ROEs of approximately 14 per cent in 2000, while credit unions/caisses populaires reported an average ROE of 8.4 per cent. P&C insurers, which reported an average ROE of 7.2 per cent in 2000, have been affected in recent years by considerable claims growth, particularly in automobile insurance.

Regulation and Supervision

The federal and provincial governments share jurisdiction over the financial services sector. Under the Constitution, the federal government has sole jurisdiction for banks; banks are therefore regulated by the federal government for both prudential and market conduct purposes under the Bank Act.

The life and health insurance sector is largely regulated for financial soundness by the federal government. Over 90 per cent of firms in this sector are federally incorporated under the Insurance Companies Act since most of them operate in more than one province or are subsidiaries of foreign companies. Smaller companies operating in only one province may also incorporate at the federal level if they so choose. Similarly, about three-quarters of companies operating in the P&C insurance sector are regulated for financial soundness by the federal government under the Insurance Companies Act. While provinces reserve the power to ensure that federally incorporated insurance companies conducting business in their respective provinces are financially sound, all provinces except Quebec accept federal regulation in this regard. All insurers are subject to market conduct regulation by the province in which they carry on business.

Trust and loan companies can also be incorporated at the federal or provincial level. Companies that are federally incorporated are regulated for prudential purposes by the federal government under the Trust and Loan Companies Act. Trust and loan companies are also regulated by both levels of government for market conduct purposes.

All credit unions and caisses populaires are provincially incorporated, as the powers of these institutions do not extend beyond their respective provincial borders. Consequently, this sector is almost exclusively regulated at the provincial level for both prudential soundness and market conduct purposes. However, the federal government does play a regulatory role in the credit union movement outside Quebec through the national and the provincial centrals. The national central, Credit Union Central of Canada, is chartered and regulated by the federal government under the Cooperative Credit Associations Act. In addition, all provincial centrals (except for those in New Brunswick, Prince Edward Island and Newfoundland and Labrador) are regulated at the federal level under the Cooperative Credit Associations Act, as well as at the provincial level.

The securities and mutual fund sectors are governed by provincial legislation regulating the underwriting, distribution and sale of securities, with a major emphasis in the various provincial acts on full disclosure. While each province has its own legislation, provincial regulators meet on a regular basis in an effort to co-ordinate and harmonize provincial regulation of the securities industry and markets. There is also extensive industry self-regulation by the Investment Dealers Association of Canada, the Mutual Fund Dealers Association of Canada and the stock exchanges.

Finance and leasing companies are not regulated as financial institutions as they do not carry out certain “core activities” such as fiduciary activities, underwriting insurance, dealing in securities and deposit taking.

The federal government provides prudential oversight through the Office of the Superintendent of Financial Institutions (OSFI). OSFI is responsible for supervising federally regulated financial institutions, including the banks, federally incorporated insurance companies and federally incorporated trust and loan companies, to ensure that they are in sound financial condition and in compliance with the laws that govern federally regulated financial institutions. If any of these institutions are found lacking in this regard, OSFI can advise management and require remedial action to be taken.

Consumer Protection

The Financial Consumer Agency of Canada has recently been established to enforce the consumer-oriented provisions of the federal financial institution statutes, to monitor the industry’s self-regulatory initiatives designed to protect the interests of consumers and small businesses, to promote consumer awareness and to respond to general consumer enquiries.

In addition, the Canada Deposit Insurance Corporation (CDIC), a federal Crown corporation, insures deposits in banks, trust companies and loan companies against loss in the event of member failure. In particular, it insures eligible deposits up to $60,000 per depositor in each member institution, which must pay premiums to cover CDIC’s insurance obligations. Deposits of credit unions and caisses populaires are protected under provincial stabilization funds and/or deposit insurance and guarantee corporations. Deposit insurance coverage ranges from $60,000 to unlimited coverage, with the amount varying by province.

Life insurance policies, accident and sickness policies and annuity contracts are guaranteed up to certain limits by the Canadian Life and Health Insurance Compensation Corporation, a private non-profit corporation created and financed by the life and health insurance sector. Similarly, the industry-run Property and Casualty Insurance Compensation Corporation guarantees most P&C insurance policies up to certain limits.

Within the securities sector the Canadian Investor Protection Fund, sponsored by the Investment Dealers Association of Canada and the stock exchanges, protects investors in the event of the insolvency of a member firm for up to $1 million per account.

Industry Outlook

In response to technological innovation and globalization, the financial services sector has undergone rapid change over the past decade. One of the key changes is the convergence occurring within the sector, as similar services are offered by the different players. This has led to the breakdown of what was known as the four “pillars” of the financial services sector (banks, trust companies, insurers and securities dealers) and to the creation of “financial groups” or conglomerates which offer a variety of financial products and services that cut across the pillars. This trend is particularly prevalent in the banking and life and health insurance sectors, where companies have established specialized subsidiaries to provide many different financial service products. For example, in addition to providing deposit-taking services, all of the major banks have subsidiaries responsible for trusts, securities and mutual fund products, while the major life and health insurers are increasingly active in wealth management, including mutual funds and segregated funds. Further, one of the largest life and health insurers has a sister subsidiary which is the largest mutual fund company in Canada.

Chart 5 shows the impact of convergence in the financial services sector on the percentage of income generated from each sector’s traditional financial product lines. For example, while the six major banks received 65 per cent of their revenue from net interest income in 1994, by 2000 they were receiving only 44 per cent of revenue from net interest income. Other sources of income, such as that from the sale of securities, now make up the majority of the banks’ total income. A similar, but weaker, trend is seen in the credit union sector, with net interest income declining from 85 per cent in 1994 to 80 per cent in 2000, as credit unions and caisses populaires also increase their focus on wealth management products. Similarly, in the life and health insurance sector, the percentage of total income from premiums has declined, while income from annuities and other wealth management products continues to increase. Only P&C insurers continue to focus on their traditional product lines, generating 88 per cent of income from premiums in 2000.

There is also significant consolidation taking place through mergers and acquisitions, resulting in a decline in the number of firms in each sector and increased concentration. For example, the six major banks currently account for about 74 per cent of the total assets of the deposit-taking sector, while the four largest life and health insurers control about 60 per cent of the sector’s domestic assets, up from 48 per cent in 1994.^[2] Consolidation trends have led to a sector that is increasingly dominated by large financial groups providing a variety of services such as deposit taking, insurance, trusts and securities operating alongside “monoline” and “niche” companies focusing on one or a few business lines, such as credit cards or retail banking.

Annex

This profile is part of a series of short monographs produced by the Department of Finance describing the Canadian financial services sector. Additional information on Canada’s financial services sector can be obtained from the Department of Finance Web site at www.fin.gc.ca.

Notes

¹ These include six large bank-owned firms and Merrill Lynch. In 2001 Merrill Lynch announced its intention to withdraw from the Canadian retail brokerage market and retain only institutional clients. CIBC World Markets has since purchased Merrill’s Canadian retail business. [Return]

² Does not include life and health insurers’ segregated assets. [Return]