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Canada’s Financial Services Sector

The Canadian Financial Services Sector

June 2005

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.

• The financial services sector is significantly integrated as different players offer similar services and "financial groups" or conglomerates offer a variety of financial products and services that cut across what was known as the four "pillars" (banks, trust companies, insurers and securities dealers). This integration 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.

• However, following a period of significant product convergence when most financial institutions, particularly in the banking and life and health insurance sectors, widened the financial services offered outside their traditional business lines, 2003 saw a slight departure from this trend, as most sectors increased their share of income generated from traditional financial product lines.

• The financial services sector is a significant contributor to Canada’s economic growth, employing over 600,000 Canadians in 2003 and having a yearly payroll of over $35 billion. The sector represented 6 per cent of Canada’s gross domestic product in 2003 and contributed close to $13 billion in taxes to all levels of government.

• Banks represent the largest portion of the Canadian financial services sector, reporting $1,257 billion in domestic assets in 2003, or over 55 per cent of the sector’s total assets in Canada. Mutual fund companies and life and health insurers were next in terms of asset size, reporting $439 billion and $315 billion in domestic assets respectively in 2003, followed by the credit union sector at $155 billion and P&C insurers with domestic assets of $88 billion.

• Canada’s banks and life and health insurers are significant participants in international markets. The six largest banks generated 33 per cent of their net income from foreign sources in 2003, while 58 per cent of the life and health insurance sector’s premium income was derived from foreign sources.

• Deposit-taking institutions and insurance companies all enjoyed similar performance levels in 2003. Banks reported an average return on equity (ROE) of 14.6 per cent, the credit union sector almost 12 per cent and life and health insurers about 13 per cent. P&C insurers reported an ROE of 11.6 per cent. While slightly lower than the ROE of other institutions, P&C insurers’ return did mark a substantial increase from the previous five years, largely due to higher premiums.

• The federal and provincial governments share jurisdiction over the financial services sector. The Government of Canada 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.

• Overall, the financial services sector is competitive. Over the past few years competition in the sector has further increased due in part to recent changes to the federal regulatory framework and to technological innovations.

Introduction

The financial services sector plays a critical role in a market economy, providing a 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. It also allows governments to finance new debt issues and support programs and services. At the same time, the sector enables Canadians to carry out their everyday financial transactions, including chequing, savings and wealth management, and to insure against risk and unexpected events. The sector is also a significant contributor to Canada’s economic growth and to job creation. It employs over 600,000 Canadians and has a yearly payroll of over $35 billion. In addition, the sector represents 6 per cent of Canada’s gross domestic product and contributes close to $13 billion in taxes to all levels of government.

Table 1
Overview of the financial services sector, 2003

Structure of the Industry

The Canadian financial services industry is made up of banks, trust and loan companies, credit unions and caisses populaires, 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. In 2003 the banking sector comprised 18 domestic banks (up from 14 in 2000), 29 foreign bank subsidiaries (down from 33 in 2000) and 22 foreign bank branches (up from 16 in 2000) for a total of 69 banks. The increase in the number of banks in Canada is the result of changes to the ownership regime and the reduction in the capital required to open a small bank, both of which were introduced with Bill C-8 in 2001. However, the 6 largest Canadian banks still account for more than 90 per cent of total bank assets and for about 76 per cent of the total assets of the deposit-taking sector. Canada’s banks operate through an extensive network that includes close to 9,000 branches and close to 16,500 automated teller machines (ATMs) across Canada. Canada’s banks also provide a range of services beyond deposit taking and lending. They are major players in the securities sector, helping private companies and governments 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. Banks also own insurance companies.

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

Canada’s credit unions and caisses populaires^[1] differ from banks in that they are provincially incorporated cooperative financial institutions that are owned and controlled by their members. Their ownership and corporate governance are based on cooperative 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 other deposit-taking institutions. They are part of a three-tiered structure composed of credit unions, provincial centrals (whose main purpose is to provide liquidity support to local cooperatives), and a national association. They also differ in that they do not operate outside provincial boundaries. At the end of 2003, Canada’s credit union sector consisted of about 600 credit unions and almost 700 caisses populaires, with almost 3,600 locations and more than 4,500 ATMs.

As in other areas of the financial services sector, there is a trend towards consolidation, with the total number of credit unions and caisses populaires declining by half from about 2,700 in 1990 to close to 1,300 by the end of 2003. At the same time, the sector is maximizing member opportunities through the purchase of bank branches in communities where banks have withdrawn from the market. Credit unions and caisses populaires have also broadened their services in non-traditional areas including full-service brokerage, mutual funds, commercial lending and wealth management. Since 2001 legislation enables credit unions to incorporate a federal association with enhanced business powers, including the potential to offer retail services through a "retail association" to clients outside the credit union system. The first retail association was established at the end of 2004.

The life and health insurance sector comprises 108 companies providing group and individual life and health insurance, as well as group and individual retirement products such as annuities, pension plans, registered retirement savings plans and registered retirement income funds. The sector is somewhat less concentrated than the banking sector, with the four largest companies accounting for 69 per cent of the sector’s domestic general assets. Wealth management products such as annuities accounted for 51 per cent of premium income in 2000, and by 2003 still accounted for a substantial, although smaller, portion of the sector’s income (40 per cent).

Canada’s P&C insurance sector comprises over 200 insurers. Product lines generally include automobile, property and liability insurance, with a few companies selling a limited amount of sickness and accident insurance and underwriting a small amount of aviation and marine insurance. The sector is diversified and competitive, with the 5 largest insurers accounting for less than 35 per cent of total domestic assets, and the top 10 companies having an estimated market share of almost 50 per cent. The P&C market has attracted considerable interest from foreign companies, which accounted for over 60 per cent of the sector’s net premium income in 2003.

The mutual fund sector consists of the manufacturers of mutual funds and the distributors, with a number of mutual fund companies involved in both segments of the business, notably those owned by the banks and the credit unions/caisses populaires. At the end of 2003, there were over 70 mutual fund companies sponsoring close to 1,900 mutual funds, and close to 200 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 (35 per cent).

The securities sector plays a key role in Canada’s financial system by raising debt and equity capital for businesses and governments and allowing investors to trade with confidence in open and fair capital markets. The sector is made up of integrated, institutional and retail 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. The integrated firms, which represent mainly the securities dealer affiliates of the six largest domestic banks, 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 2003 there were 207 securities firms operating in Canada, with the 6 large integrated firms accounting for 73 per cent of total industry revenue.

The finance and leasing sector finances 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.

After banks and credit unions, the finance and leasing sector is the most important supplier of debt financing to Canadians.

It is estimated that this industry has over $100 billion in financing in place, with small and medium-sized businesses representing approximately 60 per cent of its customers. While many finance companies are subsidiaries of manufacturers, or "captives," assisting in the financing of their parent company’s products, there has been significant growth in the last decade, with the number of players in the Canadian marketplace, both domestic and foreign, continuing to increase.

Assets and Revenue

As shown in Chart 1, banks represent the largest portion of the Canadian financial services sector in terms of asset size. In 2003 they reported $1,257 billion in assets held in Canada, or 56 per cent of the sector’s total assets, up slightly from 55 per cent in 2000. Mutual fund companies and life and health insurers were next in terms of domestic asset size, reporting $439 billion (19 per cent) and $315 billion (14 per cent) in assets respectively for 2003.

As shown in Chart 2, the banks also have the greatest revenue share, accounting for almost 46 per cent of the sector’s total revenues in 2003. This large share of industry revenues reflects the banks’ acquisitions of trust companies and securities dealers during the 1990s, which contributed to the steady increase of their revenues up to 2001. However, in 2002 and 2003, a combination of decreased total revenues^[2] in the banking sector and increased revenues in the insurance sector lowered the revenue share of banks to less than 46 per cent from its peak of 55 per cent in 2001.

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, with approximately 33 per cent of their revenue generated outside Canada in 2003 (see Chart 3). This figure is significantly lower than the 45 per cent generated abroad in 2000 for three reasons. First, revenue earned in Canada has grown significantly faster than revenue earned abroad. Second, after the capital market declines in 2000, several large banks refocused on domestic retail banking and exited or downsized their international lines of business. And last, the U.S. currency depreciation affected the value of revenues earned in the U.S.

The Canadian life and health insurance sector is even more internationally oriented, with branches and subsidiaries in more than 20 countries around the world. Life and health insurers’ share of total premium income from foreign sources increased from 37 per cent in 1990 to 58 per cent in 2003.

As shown in Table 2, Canadian-owned banks and life and health insurers are also strong in the domestic market. In 2003 Canadian-owned banks accounted for 93 per cent of the domestic revenue of the banking sector. The market share for foreign banks increased from 6 to 7 per cent between 2000 and 2003. Canadian-owned life and health insurers had a 73-per-cent domestic market share in 2003, up slightly from 71 per cent in 2000.

Table 2
Domestic market share of Canadian and foreign financial institutions, 2003

The P&C insurance sector has a much higher involvement of foreign companies than other sectors: in 2003, 5 of the 10 largest P&C insurers were foreign-owned, and foreign P&C insurers accounted for about 62 per cent of net premiums earned in Canada, down somewhat from 66 per cent in 2000.

Given the governance structure of the credit union sector (i.e. it is made up of member-owned cooperatives), it is 100-per-cent Canadian-owned.

Return on Equity

Most industries in the sector improved their overall profitability in 2003, with banks and P&C insurers recording the largest increases in return on equity (ROE)

As shown in Chart 4, banks recorded an ROE of 14.6 per cent in 2003, up from an ROE of 9.5 per cent in 2002 that was largely due to financial markets’ poor performance and the deterioration of corporate loan portfolios. Life and health insurers posted an ROE of 13.1 per cent in 2003.

P&C insurers’ ROE increased substantially, jumping from their worst result on record of less than 2 per cent in 2002 to 11.6 per cent in 2003. This result marked the end of a five-year trend of a steadily decreasing ROE. This reversal is largely due to increased premiums, but also to a slowdown in claims growth and rising investment income.

The credit union sector recorded an ROE of almost 12 per cent in 2003, down from slightly more than 14 per cent in 2002, but substantially improved from 8.4 per cent in 2000.

Regulation and Supervision

The federal and provincial governments share jurisdiction over the financial services sector. Under the Constitution, the Government of Canada is solely responsible for the prudential and market conduct regulation of banks in Canada. However, given the evolution of the business of banking, some of the banks’ activities, such as trustee services and securities dealing, which are carried out by bank subsidiaries, are provincially regulated.

The life and health insurance sector is largely regulated for financial soundness by the Government of Canada. 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 Government of Canada under the Insurance Companies Act. While provinces reserve the power to ensure that federally incorporated insurance companies conducting business in their respective jurisdictions 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 be regulated by both levels of government. Market conduct is regulated at the provincial level, and companies that are federally incorporated are regulated for prudential purposes by the Government of Canada under the Trust and Loan Companies Act. Ontario no longer provides for the incorporation of new trust and loan companies in its jurisdiction.

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 Government of Canada does play a regulatory role in the credit union movement outside Quebec through the national and provincial centrals. The national central, Credit Union Central of Canada, is chartered and regulated by the Government of Canada under the Cooperative Credit Associations Act. In addition, provincial centrals (except 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 coordinate 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 Market Regulation Services Inc.

Currently the securities regulatory framework in Canada is under review. In December 2003 the Wise Persons’ Committee presented its report recommending that the federal and provincial governments collaborate to establish a single securities regulator in Canada. The Government of Canada committed to improve the efficiency and effectiveness of Canada’s capital markets and, in this regard, continues to work with the provinces towards the development of a new, enhanced system of securities regulation.

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 Government of Canada 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 and federally incorporated insurance and 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.

The legislation governing Canada’s federally regulated financial institutions is subject to review every five years. The last scheduled review was completed in 2001, and amendments to the relevant financial statutes came into force in October of that year. The legislated five-year review provision ensures that the regulatory framework remains current and that the financial services sector has the flexibility it needs to react to changing times. The next legislative review will be completed in 2006.

Consumer Protection

The Financial Consumer Agency of Canada has a legislative mandate 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 and trust and loan companies against loss in the event of member failure. In particular, it insures eligible deposits up to $100,000^[3] 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.

To aid consumers in their dealings with financial institutions, the Government of Canada requires all federally regulated financial institutions to have dedicated procedures and personnel in place to handle consumer complaints, and belong to an independent third-party dispute resolution system. Additionally, the recently established Centre for the Financial Services OmbudsNetwork (CFSON) provides consumers of banking, life and health insurance, P&C insurance, securities and mutual fund services with single-window access to a network of industry-level ombudsman services. These ombudsmen provide independent and impartial dispute resolution and redress services at no cost to consumers. The CFSON’s mandate also includes the development and promotion of industry standards and best practices relating to financial consumer complaint handling.

Industry Outlook

Changes to federal laws and regulations and external factors have driven change in the financial services sector.

The financial services sector is an increasingly competitive sector as changes to federal laws and regulations have resulted in the entry of new domestic and foreign competitors in the Canadian market. Moreover, technological developments have triggered the appearance of new types of competitors such as monoline credit card issuers and have given financial institutions the opportunity to offer more products and services.

In response to technological innovation and globalization, the financial services sector has undergone rapid change. One of the key changes has been integration within the sector as different players offer similar services. 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 offering 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, major banks have subsidiaries responsible for trusts, securities, insurance and mutual fund products, while the major life and health insurers are increasingly active in wealth management, including mutual funds and segregated funds. One of the largest life and health insurers has a sister subsidiary which is the largest mutual fund company in Canada and another has a banking subsidiary.

However, Chart 5 shows that the trend observed from 1995 to 2000, when most sectors were generating more revenues from their non-traditional financial product lines, is showing signs of reversal. Between 2000 and 2003 most sectors slightly increased their share of income generated from traditional financial product lines. For example, while the banks’ revenue from net interest income dropped to 44 per cent in 2000 from 65 per cent in 1995, by 2003 they were making 48 per cent of revenue from net interest income. This increase is due to a decline in the portion of revenue earned from other sources of income such as the sale of mutual funds and securities. A similar phenomenon is seen in the life and health insurance sector, where premium income increased from 71 per cent of total revenue in 2000 to 72 per cent in 2003, and in the P&C insurance sector, where premium income rose from 87 per cent to 93 per cent of revenue. Only in the credit union sector did the percentage of total income from net interest steadily decline-from 85 per cent in 1995 to 75 per cent in 2003-as credit unions and caisses populaires continued increasing their focus on wealth management products.

Significant consolidation is also taking place through mergers and acquisitions, resulting in a decline in the number of firms in most sectors and increased concentration. For example, the six major banks currently account for about 76 per cent of the total assets of the deposit-taking sector, while the four largest life and health insurers control about 69 per cent of the sector’s domestic assets, up from 48 per cent in 1994. 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, and operating alongside "monoline" and "niche" companies focusing on one or a few business lines, such as credit cards or retail banking.

Annex

Top 10 financial services institutions by asset size (consolidated basis), 2003

Sources

Publications

Bank of Canada, Banking and Financial Statistics, March and September 2004.

Canadian Payments Association, statistics available on website at www.cdnpay.ca.

Conference Board of Canada, The Canadian Financial Services Industry, The Year in Review, 2003 edition.

Office of the Superintendent of Financial Institutions, financial data published on website at www.osfi-bsif.gc.ca.

Statistics Canada, Gross Domestic Product by Industry, cat. no. 15-001-XIE, August 2004.

Statistics Canada, Quarterly Financial Statistics for Enterprises, cat. no. 61-008-XIE, special extraction, 2004.

Statistics Canada, Financial and Taxation Statistics for Enterprises, cat. no. 61-219-XIE, 2003.

Stone & Cox Limited, Canadian Insurance 2004 Annual Statistical Issue.

Industry Associations

Canadian Bankers Association

Canadian Finance & Leasing Association

Canadian Life and Health Insurance Association

Credit Union Central of Canada

Insurance Bureau of Canada

Investment Dealers Association of Canada

Investment Funds Institute of Canada

Mutual Fund Dealers Association of Canada

Notes

¹ Caisses populaires operate primarily in Quebec, but also in some francophone communities in Ontario, New Brunswick and Manitoba. [Return]

² While total revenues decreased, net revenues of banks increased significantly in 2003. [Return]

³ Budget 2005 announced the Government’s intention to raise the insured amount to $100,000 from $60,000. [Return]

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