Financial Market Supervision: Canada's Perspective

Financial Market Supervision: Canada's Perspective

Financial Market Supervision:
Canada’s Perspective
James K. Jackson
Specialist in International Trade and Finance
April 4, 2013
Congressional Research Service
7-5700
www.crs.gov
R40687
CRS Report for Congress
Pr
epared for Members and Committees of Congress

Financial Market Supervision: Canada’s Perspective

Summary
The international financial crisis of 2008-2009 spurred policymakers in the United States and
elsewhere to consider changing the way they supervised financial institutions and financial
markets to reduce the prospects of experiencing another global financial crisis. Canada’s financial
system, in particular, garnered attention, because it has seemed to be more resistant to the failures
and bailouts that have marked banks in the United States and Europe. In particular, some
observers assessed the merits of the way Canada supervises and regulates its banks as one
possible model for the United States. There likely are aspects of Canada’s financial supervisory
framework that may offer an approach to supervising financial markets that may be useful for the
United States to consider. However, the smaller scope of Canada’s financial system and its
economy likely lessen the transferability of systems or procedures used in Canada to the vastly
more complex U.S. financial system. This report presents an overview of Canada’s financial
system and its supervisory framework and draws some distinctions between that system and the
current U.S. framework.

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Financial Market Supervision: Canada’s Perspective

Contents
Background ...................................................................................................................................... 1
The U.S. Financial Supervisory System ........................................................................................ 10
Canada’s Financial System ............................................................................................................ 12
Economic Effects of Canada’s Supervisory System ...................................................................... 17

Figures
Figure 1. U.S. System for Supervising Financial Markets ............................................................ 11
Figure 2. Canada’s Financial System Supervisory Structure ......................................................... 13

Tables
Table 1. Canada’s Actual and Projected Real GDP, Consumer Prices,
and Rate of Unemployment .......................................................................................................... 2
Table 2. Canada’s Economic Action Plan ........................................................................................ 5
Table 3. Capital Ratios of Major Banks ........................................................................................... 6
Table 4. Balance Sheet Liquidity of Major Banks ........................................................................... 7
Table 5. Depository Funding of Major Banks ................................................................................. 8
Table 6. Canada: Financial Sector Structure, End-2006 ................................................................ 16

Contacts
Author Contact Information........................................................................................................... 18

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Financial Market Supervision: Canada’s Perspective

Background
The 2008-2009 financial crisis prompted U.S. and foreign leaders to search for national models
for supervising and regulating financial markets that have proven superior and for a new
international order that can help mitigate any recurrence of the crisis. Canada’s financial system,
in particular, garnered attention because it has been more resistant during the crisis to the failures
and bailouts that have marked banks in the United States and Europe. In particular, some
observers assessed the merits of Canada’s financial system, especially the way it supervises and
regulates its banks, as one possible model for the United States. Currently, advanced economies
employ a number of institutional structures to supervise and regulate their financial sectors.
No single model of market supervision has proven to be clearly superior, but the trend seems to
be toward more integrated arrangements. Reportedly, the Obama Administration considered at
one time replacing the multiple agencies that supervise and regulate the U.S. financial system
with a single regulator.1 Instead, Congress adopted the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank) (P.L. 110-203) and considered measures to reform
securitization, banking supervision, hedge funds, financial consumer protection, and derivatives,
among a number of other topics. The Dodd-Frank measure enhances the role of the Federal
Reserve and created a new Bureau of Consumer Financial Protection.2 A number of countries
have opted for a twin peaks approach where prudential regulation (focusing on the long-term
view of market performance) is assigned to one regulator and market conduct regulation
(focusing on the day-to-day operation of the market) to another. Great Britain had employed a
different model where a fully unified regulator, the Financial Services Authority, was separate
from the central bank. Recently, however, the UK has opted instead to replace the FSA with an
independent Financial Conduct Authority and the Prudential Regulation Authority, which is part
of the Bank of England. Others, like the United States, have opted for specialized federal
regulators, while reserving a role for state regulators in securities regulation. Canada’s model
assigns the central bank the main role of conducting monetary policy and maintaining price
stability. It has assigned the core responsibility for supervising and regulating some aspects of the
financial system to a separate federal agency, while also giving provincial governments authority
over other parts of the financial system.
While Canada did not inject capital directly into its banks to forestall a failure, the financial crisis
and global economic recession battered the Canadian economy in ways that are similar to those in
the United States and in Europe. In April 2011, the International Monetary Fund (IMF) indicated
that the Canadian economy, as represented by gross domestic product (GDP), contracted by 2.8%
in 2009, before rebounding with a positive rate of economic growth of 3.2% in 2010 and 2.6% in
2011. Recent estimates by the IMF indicate that the rate of economic growth in Canada slowed in
2012, particularly in the second half of the year, to 2.0% and is projected to grow at a rate of
1.8% in 2013, as indicated in Table 1.3 The vast economic and financial linkages between Canada
and the United States mean that Canada is feeling the impact of the slowing U.S. economy.

1 Appelbaum, Binyamin, and Zachary A. Goldfarb, U.S. Weighs Single Agency to Regulate Banking Industry, The
Washington Post, May 28, 2009, p. A1.
2 For additional information, see CRS Report R40975, Financial Regulatory Reform and the 111th Congress,
coordinated by Baird Webel.
3 Canada: Article IV Consultations, International Monetary Fund, February 2013.
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The IMF forecast indicates that the U.S. economy is expected to grow at an annual rate of 2.2%
in 2012 and 2.1% in 2013. 4 It also indicates that the unemployment rate in Canada will fall to
7.3% by 2012 and 7.3% 2013. The Bank of Canada projects a slow return to the trend rate of
economic growth in 2013 and after propelled in large part by an increase in business investment
and a rebound in exports.5
Table 1. Canada’s Actual and Projected Real GDP, Consumer Prices,
and Rate of Unemployment
(Annual percentage changes and percent of labor force)
2009 2010 2011 2012 2013
Actual
Projected
Real GDP
-2.8%
3.2%
2.6%
2.0%
1.8%
Consumer
1.7
Prices
0.3 1.8 2.9 1.6
Unemployment
8.3 8.0 7.5 7.3 7.3
Source: Canada Article IV Consultations, International Monetary Fund, February, 2013.
Much of Canada’s economic recovery after the financial crisis is attributed to low interest rates
and a $33 billion fiscal stimulus package-one of the largest among advanced economies-over two
years in infrastructure spending, tax decreases, worker retraining, housing, and aid to struggling
industries. In addition, the federal government pumped additional liquidity into the economy by
purchasing insured mortgages. In April 2009, the Bank of Canada lowered the nation’s key
interest rate to 0.25%. A drop in commodity prices caused the Canadian dollar to fall relative to
the U.S. dollar, which improved the cost competitive position of Canada’s exports. In relative
terms, Canada’s fiscal outlook is among the best in the G-20.
According to the Bank of Canada, major risks to Canada’s economic recovery remain high and
primarily arise from: 1) global sovereign debt issues associated with some European countries
that potentially could raise borrowing costs for Canadian banks; 2) the risk that global financial
imbalances arising from large current account (exports and imports of goods, services, and
income) imbalances could be disorderly and create sharp adjustments to exchange rates and other
financial asset prices; 3) a protracted recovery in other major economies will be a drag on
economic growth; 4) low interest rates could encourage excessive risk taking; 5) high levels of
indebtedness among Canadian households leaves them vulnerable to economic and financial
shocks. Although Canadian banks are not highly exposed to public or private entities in Greece,
Italy, Spain, or Portugal, Canadian banks are exposed to banks in Europe and the United States
that are themselves highly exposed to the four countries. This high level of financial linkages
could amplify shocks throughout the global financial system.
The IMF has concluded that Canada’s financial system is highly mature, sophisticated, and well-
managed. In addition, the system is characterized by strong prudential regulation and supervision,
stringent capital requirements, low risk tolerance, a well-designed system of deposit insurance
and arrangements for crisis management and resolution of failed banks, a well-regulated and

4 World Economic Outlook, The International Monetary Fund, October, 2012, p. 2.
5 Monetary Policy Report, the Bank of Canada, January 2013, p. 17.
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conservative mortgage market, and comprehensive mortgage insurance coverage. Supervisory
responsibility for the financial sector in Canada is divided among the federal government, the
provincial governments, and among a group of agencies within the federal government. The
federal government is responsible for supervising all banks, federally incorporated insurance
companies, trust and loan companies, cooperative credit associations and federal pension plans.
Provincial governments are responsible for supervising securities dealers, mutual fund and
investment advisors, credit unions, and provincially incorporated trust, loan, and insurance
companies. As a result, there are 13 regulatory authorities, each administering a separate set of
securities laws and regulations.
The IMF also concluded that Canada was generally better situated than many other countries to
weather the financial crisis and the global economic downturn. This resilience is attributed to
three factors. First, Canada positioned itself well prior to the financial crisis through a
conservative macroeconomic policy that reduced the federal government’s debt relative to GDP
and through a relatively tight monetary policy that focused on price stability.6
Secondly, the IMF argues that Canadian banks performed better because Canadian authorities
acted proactively in addressing the potential economic slowdown. They did this by (1) adopting a
major fiscal stimulus of Can$65 billion on October 30, 2008; (2) adopting an additional fiscal
stimulus program in early January 2009; and (3) easing monetary policy through a series of cuts
in key interest rates. As part of Canada’s Economic Action Plan adopted in January 2009, officials
implemented additional policy measures they could have employed if they had decided that
further actions had been necessary. The economic plan comprised five elements: (1) funding for
job and skills training; (2) funding to stimulate housing construction; (3) investment in
infrastructure; (4) support for major export sectors, including automotive, forestry, and
manufacturing; and (5) improving access to financing through the Extraordinary Financing
Framework. In the early stages of the financial crisis, the Bank of Canada also provided liquidity
by expanding its liquidity facilities and the Government of Canada purchased some insured
mortgages through the Canada Mortgage and Housing Corporation.7
In addition, the Extraordinary Financing Framework is comprised of five elements: (1) providing
funding to Canadian financial institutions through the Insured Mortgage Purchase Program and
the Canada Mortgage Bond program; (2) expanding financing for Canadian businesses through
Export Development Canada and the Business Development Bank of Canada; (3) increasing
collaboration between financial Crown corporations8 and private sector lenders and credit
insurers under a business Credit Availability program; (4) designing a Canadian Secured Credit
Facility; and (5) initiating a Canadian Lenders Assurance Facility and the Canadian Life Insurers
Assurance Facility to provide insurance on the wholesale term borrowing of federally regulated
deposit-taking institutions, and life insurers. Additional measures include the ability to offer
guarantees on bank and insurance liabilities, and the authority to engage in transactions to
maintain financial stability, including providing capital injections. 9
Finally, the IMF argues that financial conditions have remained more favorable in Canada,
because Canadian banks are managed conservatively. Canadian banks are required to maintain

6 Canada Article IV Consultation, International Monetary Fund, December 2010.
7 Financial System Review, p. 3.
8 State-owned corporations at either the federal, state, or territorial level.
9 Canada’s Economic Action Plan, 2009 Budget, Chapter 3, Ministry of Finance.
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larger capital requirements than elsewhere, which has meant that Canadian banks had a stronger
balance sheet position as the crisis developed. This higher level of capital and liquidity means that
Canada is well positioned to meet the higher capital and liquidity standards adopted under the
Basel III framework. The regulatory structure also discourages Canadian banks from taking
excessive risks. This system is centered around two key thresholds: minimum risk-based capital
ratios; and a maximum assets-to-capital multiple. Canada requires banks to hold capital at rates
that are higher than those set in the Basel Accords; Canada requires its banks to hold tier 1
capital10 of at least 7% and total capital of 10%, compared with 4% and 8%, respectively, for the
Basel Accord. In addition, Canada requires that 75% of the tier 1 capital be in the form of
common equity and it restricts innovative instruments to 15% of tier 1 capital. In addition, the
assets-to-capital multiple is set at 20%, which translates into a leverage ratio of 5%. The capital
requirements not only provide an enhanced capital cushion for Canadian banks, but they restrict
rapid balance sheet expansion and discourage engaging in wholesale operations.11 Nevertheless,
as the financial crisis unfolded, the banks came under pressure from markets to increase their
capital ratios, which they apparently did by tapping private sources.12 In addition, the IMF points
out that Canadian banks have been more resilient, because Canada has a strong financial
regulatory and supervisory framework.13
As a result of these three factors, no Canadian bank needed public capital injections and none
used public guarantees.14 Nevertheless, the banks suffered a loss of 50% in the value of their
equities, similar to the experience of such equities in the United States and Europe. The Canadian
Imperial Bank of Commerce lost $2.1 billion in derivatives in 2008. The drop in commodity
prices also caused the Canadian dollar to fall relative to the U.S. dollar, which improved the cost
competitive position of Canada’s exports. As the recovery began, however, demand for raw
materials increased, which, in turn, caused the Canadian dollar to appreciate. The slowdown in
global trade, the shake-out in the auto industry, and a slowdown in exports of construction-related
products following the financial crisis had far-reaching negative effects on the Canadian
economy. In January, 2009, the Canadian Government announced about a Can$40 billion fiscal
stimulus package over two years in infrastructure spending, tax decreases, worker retraining,
housing, and aid to struggling industries to spur the Canadian economy, as indicated in Table 2.
The stimulus to the Canadian economy provided by this economic package supplemented
spending by the provincial governments. In addition, on April 21, 2009, the Bank of Canada
lowered the nation’s key interest rate to 0.25%.

10 Tier 1 capital is the core measure of a bank’s financial strength from a regulator’s perspective. It generally is
comprised of common stock and disclosed reserves.
11 Rostnovski, Lev, and Rocco Huang, Why Are Canadian Banks More Resilient? IMF Working Paper WP/09/152.
International Monetary Fund, July 2009, , p. 16.
12 Financial System Review, p. 4.
13 Concluding Statement on the IMF’s 2009 Article IV Mission to Canada.
14 Financial System Review, p. 1.
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Table 2. Canada’s Economic Action Plan
(in millions of Canadian dollars)
2009
2010
Total
Action to Help Canadians and Stimulate Spending
$5.880 $6.945 $12.825
Action to Stimulate Housing Construction
5,365 2,395 7,760
Housing leverage
725
750
1,475
Immediate Action to Build Infrastructure
6,224 5,605 11,829
Infrastructure leverage
4,532
4,365
8,897
Action to Support Businesses and Communities
5,272 2,255 7,527
Sectoral leverage
1,300

1,300
Total Federal Stimulus
22,742 17,200 39,942
Total Stimulus (with leverage)
29,298 22,316 51,613
Total Stimulus as a share of GDP (%)
1.5
1.1
2.5
Total Stimulus (with leverage) as a share of GDP (%)
1.9
1.4
3.2
Source: Canada’s Economic Action Plan, 2009 Budget, Chapter 3, Ministry of Finance.
The IMF used three measures to assess the financial strength of Canada’s banks as a way of
understanding the relative success the banks experienced in avoiding the same intensity of
financial troubles that afflicted banks in other major economies. These measures include (1)
capital-assets ratios (total equity divided by total assets), since better-capitalized banks likely can
sustain higher losses without becoming insolvent; (2) balance sheet liquidity (total liquid assets
divided by total liabilities), because a buffer of liquid assets allows banks to cover transitory cash-
flow shortfalls; and (3) the funding structure of the banks, or the share of their funding that is
derived from deposits, since deposit insurance likely improves the stability of this source of
funding. The results of the measures are presented in Table 3, Table 4, and Table 5. The three
tables also include a measure of the percentage decline from January 2007 to January 2009 in the
value of the equity of the individual banks. They also provide some basic information on the
nature of any government intervention that was needed to assist the individual banks.
Table 3, Table 4, and Table 5 indicate that Canadian banks were not exceptionally financially
strong relative to banks in other OECD countries. In some cases, the capital ratios of Canadian
banks were half or less than that of a number of U.S. firms that experienced significant liquidity
problems as the financial crisis progressed. Similarly, Canadian banks did not have balance sheet
liquidity that was significantly different from that of other banks. As indicated by the IMF report,
and as indicated in Table 5, the major difference between Canadian banks and banks in other
OECD countries was the funding source of those banks. Canadian banks generally relied much
less on wholesale funding, or borrowing from short-term from money markets. Instead, the banks
relied on depository funding, much of which came from such retail sources as households, for a
higher share of their funding.15 This success in attracting household deposits may in part stem

15 Ratnovski, Huang, Why Are Canadian Banks More Resilient?, p. 4.
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from the ability of Canadian banks, as universal banks, to offer one-stop service in mutual funds
and asset management.16
Table 3. Capital Ratios of Major Banks
Capital
Value
Bank Country
Ratio
decline Intervention
Hypo Real Estate Holding AG
Germany
2.1
97% Asset guarantees and public
loans
Deutsche Bank AG
Germany
2.1
81

UBS AG
Switzerland
2.3
79
Capital injection
Commerzbank AG
Germany
2.5
89
Capital injection
ABN Amro Holding NV
Netherlands
2.6
NA Nationalized (carved out
from Fortis)
Barclays Plc
United Kingdom
2.7
85

Fortis
Belgium
2.8
94
Broken up, part nationalized
Dresdner Bank AG
Germany
3.0
NA Capital injection
Northern Rock Plc
United Kingdom
3.2
100
Nationalized
Dexia Belgium
3.3
89
Nationalized
ING Groep NV
Netherlands
3.3
81
Recapitalized, asset
guarantees
Lloyds TSB Group Plc
United Kingdom
3.3
78
Capital injection
HBOS Plc
United Kingdom
3.6
100
Recapitalized (part of
Lloyds)
Canadian Imperial Bank of Commerce
Canada
4.1
54

Royal Bank of Canada RBC
Canada
4.3
44

Credit Suisse Group
Switzerland
4.7
66

Banque de Montreal-Bank of Montreal
Canada
4.8
53

Bank of Nova Scotia (The)
Canada
4.9
42

Royal Bank of Scotland Group Plc
United Kingdom
5.2
96
Capital injection, asset
(The)
guarantees
Westpac Banking Corporation
Australia
5.3
38

Commonwealth Bank of Australia
Australia
5.7
46

National Australia Bank
Australia
5.7
53

Toronto Dominion Bank
Canada
5.7
43

Australia and New Zealand Banking
Australia 5.9
54

Group
Citigroup Inc
USA
6.4
94
Recapitalized, asset
guarantees
HSBC Holdings Plc
United Kingdom
6.6
41

16 Ibid., p. 11.
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Capital
Value
Bank Country
Ratio
decline Intervention
Washington Mutual Inc.
USA
8.5
100
Failed, taken over by FDIC
JP Morgan Chase & Co.
USA
8.6
50

Bank of America Corporation
USA
9.3
87
Capital injection, asset
guarantees
Wells Fargo & Company
USA
9.5
47

Wachovia Corporation
USA
10.3
100
Failed, acquired by Wel s
Fargo
Capital One Financial Corporation
USA
16.9
80

Source: Ratnovski, Lev, and Rocco Huang, Why Are Canadian Banks More Resilient?, IMF Working Paper
WP/09/152, International Monetary Fund, July 2009.
Note: Capital represents bank equity divided by total assets. Value decline is a measure of the percentage
decline from January 2007 to January 2009 in the value of the equity of the respective bank. Intervention
represents some basic information about the nature of any government intervention.
Table 4. Balance Sheet Liquidity of Major Banks
Bank Country
Liquidity
Value
decline
Intervention
Capital One Financial
USA 3.70%
80%

Corporation
National City Corporation
USA
4.00
100
Acquired by PNC Bank
Citizens Financial Group Inc.
USA
4.30
NA
NA (owned by RBS)
SunTrust Banks, Inc.
USA
4.30
85

US Bancorp
USA
4.40
58

Washington Mutual Inc.
USA
4.80
100
Failed, taken over by FDIC
Regions Financial
USA 5.00
90

Corporation
Nomura Holdings Inc
JAPAN
5.60
76

Wel s Fargo & Company
USA
6.00
47

Northern Rock Plc
United
6.70 100 Nationalized
Kingdom
Kookmin Bank
Korea
7.80
56

Bank of Ireland
Ireland
8.40
96
Capital injection, liabilities
guarantee
Commonwealth Bank of
Australia 8.90
46
Australia
Australia and New Zealand
Australia 10.32 54
Banking Group
Westpac Banking
Australia 10.42 38
Corporation
Wachovia Corporation
USA
10.69
100
Failed, acquired by Wel s
Fargo
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Bank Country
Liquidity
Value
decline
Intervention
HBOS Plc
United
11.14
100
Capital injection (part of
Kingdom
Lloys)
National Australia Bank
Australia
11.15
53

Lloyds TSB Group Plc
United
15.67 78 Capital
injection
Kingdom
Banque de Montreal-Bank of
Canada 23.99
53

Montreal
Toronto Dominion Bank
Canada
24.37
43

Bank of Nova Scotia (The)
Canada
24.43
42

Royal Bank of Scotland Group United
25.11
96
Capital injection, asset
Plc (The)
Kingdom
guarantees
Bank of America Corporation USA
25.59
87
Capital injection, asset
guarantees
Canadian Imperial Bank of
Canada 26.00
54

Commerce
Royal Bank of Canada RBC
Canada
32.11
44

HSBC Holdings Plc
United
33.20 41
Kingdom
Citigroup Inc
USA
39.46
94
Recapitalized, asset
guarantees
Barclays Plc
United
40.75 85
Kingdom
JP Morgan Chase & Co.
USA
46.80
50

Credit Suisse Group
Switzerland
64.93
66

UBS AG
Switzerland
65.20
79
Capital injection
Source: Ratnovski, Lev, and Rocco Huang, Why Are Canadian Banks More Resilient?, IMF Working Paper
WP/09/152, International Monetary Fund, July 2009.
Note: Liquidity represents total liquid assets divided by total liabilities. Value decline is a measure of the
percentage decline from January 2007 to January 2009 in the value of the equity of the respective bank.
Intervention represents some basic information about the nature of any government intervention.
Table 5. Depository Funding of Major Banks
Depository
Value
Bank Country
funding
decline
Intervention
Hypo Real Estate
Germany
24.0%
97% Asset guarantees and public loans
Holding AG
Northern Rock Plc
United Kingdom
28.7
100
Nationalized
Deutsche Bank AG
Germany
34.1
81

BNP Paribas
France
36.7
65

Citigroup Inc
USA
37.8
94
Capital injection, asset guarantees
HBOS Plc
United Kingdom
41.0
100
Capital injection (part of Lloyds)
Société Générale
France
42.0
74

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Depository
Value
Bank Country
funding
decline Intervention
Banca Monte dei
Italy 44.1
68

Paschi di Siena SpA
Dexia Belgium 44.9
89
Nationalized
DnB Nor ASA
Norway
45.4
74

Danske Bank A/S
Denmark
46.3
78

Commerzbank AG
Germany
47.0
89
Capital injection
JP Morgan Chase &
USA 47.3
50

Co.
Barclays Plc
United Kingdom
47.7
85

Bank of America
USA
47.9
87
Capital injection, asset guarantees
Corporation
National Australia
Australia 51.7
53

Bank
Commonwealth Bank
Australia 53.4
46

of Australia
HSBC Holdings Plc
United Kingdom
54.9
41

Credit Suisse Group
Switzerland
55.6
66

Capital One Financial
USA 57.3
80

Corporation
Lloyds TSB Group Plc United Kingdom
58.7
78
Capital injection
Royal Bank of
United Kingdom
59.3
96
Capital injection, asset guarantees
Scotland Group Plc
(The)
Wachovia
USA
62.8
100
Failed, acquired by Wel s Fargo
Corporation
UBS AG
Switzerland
64.1
79
Capital injection
Wells Fargo &
USA 64.4
47

Company
Royal Bank of Canada
Canada 65.1
44

RBC
Banque de Montreal-
Canada 65.2
53

Bank of Montreal
Australia and New
Australia 65.4
54

Zealand Banking
Group
Toronto Dominion
Canada 67.9
43

Bank
Canadian Imperial
Canada 68.2
54

Bank of Commerce
Bank of Nova Scotia
Canada 71.4
42

(The)
Westpac Banking
Australia 74.1
38

Corporation
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Depository
Value
Bank Country
funding
decline Intervention
Washington Mutual
USA
74.6
100
Failed, taken over by FDIC
Inc.
Source: Ratnovski, Lev, and Rocco Huang, Why Are Canadian Banks More Resilient?, IMF Working Paper
WP/09/152, International Monetary Fund, July 2009.
Note: Depository funding represents the share of total bank funding that is derived from deposits. Value decline
is a measure of the percentage decline from January 2007 to January 2009 in the value of the equity of the
respective bank. Intervention represents some basic information about the nature of any government
intervention.
The U.S. Financial Supervisory System
Currently, the United States has a complex regulatory framework in which agencies have
overlapping jurisdiction, and in which there are some regulatory gaps.17 Congress and the
Administration attempted to improve this process by adopting the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Dodd-Frank) (P.L. 110-203) that instituted changes to the
supervisory framework in an effort to improve the system and to correct weaknesses. Dodd-Frank
created the Bureau of Consumer Financial Protection, the interagency Financial Stability
Oversight Council (FSOC) to monitor systemic risk, and consolidated bank regulation from five
agencies to four by eliminating the Office of Thrift Supervision. The Council is chaired by the
Secretary of the Treasury and consists of the heads of 10 other agencies, including the Federal
Reserve, FDIC, OCC, NCUA, SEC, CFTC, and FHFA. For banks and non-banks designated by
the FSOC as creating systemic risk, the Federal Reserve has oversight authority, and the Federal
Deposit Insurance Corporation (FDIC) has resolution authority. As indicated in Figure 1,
financial supervision can be separated into three main categories: supervision of banks,
supervision of non-banks, and those markets that are unregulated. For ease of presentation, the
figure shows only the major lines of supervisory responsibility. For instance, the President
nominates the governors of the Federal Reserve Board, but the Treasury Department closely
coordinates with the Federal Reserve in developing and implementing policy. The chairman of
the Federal Reserve, however, formally reports to Congress, so the figure shows only this line of
responsibility. Similarly, the Administration coordinates closely with many of the other
independent agencies that supervise parts of the financial system.

17 For greater detail, see CRS Report R40249, Who Regulates Whom? An Overview of U.S. Financial Supervision, by
Edward V. Murphy.
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Figure 1. U.S. System for Supervising Financial Markets

Source: Developed by CRS.
The U.S. financial system is also characterized by a combination of federally chartered financial
institutions and financial institutions chartered by the 50 individual states. This system, some
observers argue, has allowed banks that faced federal regulatory action to walk away from federal
regulators and move under state supervision by converting their charters to a state charter.18
National banks are supervised by the Office of the Comptroller of the Currency (OCC), which is
under the direction of the U.S. Treasury Department. Under Dodd-Frank, the OCC assumed
supervision of the Office of Thrift Supervision over state and federally chartered thrift
institutions. Next, the U.S. Congress has established a number of independent agencies that
supervise various parts of the financial system. These agencies include the Federal Deposit
Insurance Corporation (FDIC), which directly supervises State banks that are not part of the
Federal Reserve System and indirectly supervises state and federally chartered thrifts and state

18 Applebaum, Binyamin, By Switching their Charters, Banks Skirt Supervision, The Washington Post, January 22,
2009, p. A1.
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banks, such as commercial banks and industrial banks. Next, the Federal Reserve System is the
central bank of the United States and is comprised of the Board of Governors and 12 District
Federal Reserve Banks. These banks supervise all state banks that are part of the Federal Reserve
System, bank holding companies, the foreign activities of member banks, the U.S. activities of
foreign banks, and Edge Act, or limited-purpose institutions that engage in foreign banking
business. Under Dodd-Frank, the Bureau of Consumer Financial Protection is an independent
entity within the Federal Reserve to supervise an array of consumer financial products and
services. The National Credit Union Administration supervises the many credit unions. In
addition to these federal entities, state entities supervise state chartered thrifts and state banks.
In the area of non-bank supervision, the U.S. Congress has chartered three independent agencies.
These agencies include the Securities and Exchange Commission, which supervises all securities
trading and securities firms, the Commodity Futures Trading Commission, which supervises the
trading of commodities, and the Federal Housing Finance Agency, which supervises the Federal
National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Association
(Freddie Mac), and the Federal Home Loan Banks. State agencies also regulate and supervise
insurance activities. Beyond this area of supervision, there is a broad group of financial activities
that have not been directly supervised, including the rapidly growing area of derivatives trading.
Canada’s Financial System
In a recent assessment of Canada’s financial system, the IMF concluded that Canada’s system is
highly mature, sophisticated, and well-managed. In addition, the system is characterized by strong
prudential regulation and supervision and a well-designed system of deposit insurance and
arrangements for crisis management and resolution of failed banks. Supervisory responsibility for
the financial sector in Canada is divided among the federal government, among the provincial
governments, and among a group of agencies within the federal government. The federal
government is responsible for supervising all banks, federally incorporated insurance companies,
trust and loan companies, cooperative credit associations and federal pension plans. Regulations
separating banks, insurers, trust companies, and investment dealers in Canada were largely
eliminated in the 1980s. Also, by the 1990s, all of the major investment dealers in Canada were
owned by banks, which not only created an integrated bank model, it also placed such dealers
under close regulatory supervision. Provincial governments are responsible for supervising
securities dealers, mutual fund and investment advisors, credit unions, and provincially
incorporated trust, loan, and insurance companies. As a result, there are 13 provincial regulatory
authorities, each administering securities laws and regulations. The Minister of Finance, however,
oversees the incorporation of banks, permitting foreign bank branches, and reviews of large bank
mergers. In particular, the minister has broad discretionary authority to disapprove mergers,
which has effectively eliminated such transactions.
Within the federal government, the Financial Institutions Supervisory Committee (FISC) acts as
the chief coordinating body that sets regulatory policy and supervises financial institutions. The
Committee is comprised of the Department of Finance of the Ministry of Finance and four
independent government agencies: the Office of the Superintendent of Financial Institutions
(OSFI); the Bank of Canada; the Canada Deposit Insurance Corporation (CDIC); and the
Financial Consumer Agency of Canada (FCAC), as indicated in Figure 2. These five semi-
official agencies report to the Minister of Finance, who is responsible to the Canadian Parliament.
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Figure 2. Canada’s Financial System Supervisory Structure

Source: Office of the Superintendent of Financial Institutions.
FISC generally meets quarterly, but can meet more often if needed. In addition, FISC conducts a
legally mandated five-year review of the National Bank Act to ensure that federal regulatory
legislation is modernized periodically. Within FISC, the OSFI plays a key role in supervising
Canada’s financial sector. The OSFI supervises all domestic banks, branches of foreign banks
operating in Canada, trust and loan companies, cooperative credit companies, life insurance
companies, and property and casualty insurance companies. The OSFI has set limits on the ability
of Canadian banks to leverage their capital and has set target capital ratios that are higher then the
international standard. In broad terms, the OSFI is responsible for a number of activities including
(1) assessing the financial conditions and operating performance of the institutions under its
jurisdiction; (2) reviewing information obtained from statutory filings, financial reporting, and
management reporting requirements; (3) conducting meetings with institutions; (4) attending
board meetings when necessary of institutions to discuss the results of supervisory reviews; (5)
providing composite risk ratings to institutions; (6) advising institutions of any corrective
measures that the institution will be requested to take; (7) monitoring any corrective measures;
and (8) reporting to the Minister of Finance on an annual basis.19
The OSFI has considerable enforcement powers, including the authority to intervene
progressively in problem institutions under “structured early intervention” provisions that
articulate a four-stage process culminating in closure, even while an institution’s capital may
remain positive. The four-stage process is comprised of the following:

19 Guide to Intervention for Federally Regulated Deposit-Taking Institutions, Government of Canada.
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• Stage 1—Early Warning. If an institution has been identified as Stage 1, the
OSFI has identified deficiencies in the institutions financial condition, policies,
or procedures that could lead the institution to fall into a Stage 2 category where
there is the risk of insolvency or failure.
• Stage 2—Risk to Financial Viability or Solvency. At this stage, an institution is
judged to pose material safety and soundness concerns and is vulnerable to
adverse business and economic conditions.
• Stage 3—Future Financial Viability is in Serious Doubt. At this stage, the
OSFI has identified that the institution has failed to remedy the problems that
were identified in Stage 2 and the situation is worsening. The situation poses
severe safety and soundness concerns and is experiencing problems that pose a
material threat to its future viability or solvency unless effectiveness corrective
measures are initiated.
• Stage 4—Non-Viability/Insolvency is Imminent. At this stage, OSFI has
determined that the institution is experiencing severe financial difficulties and
has deteriorated to such an extent that (1) the institution has failed to meet
regulatory capital requirements; (2) the statutory conditions for taking control
have been met; and (3) the institution has failed to develop and implement an
acceptable business plan.
In addition, the OSFI plays a key role in regulating Canada’s financial sector, providing a nearly
unified regulatory and supervisory framework. As is the case with supervision, OSFI is
responsible for regulating federal financial institutions, including banks, insurance companies,
foreign bank representative offices, and pension plans that are under federal jurisdiction. One
weakness of this system is that there are gaps in the regulatory framework concerning such
collective investment schemes as mutual funds, where the operators of such funds have not been
subject to a registration regime.
The Bank of Canada is responsible primarily for conducting monetary policy by setting interest
rate targets and adjusting the supply of credit. The Bank also serves as the key component in the
payments system by providing a check clearing function, and it serves as the traditional lender of
last resort. In its conduct of monetary policy, the Bank of Canada adopted in 2000 a system of
eight pre-set dates per year on which it announces its key policy rate—the target overnight rate of
interest. It has veered from these pre-set dates only under exceptional circumstances.20 While the
Bank of Canada reports to the Minister of Finance, this public announcement system acts as an
important element in making the Bank’s activities transparent to the public and to the financial
markets and relatively free from non-economic considerations. The Bank also has three credit
facilities at its disposal in its traditional role as the lender of last resort, including a facility to
provide liquidity to any financial or nonfinancial firm through outright purchases of a wide range
of claims in the event of “severe and unusual stress on a financial market or financial system.”
Canada established a working group in 2010 headed by the Bank of Canada to assess reforms to
the over-the-counter derivatives markets in Canada as a result of recommendations developed by
the Financial Stability Board and approved by the Group of Twenty (G-20) nations.21 Canadian

20 Macklem, Tiff, Information and Analysis for Monetary Policy: Coming to a Decision, Bank of Canada Review,
Summer 2002, p. 12.
21 For more detail about the over-the-counter derivatives markets reforms see: CRS Report R42961, Comparing G-20
(continued...)
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authorities were faced with deciding between establishing local central counterparties (CCPs)
located in Canada to clear derivatives transactions or using global clearing, which would mean
relying on large foreign-domiciled CCPs. Canadian authorities concluded that Canadian market
participants could clear OTC derivatives using any CCP recognized by Canadian authorities,
including global CCPs.22 In addition, the Bank of Canada adopted a set of 24 principles related to
risk management, efficiency and transparency for systemically important payment systems,
securities settlement systems, central securities depositories, central counterparties and trade
repositories, collectively referred to as financial market infrastructures, or FMIs.23 The 24
principles have been summarized into 10 broad requirements the Bank of Canada is
implementing to promote the safety and security of the financial markets:
1. FMIs should have a strong foundation for their risk-management practices.
2. FMIs should collect adequate high-quality financial assets from participants to
manage credit risk.
3. FMIs should have robust sources of liquidity.
4. FMIs should take appropriate actions to ensure that they are able to complete
settlement as expected.
5. FMIs should minimize disruptions associated with the failure of one or more of
their participants.
6. FMIs should be able to continue providing critical services in all circumstances.
7. FMIs should set fair, open and risk-based access requirements and manage the
risks that arise from participation.
8. FMIs should mitigate the risks associated with interdependencies that can
amplify disruptions within the financial system.
9. FMIs should provide their services and manage their risks in an efficient manner.
10. FMIs, especially trade repositories, should provide relevant information to
participants, authorities and the public to improve transparency in markets.
Canada’s financial system is dominated by five large banking groups (Royal Bank of Canada, TD
Canada Trust, Bank of Nova Scotia, Bank of Montreal, and Canadian Imperial Bank) that account
for about 60% of the total assets of Canada’s financial sector, as indicated in Table 6. In
comparison, foreign banks account for about 4% of Canada’s total assets in the financial sector.
The low representation by foreign banks is attributed to the “widely-held” rule for large banks
that limits the concentration of bank share ownership and, therefore, reduces the scope for
mergers and for foreign entry through acquisitions or mergers. This lack of competition,
combined with Canada’s financial legal framework, allows Canadian banks to concentrate more
on their low-risk, profitable domestic retail banking activities (services provided to individuals
including deposits, savings accounts, mortgages, credit cards, etc.), generally leaving large

(...continued)
Reform of the Over-the-Counter Derivatives Markets, by James K. Jackson and Rena S. Miller.
22 Chande, Nikil, Jean-Phillippe Dion, Darcey McVanel, and Joshua Silve, The Canadian Approach to Central Clearing
for Over-The-Counter Derivatives, Financial System Review, the Bank of Canada, December 2012, p. 43.
23 McVanel, Darcey, and Joey Murray, The Bank of Canada’s Approach to Adopting the Principles for Financial
Market Infrastructures, Financial System Review, the Bank of Canada, December 2012, p. 51.
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domestic borrowers to conduct their wholesale banking activities (services provided to
corporations, governments, and other entities) abroad. Some observers argue that this framework
also reduces incentives for innovation among Canada’s protected banks and has proved to be
difficult for small businesses and venture capitalists. Canada’s insurance sector is dominated by
three large domestic groups, which account for over 80% of the assets in this sector. The
securities sector is marked by large Canadian, as well as U.S. and UK securities firms.
Table 6. Canada: Financial Sector Structure, End-2006
Assets
Percent of Total

Billions of $Can.
Assets
Percent of GDP
Banks
$2,389.0 59.3% 166.0%
Canadian
2,214.0
54.9
153.8
Foreign
175.0
4.3
12.2
Trusts (including bank subsidiaries)
254.7 6.3 17.7
Credit unions
193.8 4.8 13.5
Life insurance companies
346.5 8.6 24.1
Canadian
331.1
8.2
23.0
Foreign
15.4
0.4
1.1
Property and casualty insurance
93.2 2.3 6.5
Mutual funds
660.2 16.4 45.9
Asset based financing and leasing
92.3 2.3 6.4
Total
4,029.7 100.0 280.0
Source: Canada: Financial System Stability Assessment – Update, International Monetary Fund, January
15, 2008, p. 11.
Unlike the United States and some European countries, subprime mortgages account for fewer
than 5% of Canadian mortgages, which sharply limited Canada’s direct exposure to the meltdown
that occurred in the subprime mortgage market. Although Canada’s mortgage markets are
somewhat less innovative than in the United States, Canadian consumers seem to be well served
and home ownership rates are comparable with those in the United States.24 In addition, Canadian
law requires that all bank-held mortgages above a loan-to-value ratio of 80% be insured, which
has curtailed the securitization of mortgages by banks in Canada. About one-third of mortgages
are securitized in Canada, about half as much in percentage terms as in the United States.25 In
addition, prepayment penalties and the lack of interest deductibility reduces the demand for long-
term mortgages, so the maturity of most mortgages generally does not exceed five to 10 years.

24 Kiff, John, Canadian Residential Mortgage Markets: Boring But Effective?, IMF Working Paper WP/09/130,
International Monetary Fund, June 2009, p. 12.
25 Ibid., p.5.
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Economic Effects of Canada’s Supervisory System
Canada’s financial system was relatively more resilient during the financial crisis compared with
counterparts in the United States and Europe. Nevertheless, Canada’s financial system was not
immune to the financial crisis nor did it escape the economic downturn that stalled global
economic growth. The Canadian economy is linked with the international economy. As a result, a
sharp drop in exports and a decline in commodity prices negatively affected the Canadian
economy. Household wealth declined, the rate of unemployment rose, and the economy has
grown below the average rate posted prior to the financial crisis. At one point, Canadian banks
suffered a loss of 50% in the value of their equities. Consequently, the banks faced pressure from
financial markets to increase their capital ratios, which they apparently did by tapping private
sources.
As a result of the financial crisis, aspects of Canada’s financial system were closely scrutinized as
the United States considered ways to amend its own financial system to limit the possibility of
another financial crisis. However, the smaller scope of Canada’s financial system and its economy
likely lessened the transferability of systems or procedures used in Canada to the vastly more
complex U.S. financial system. In addition, it can be argued that Canada’s supervisors and
regulators can take a more conservative approach than their U.S. counterparts as a result of
Canada’s proximity to the U.S. capital markets. Nevertheless, Canada’s financial supervisory
system and regulatory structure have proven to be less susceptible to the bank failures that have
loomed in the United States and Europe and may offer some insight for U.S. policymakers.
Canada’s reliance at the federal level on a unified supervisor and regulator appears to have some
merits as compared to a more decentralized approach.
Canada’s approach does have some drawbacks. Specifically, Canada’s system of regulating
securities markets at the provincial level means that regulations regarding market participants and
investor protection differ by province, creating inefficiencies in the system and raising costs to
providers and consumers. Differences between provinces also mean that coordinating policy
approaches across the 13 provinces can be slow and cumbersome.
Furthermore, the nature, structure, and powers of the provincial regulators vary, which increases
the costs to financial services providers and to consumers, because financial services providers
are required to pay fees to the regulatory authorities in all of the provinces where they raise
capital. This ultimately raises the cost of capital and limits access to funding. It also inhibits the
growth and development of the markets and innovation in developing financial instruments. In
addition, while the conservative, risk-adverse approach employed by Canada’s banks helped to
shield them from some of the current financial turmoil, the approach also reduces efficiency in
the market and reduces competition. Acquisitions of Canadian banks are significantly impeded by
the rule that bank stocks be widely held and mergers are effectively prohibited. With reduced
competitiveness pressures, Canadian banks maintain low-risk balance sheets at the expense of
greater innovation and more efficient capital allocation. This approach also means that financing
for small firms and venture capital for potentially high-growth companies is sharply reduced.

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Author Contact Information

James K. Jackson

Specialist in International Trade and Finance
jjackson@crs.loc.gov, 7-7751

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