Bank Regulatory Structure: Canada (Chapter Report, 09/28/95,
GAO/GGD-95-223).
Pursuant to a congressional request, GAO reviewed the Canadian bank
regulatory structure and its key participants.
GAO found that: (1) the Office of the Superintendent of Financial
Institutions (OSFI) is the primary supervisor of Canadian financial
institutions and is responsible for incorporating financial
institutions, issuing regulations and guidelines, taking enforcement
actions, and resolving problems; (2) OSFI has the authority to examine
all of the activities of Canadian financial institutions, but securities
activities conducted in subsidiaries are reviewed by provincial
securities regulators; (3) OSFI relies on external auditors for
assessments of the institutions' financial statements or anything that
might affect the institutions' well-being; (4) the Canada Deposit
Insurance Corporation has a secondary supervisory role in issuing
standards, but it takes the lead in resolving failed institutions; (5)
the Minister of Finance has final decisionmaking authority over key
supervisory decisions, such as closing an institution; (6) the Bank of
Canada's supervisory role is limited to providing information to other
participants in the decisionmaking process; (7) the four regulatory
agencies share in certain financial responsibilities such as liquidity
provision, crisis management, and international representation; and (8)
two primary committees have been established to improve the
relationships and sharing of information among the regulatory agencies.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-95-223
TITLE: Bank Regulatory Structure: Canada
DATE: 09/28/95
SUBJECT: Financial institutions
Banking regulation
Banking law
Bank management
Foreign governments
Bank examination
Bank failures
Deposit funds
Reporting requirements
International economic relations
IDENTIFIER: Canada
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Cover
================================================================ COVER
Report to the Honorable
Charles E. Schumer
House of Representatives
September 1995
BANK REGULATORY STRUCTURE - CANADA
GAO/GGD-95-223
Canada
(233455)
Abbreviations
=============================================================== ABBREV
BIS - Bank for International Settlements
CAMEL - Capital Adequacy, Assets Quality, Management Quality,
Earnings, and Liquidity
CBA - Canadian Bankers Association
CCB - Canadian Commercial Bank
CDIC - Canada Deposit Insurance Corporation
CEO - Chief Executive Officer
CICA - Canadian Institute of Chartered Accountants
CPA - Canadian Payments Association
FSP - Financial Sector Policy
FIRP - Financial Institutions Restructuring Process
FISC - Financial Institutions Supervisory Committee
GAAP - generally accepted accounting principles
IMF - International Monetary Fund
OECD - Organization for Economic Cooperation and Development
OSFI - Office of the Superintendent of Financial Institutions
OIGB - Office of the Inspector General of Banks
P&A - Purchase and Assumption
SAC - Senior Advisory Committee
Letter
=============================================================== LETTER
B-259978
September 28, 1995
The Honorable Charles E. Schumer
House of Representatives
Dear Mr. Schumer:
Proposals to consolidate United States bank regulatory agencies have
raised questions about how other countries structure and carry out
their various bank regulation and central bank activities. You asked
us to provide you with information about the structure and operations
of regulatory activities in several countries. This report presents
the information you requested for Canada. It describes the Canadian
bank regulatory structure and its key participants, how that
structure functions, and how banks are examined in Canada.
As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
from the date of this letter. At that time, we will send copies of
this report to Members of the House Committee on Banking and
Financial Services, other congressional committees, and other
interested parties. We will also make copies available to others on
request.
The report was prepared under the direction of Mark J. Gillen,
Assistant Director, Financial Institutions and Markets Issues. If
you have any questions, please call me on (202) 512-8678. Other
major contributors are listed in appendix I.
Sincerely yours,
James L. Bothwell, Director
Financial Institutions
and Markets Issues
EXECUTIVE SUMMARY
============================================================ Chapter 0
PURPOSE
---------------------------------------------------------- Chapter 0:1
Proposals to consolidate U.S. bank regulatory agencies have raised
questions about how other countries structure and carry out their
bank regulation and supervision and central bank activities.
Representative Charles E. Schumer asked GAO to provide information
about the structure and operations of such activities in several
countries.\1 This report presents the information requested for
Canada, which provides an example of a structure that features a
federal supervisor other than the central bank. GAO's objectives
were to describe (1) the Canadian bank federal regulatory and
supervisory structure, and its key participants; (2) how that
structure functions, particularly with respect to bank authorization
or chartering, regulation, and supervision; (3) how banks are
examined; and (4) how participants handle other financial system
responsibilities. This report provides requested information about
the Canadian bank regulatory structure, but does not attempt to
evaluate that structure.
--------------------
\1 For information on GAO's already issued reports on the German and
British regulatory systems, see Bank Regulatory Structure: The
Federal Republic of Germany (GAO/GGD-94-134BR, May 9, 1994) and Bank
Regulatory Structure: The United Kingdom (GAO/GGD-95-38, Dec. 29,
1994). GAO is also preparing reports on the regulatory systems of
France and Japan.
BACKGROUND
---------------------------------------------------------- Chapter 0:2
The banking structure in Canada is relatively concentrated. Canada
has six major domestic banks with nationwide branch networks and
diversified operations that held 90.9 percent of Canada's total bank
assets and 88.6 percent of domestic assets. As of December 31, 1994,
there were 11 domestic banks in Canada and 53 subsidiaries of foreign
banks, which were first allowed to enter Canada as banks in 1980.
Banks in Canada are required to be federally chartered and carry out
a number of nonbanking activities--including trust, securities, and
most insurance activities through wholly owned subsidiaries.
Government inspection of banks was introduced in 1924 when the
Canadian government amended the Bank Act to create the Office of the
Inspector General of Banks (OIGB) after the failure of a large bank
that had over 70 branches. A number of failures in the early 1980s
led to a review of the supervisory methods of OIGB. The review
recommended consolidation of bank and insurance company supervisory
offices, which resulted in the creation of the Office of the
Superintendent of Financial Institutions (OSFI) in 1987. The
founding of OSFI was intended to create a strong supervisory
institution to oversee the safety and soundness of financial
institutions and to address the growing similarities between banks
and nonbank financial institutions. To accomplish these goals,
OSFI's authority was strengthened and its scope was extended to all
federally incorporated financial institutions.\2
Deposit insurance in Canada was introduced in 1967 when the Canada
Deposit Insurance Corporation (CDIC) was established following a few
financial institution failures and the dissatisfaction of provincial
governments with the lack of deposit insurance. CDIC insures the
deposits of all federally incorporated financial institutions along
with deposits of most provincially incorporated institutions. CDIC
is run by a Board of Directors and a Chairman, who report to
Parliament through the Minister of Finance.
Canada established its central bank in the Bank of Canada Act of
1934. The main responsibility of the Bank of Canada was, and is
today, the formulation and implementation of monetary policy. After
its establishment, disagreements over responsibility for monetary
policy arose between the Bank of Canada and the federal government.
To resolve those differences, a mechanism was incorporated into the
Bank of Canada Act in 1967 that requires the Governor and the
Minister of Finance to "consult regularly on monetary policy and on
its relation to general economic policy." The mechanism also provides
an explicit directive through which the Minister of Finance can
override the Bank of Canada's monetary policy.
--------------------
\2 Henceforth, financial institutions in this report refer to
federally chartered deposit-taking financial institutions, which
include all banks and federally chartered trust companies.
RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3
Since 1987, OSFI has been formally recognized in statute as the
primary supervisor of federal financial institutions in Canada.
OSFI's responsibilities include administering the application process
for incorporating financial institutions; issuing financial
institution regulations and guidelines; taking both formal and
informal enforcement actions--relying mostly on informal actions,
such as recommendations; and taking the lead in resolving problem
institutions. OSFI also has the authority to examine and receive
considerable information from financial institutions. OSFI has
overall supervisory responsibility for all activities of financial
institutions, but securities activities conducted in subsidiaries are
reviewed for OSFI by the cognizant provincial securities regulator.
OSFI conducts full-scope, on-site examinations of financial
institutions with a staff of full-time examiners. OSFI relies on a
financial institution's external auditors for an assessment of the
fairness of an institution's annual financial statements. External
auditors also have a responsibility to report to OSFI anything that
they discover during the course of their work that might affect the
well-being of an institution, and OSFI advises external auditors
about anything material that has come to its attention concerning a
financial institution.
OSFI shares certain regulatory and supervisory responsibilities with
other government agencies, such as CDIC and the Department of
Finance. CDIC has a secondary supervisory role, but it has increased
its influence over supervision and regulation in recent years by
taking advantage of its authority to issue standards. For example,
the Standards of Sound Business and Financial Practices By-laws set
forth that each member institution should establish sound business
and financial practices in eight areas, such as liquidity management.
In addition, CDIC has some enforcement authority, such as terminating
deposit insurance or assessing premium surcharges, and takes the lead
in resolving failed institutions. The Minister of Finance has final
decisionmaking authority over key supervisory decisions, such as
incorporating a financial institution, closing an institution or
terminating deposit insurance. The Bank of Canada's current role in
bank supervision is largely limited to providing information to other
participants in the decisionmaking process.
OSFI, CDIC, the Minister of Finance, and the Bank of Canada also
share, to some degree, in other financial system responsibilities,
such as liquidity provision, crisis management, payment and
settlement systems management, international representation, and
lender of last resort responsibilities.
Two primary committees have been established to improve the
relationships and the sharing of information among the four
regulatory agencies. The Financial Institutions Supervisory
Committee (FISC) was established to enhance communication on
financial institutions' supervisory issues and is not a
decisionmaking or advisory body. The Committee is chaired by the
Superintendent of Financial Institutions and includes the Deputy
Minister of Finance, the Governor of the Bank of Canada, and the
Chairman of CDIC. These four members also make up the Senior
Advisory Committee (SAC) that meets under the Chairmanship of the
Deputy Minister of Finance to discuss policy changes or legislative
proposals. A current White Paper proposal is intended to further
clarify roles and coordination among these agencies.\3
Figure 1: Responsibility for
Bank Regulatory and Related
Functions in Canada
(See figure in printed
edition.)
Note: OSFI, CDIC, the Bank of Canada, and the Minister of Finance
are all involved in information sharing and coordination of
activities.
\a CDIC does special examinations for troubled banks.
\b CDIC has a more limited role than the Bank of Canada in serving as
lender of last resort.
\c The Bank of Canada does not conduct regular examinations, but has
the power to request special examinations.
\d External auditors may perform special audits for OSFI, CDIC, or
the Bank of Canada; and OSFI uses their financial audits in deciding
upon the scope of the examination.
Source: GAO analysis.
--------------------
\3 The White Paper is a policy paper called Enhancing the Safety and
Soundness of the Canadian Financial System, which was released on
February 9, 1995. It contains a set of proposals that allow for
early intervention in problem institutions, enhanced disclosure of
financial information, a stronger prudential framework for financial
institutions, a revised framework for the protection of
policyholders, and measures to contain costs for the deposit insurer
and to control systemic risk in the clearance and settlement systems.
PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:4
OSFI HAS PRIMARY
RESPONSIBILITY OVER
AUTHORIZATION AND
SUPERVISION
-------------------------------------------------------- Chapter 0:4.1
Although, technically, the Minister of Finance issues "letters
patent" that incorporate federal financial institutions, OSFI
actually is responsible for the application process and recommends to
the Minister of Finance whether a financial institution should be
federally chartered. CDIC is responsible for approving applications
for deposit insurance, and CDIC and OSFI are to coordinate this
process. Provincially incorporated financial institutions apply to
provincial regulators for incorporation and apply to CDIC for deposit
insurance.
OSFI and CDIC can both take enforcement actions against federal
financial institutions, although OSFI has available a wider range of
enforcement actions compared to the more narrowly defined actions
available to CDIC. According to OSFI officials with whom we spoke,
the enforcement actions taken by OSFI have usually been informal. In
such cases, OSFI recommends that certain actions are to be taken by a
financial institution to remedy identified problems. Formal
enforcement actions, such as directions of compliance, have rarely
been used. According to OSFI officials, institutions usually comply
with informal recommendations, knowing that OSFI will not hesitate to
use more formal action if compliance is not forthcoming. CDIC
officials with whom we spoke said formal enforcement actions consist
primarily of imposing a premium surcharge--which has never been
done--and terminating a member's deposit insurance--which was done
once for an otherwise solvent member.
OSFI AND CDIC HAVE
RESPONSIBILITY FOR
REGULATIONS AND GUIDELINES
-------------------------------------------------------- Chapter 0:4.2
OSFI is responsible for administering and interpreting legislation
concerning financial institutions by developing regulations and
guidelines. OSFI generally issues guidelines because the process of
issuing regulations is long, complex, and less flexible. Although
guidelines do not have the force of law, according to OSFI officials,
they are usually followed by all financial institutions.
CDIC has the authority to issue bylaws, which have the force of law.
CDIC bylaws pertain to the operations and functions of CDIC and its
members and include eight Standards of Sound Business and Financial
Practices By-Laws for member institutions. The Standards By-laws
were enacted in 1993 and cover eight areas, such as credit risk
management. The Standards By-laws have related guidance that CDIC
issues to assist member institutions in following the Standards
By-laws. Compliance with the Standards is measured through a
financial institution's self-assessment process, which, starting in
1995, OSFI is to review and verify during its annual examination of
federal financial institutions.
OSFI, CDIC, AND THE BANK OF
CANADA RELY ON MANY SOURCES
OF INFORMATION TO CARRY OUT
THEIR RESPONSIBILITIES
-------------------------------------------------------- Chapter 0:4.3
OSFI, CDIC, and the Bank of Canada have developed a shared
statistical reporting system, whereby financial institutions are
required to report data, such as quarterly income statements and
annual financial reports.\4 This data reporting system meets the
supervisory and deposit insurance needs of OSFI and CDIC, as well as
the monetary policy information needs of the Bank of Canada.
To carry out its supervisory responsibilities, OSFI relies on several
sources of information beyond that provided in the data reporting
system. Financial institutions are required to file periodic
reports, including annual financial statements, with OSFI.
Institutions provide more specific information if requested to do so.
In addition, OSFI obtains supplemental information from numerous
informal meetings and discussions with financial institutions and
from several formal meetings with institutions' management, audit
committees, and external auditors. These meetings allow OSFI to
gather information on an institution's activities, such as how an
institution is controlling risk, and provide a formal opportunity for
discussing OSFI's examination findings.
Although CDIC relies on OSFI for most of its information on the
financial condition of its members, it can also receive financial
statements directly from financial institutions and other financial
information from the data reporting system. In addition, CDIC can
request that a special examination be done by either OSFI examiners
or hiring its own consultants if, for instance, its Board of
Directors has determined that a financial institution poses a high
risk of failure. Such examinations are intended to provide CDIC with
additional current information to assess failure resolution options
and CDIC's potential liability if a financial institution were to
fail.
The Bank of Canada uses the data reporting system to get information
about the financial system and individual institutions, primarily to
fulfill its monetary policy responsibilities. In addition, the Bank
of Canada receives information directly from financial
institutions--particularly the six largest banks--and market
intelligence from such sources as money markets, investment banks,
and contacts with other financial institutions.
Several committees, such as FISC and SAC, have been established to
address problems of coordination and overlap among the participants
in financial institution regulation and supervision at the federal
level. The White Paper proposals, which are currently being
discussed, are intended to help improve the supervisory and
regulatory system by further clarifying participants' roles,
providing for greater transparency in the system, establishing an
earlier intervention process, and increasing supervision over the
clearing and settlement system.
OSFI is required to examine financial institutions once a year. This
responsibility is carried out by OSFI's part-time examiners who plan,
conduct, and report the results of the examinations. OSFI officials
said the scope of the examinations typically include the financial
institution's activities and exposures to risk, the solvency of an
institution, and an institution's compliance with legislation and
guidelines. During the examination planning process, OSFI examiners
are to review the work of the external auditors to identify issues
that should be addressed in the on-site examination, to minimize
duplication, and to determine the scope of the examination.
--------------------
\4 Under the data reporting system, financial institutions submit
their data to OSFI, which then redirects it to the Bank of Canada for
processing. Once processed, the information is redistributed to OSFI
and CDIC.
PARTICIPANTS HAVE SEVERAL
OTHER FINANCIAL SYSTEM
RESPONSIBILITIES
-------------------------------------------------------- Chapter 0:4.4
OSFI, CDIC, the Minister of Finance, and the Bank of Canada share
several other financial system responsibilities.
The Superintendent of Financial Institutions, a Deputy
Superintendent of Financial Institutions, the Deputy Minister of
Finance, and the Governor of the Bank of Canada are all members
of CDIC's Board of Directors.
The Bank of Canada services day-to-day liquidity needs for the
banking system.
The Bank of Canada and CDIC, in a more limited capacity, act as
lenders of last resort to solvent institutions. In this
capacity, the bank of Canada seeks the assurance of OSFI
regarding the viability of the institution. The Bank of
Canada's lending is on a secured basis, and CDIC's lending is on
either a secured or unsecured basis.
OSFI, CDIC, the Minister of Finance, and the Bank of Canada all
play roles in crisis management involving financial
institutions.
OSFI and the Bank of Canada both represent Canada on the Basle
Committee of Bank Supervisors.\5 The Bank of Canada and the
Associate Deputy Minister of Finance also represent Canada in
other forums, such as meetings of the finance ministers and
governors of the Group of Seven Countries.
The Bank of Canada is the settlement institution for members of the
payments system and appoints the Chairman of the Board of
Directors of the Canadian Payments Association. Although the
Bank of Canada does not own or operate the payments system, the
recent White Paper proposal would give the Bank of Canada
regulatory oversight of the systemic risk aspect of the clearing
and settlements system.
--------------------
\5 The Basle Committee on Bank Supervision was created in 1974 under
the auspices of the governors of the G-10 central banks and is the
main forum for central bankers and supervisors to reach agreement on
how best to supervise international banks. Its members meet several
times a year and consist of senior representatives of bank
supervisory authorities and central banks from 12 countries.
RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:5
This report contains no recommendations.
AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:6
Senior officials from OSFI, CDIC, the Department of Finance, and the
Bank of Canada reviewed and commented on a draft of this report.
These comments were generally technical in nature and were
incorporated where appropriate.
INTRODUCTION
============================================================ Chapter 1
The banking system in Canada is relatively concentrated, with six
large banks that have nationwide branch networks and diversified
operations. Bank regulation and supervision are the exclusive
responsibility of the federal government, although certain
provincially incorporated financial institutions, such as securities
firms, are under the jurisdiction of the provinces. As a result of
financial institution failures and reviews of the supervisory
process, the federal regulatory system has gradually evolved from a
system of minimal regulation of federal financial institutions to one
with more oversight by federal supervisors.
OVERVIEW OF CANADIAN BANKING
INDUSTRY
---------------------------------------------------------- Chapter 1:1
Banks in Canada carry out a number of nonbanking
activities--including trust, securities, and most insurance
activities--through wholly owned bank subsidiaries.\6 Banks were
given the authority to enter the securities business under 1987
revisions to the Bank Act.\7 In 1992, banks were permitted to enter
into the insurance and trust businesses through subsidiaries. All of
the major banks have wholly owned securities and trust subsidiaries
and have recently started to enter the insurance business.
The Canadian banking industry has consolidated quite significantly,
from 36 banks in the early 1900s--many of which were locally
based--to 9 domestic banks and 53 foreign-owned banks, with over
8,200 branches serving more than 2,700 communities in the provinces
and territories. As of December 31, 1994, Canada's six largest banks
held 90.9 percent of total bank assets and 88.6 percent of domestic
bank assets. As a result of nationwide branching and a broad range
of permissible activities, the major chartered banks\8 in Canada are
able to diversify geographically as well as by lines of business.
Until 1980, foreign banks were prohibited from establishing
subsidiaries, branches, or agencies in Canada.\9 Banks in Canada were
required to be mostly Canadian-controlled and to be widely held; that
is, no individual shareholder could hold more than 10 percent of the
bank's voting shares. These banks were classified as Schedule "I"
banks. The Banks and Banking Law Revision Act of 1980 opened the
Canadian market to subsidiaries of foreign banks by creating a new
category of permissible banks, called Schedule "II" banks. Ownership
of these banks was initially limited to foreign banks, but in 1992
Schedule II banks were expanded to include ownership by foreign and
domestic banks, which are also required to be widely held. At the
time of the initial legislation, there were several legal differences
between the Schedule I and II banks. However, primarily due to
international agreements, there are not likely to be any significant
differences, and Schedule II banks operate in the same manner as
Schedule I banks.
As of 1994, there were 11 domestic banks in Canada--9 Schedule I
banks and 2 Schedule II banks--most of which had nationwide branches;
and 53 Schedule II banks that were subsidiaries of foreign banks.
Other financial institutions that provided banking services included
20 trust companies, 10 loan companies, and 7 cooperative credit
associations.
Table 1.1
Federal Canadian Financial Institutions
(October 31, 1994)
(Canadian dollars in billions\a)
Percent of
credit
Number of industry
Type of institution institutions Total assets assets
------------------------- ------------- ------------- -------------
Schedule I banks 9 $740.5 84.6%
Schedule II banks 2 10.8 1.2
(domestic)
Schedule II banks 53 65.1 7.4
(foreign)
Trusts\b 20 15.3 1.7
Loan companies\b 10 36.3 4.1
Cooperative credit 7 7.3 0.8
associations\c
======================================================================
Total 101 $875.3\d 100.0%\e
----------------------------------------------------------------------
\a On April 1, 1995, the Canadian dollar was worth 0.713 in U.S.
dollars.
\b Trust company and loan company statistics are as of November 30,
1994. Trust company numbers include only federally chartered trust
companies and exclude all trust companies owned by banks. Loan
company numbers exclude those owned by mortgage companies.
\c Cooperative credit association statistics are as of December 31,
1993. Cooperative credit associations are nonprofit associations
that are owned by their respective member credit unions.
\d Schedule I and II Banks make up $816.4 billion (Canadian), or over
90 percent, of the total assets of federally regulated financial
institutions.
\e Percentages may not add to 100 percent due to rounding.
Source: Policy and Research Division, OSFI.
--------------------
\6 Canadian banks are prohibited by law from establishing bank
holding companies, which are entities that may have significant
ownership interests in both banks and nonbank financial firms.
\7 The Bank Act was first known as an Act Relating to Banks and
Banking, and throughout this report we refer to it as the Bank Act.
\8 Commercial banks in Canada are commonly referred to as chartered
banks, because for a long time a bank could be established only by a
charter granted in a special act from the Canadian Parliament.
\9 The prohibition on foreign interests establishing banks in Canada
existed between 1967 through 1980.
HISTORY OF BANK REGULATION AND
SUPERVISION IN CANADA
---------------------------------------------------------- Chapter 1:2
During the first century of federal bank supervision, Canada
gradually increased the attention given to the safety and soundness
of banks' operations. The creation of the Office of the
Superintendent of Financial Institutions (OSFI) in 1987 was intended
to improve bank supervision by increasing government involvement in
the supervisory process.
FEDERAL BANK SUPERVISION
EVOLVED BETWEEN 1867-1978
-------------------------------------------------------- Chapter 1:2.1
Banks in Canada were originally incorporated by individual provinces,
and rules on how banks were governed differed from province to
province. In 1867, when Canada became a confederation, the British
North America Act gave the new federal government exclusive
jurisdiction over all matters related to money and banking to ensure
that the rules for the banking industry would be the same throughout
the country.
To implement this change in jurisdiction and to govern how banks
operate in Canada, the Canadian government passed the Bank Act in
1871. The Bank Act governs banks and prescribes the conditions under
which banks may be formed, the range of activities in which they may
engage, the general conduct of their operations, and the relationship
they will have with the government and bank regulators. The Bank Act
is revised approximately every 10 years to ensure that it remains in
tune with changes in public policy, economic conditions, or any other
developments affecting the financial system.
The first Bank Act (1871 Act) institutionalized branch banking in
Canada by authorizing all banks previously incorporated in the
provinces to open branches and do business throughout Canada. It
also raised capital requirements for banks in order to exclude those
entities without sufficient start-up capital from becoming banks.
However, there was no provision made for any form of external
supervision of banks. The Bank Acts of 1881 and 1891 did not deal
with supervisory issues.
The Canadian Bankers Association (CBA), a private industry
association, was established in 1891 and was tasked with establishing
and operating a clearing system for the banking community. In 1980,
the operation of the clearing system was taken over from the CBA by
the quasi-public organization, the Canadian Payments Association
(CPA) in order to ensure that nonbank depository institutions would
have equal access to the payments system.
Proposals for various forms of external supervision of Canadian banks
were put forward as early as 1880 following a round of bank failures.
However, it was not until the 1913 revision of the Bank Act that a
requirement for independent audits of banks was enacted for the first
time. Under this provision, banks were required to have annual
audits by an external auditor chosen by the bank's shareholders from
a panel selected by the CBA and the Minister of Finance.
Before the Bank Act could be revised again, Canada went through a
significant economic downturn. There was a general fall in the
prices of farm products along with more bank failures, both of which
were frequently blamed on the banking system because of the lack of
available credit. The government's response, as represented by the
Minister of Finance, was to improve the system of external bank
audits already put in place by the 1913 revision of the Bank Act.
The 1923 revision of the Bank Act consequently made changes to the
previously enacted audit requirement by (1) requiring each bank to be
audited by two audit firms, subject to replacement every 2 years; (2)
requiring that bank auditors be experienced and belong to an
association of accountants; and (3) authorizing the Minister of
Finance to select an auditor to examine the affairs and business of a
bank and provide an audit report to the Minister of Finance. The
1923 revision was intended to ensure that audit reports would be
filed in a routine manner by qualified auditors, thereby providing
some form of supervision over banks, but not requiring government
inspection.
In 1924 the failure of the Home Bank, a bank with 70 branches,
provided the impetus for additional changes to the Bank Act. An
inquiry into the conduct of the Minister of Finance in connection
with the Home Bank failure and the Department of Finance's
supervisory capability determined that if the Minister of Finance had
investigated the Home Bank and acted on the findings, the bank could
have been liquidated at a cost lower than the cost that resulted from
its failure.
The conclusions of the Home Bank inquiry led the Canadian government
to establish a system of government bank inspections. An amendment
to the Bank Act in 1924 provided for the appointment of an Inspector
General of Banks to head the relatively small Office of the Inspector
General of Banks (OIGB). OIGB's primary duty, on behalf of the
Minister of Finance, was to make sure that banks observed the safety
and soundness provisions of the Bank Act. It fulfilled this duty by
conducting annual bank inspections as well as by relying on
information submitted by banks on an annual basis, audit reports from
external auditors, and discussions with bank managers. Although OIGB
did not have enforcement authority, it could turn to the courts if it
needed to take some specific action, such as closing a bank.
During the late 1920s and early 1930s, Canada, similar to many
countries, experienced a major depression. Although no banks failed,
the banking industry was thought to have contributed to the
depression because it had not extended credit. As a result, in 1933,
before the next decennial revision of the Bank Act, the Canadian
government set up a board of inquiry to (1) consider the advisability
of establishing a central bank as a "preliminary step toward an easy
money policy," (2) examine the Bank Act, and (3) look at the
functions and operations of the Canadian banking system.
The result of the inquiry was the enactment in 1934 of the Bank of
Canada Act establishing Canada's central bank. Although the creation
of the Bank of Canada led to the initiation of required bank reserves
and the phasing out of privately issued bank notes, the main
responsibility of the Bank of Canada was, and remains today, the
formulation and implementation of monetary policy. Its role in this
area has not been without controversy: In 1956, the Minister of
Finance blamed the Bank of Canada for following a tight monetary
policy during a period of high unemployment and slow economic growth.
By 1961, continuing conflicts between the government and the Bank of
Canada forced the resignation of the Governor of the Bank of Canada.
In response to the treatment of his predecessor, the new Governor of
the Bank of Canada insisted that in the normal course of events, the
Bank of Canada would have responsibility for monetary policy; but in
the case of disagreement between the Minister of Finance and the Bank
of Canada, the government would be responsible for directing the Bank
of Canada's monetary policy. The Minister of Finance agreed, and the
Bank of Canada Act was amended in 1967 to formalize the arrangement.
According to Bank of Canada officials, this arrangement made it clear
that the government was to take ultimate responsibility for monetary
policy, but that the Bank of Canada was to accept immediate
responsibility for monetary policy so long as a directive was not in
effect. As of April 1995, a directive had never been issued.
In 1964, the Canadian government appointed the Porter Commission to
report on the banking and financial system and to recommend
legislative changes. The Commission concluded that large banks had
too much power and independence. Its findings resulted in several
legislative changes that increased competition among financial
entities but did not extend federal supervision to nonbank financial
entities. The 1967 revision of the Bank Act reduced regulation of
banks by (1) softening the distinction between banks, trusts, and
loan companies; (2) allowing banks to make mortgage loans; and (3)
removing the interest rate ceiling on bank loans. In addition, bank
reserve requirements were lowered.
The dissatisfaction of provincial governments with the absence of
deposit insurance in Canada led the federal government to introduce
legislation on deposit insurance. The Canada Deposit Insurance
Corporation (CDIC) was thus established in 1967 and provided coverage
for other financial institutions, such as trust companies and credit
unions. The province of Quebec was the only province that had
established its own deposit insurance system, but only for
institutions incorporated in Quebec. All banks and other financial
institutions in Canada are members of CDIC and are therefore covered
by its deposit insurance system, bylaws, and standards.
DISSATISFACTION WITH
SUPERVISION LED TO CREATION
OF OSFI IN 1987
-------------------------------------------------------- Chapter 1:2.2
The failure of a number of financial institutions in the early 1980s
led to a review of OIGB's supervisory methods. The Canadian
government set up a special commission of inquiry, the Estey
Commission, to examine the effectiveness of the supervisory and
regulatory system. The reviews were made public in 1986 along with
the federal government's Blue Paper, "New Directions for the
Financial Sector," which recommended the consolidation of the bank
and insurance company supervisory offices. In 1987, the Department
of Insurance and OIGB were merged to form the Office of the
Superintendent of Financial Institutions (OSFI).
Because OSFI governs other federally incorporated financial
institutions, such as insurance companies and trust companies, OSFI
was established by the Office of the Superintendent of Financial
Institutions Act of 1987 instead of the Bank Act. OSFI was created
to deal with the growing similarity between banks and nonbank
financial institutions and with the need for a modern regulatory
framework, including a strong supervisory capability. To accomplish
this goal, OSFI's supervisory authority was strengthened--its
staffing increased, and its scope of authority was extended to
include all federally incorporated financial institutions, including
banks, insurance companies, and trusts.\10
At the time OSFI was created, the decision was made to keep CDIC
separate from OSFI. The federal government decided that the mandates
of CDIC, as the deposit insurer, and OSFI, as the supervisor, were
substantially different, thus justifying keeping the two separate
despite some overlap in their responsibilities. According to
Canadian officials, the government felt that some overlap was useful,
since it created checks and balances in the supervisory system. As
the insurer, CDIC had to be concerned about minimizing the cost to
the system of financial institutions' failures. As the supervisor,
OSFI had to be concerned about maintaining confidence in the
financial system.
Canadian banks are to be regulated and supervised with the specific
purpose of ensuring safety and soundness of individual banks along
with the stability of the system as a whole. Canadian banking law
does not address such issues as fair lending or community
reinvestment. Even so, in consultation with bank regulators CBA has
developed voluntary guidelines on such issues as consumer and small
business lending. The large Schedule I banks have also played a
significant role in developing and promoting these guidelines--partly
out of a sense of social responsibility, and partly to head off
legislated solutions to problems.
--------------------
\10 Henceforth, the term financial institutions in this report is
used to designate federal deposit-taking financial institutions, such
as banks and trust companies.
SUPERVISION OF BANKS' NONBANK
ACTIVITIES
---------------------------------------------------------- Chapter 1:3
As previously noted, OSFI is responsible for supervising financial
institutions that are federally incorporated, such as banks,
insurance companies, and federally incorporated trusts. However,
since all securities firms and some trusts are incorporated at the
provincial level, the 10 provinces have the principal responsibility
for the supervision of such institutions.
Under an agreement signed in April 1987 by the federal Minister of
Finance and the Ontario Minister of Finance, OSFI is to be
responsible for regulating "securities-related activities of federal
financial institutions carried on directly by the institution."\11
Securities activities that are restricted to subsidiaries of a bank
or insurance company--including underwriting of equity and debt and
secondary market trading in equities--are to be supervised at the
provincial level.
OSFI and the Ontario Securities Commission have signed a Memorandum
of Understanding that enables OSFI to receive regulatory information
on nonbank subsidiaries from provincial regulators and enables the
provincial regulators to obtain from OSFI information on the banks
owning subsidiaries.\12 OSFI is also to receive financial information
from the parent companies on their securities subsidiaries. OSFI
remains responsible for the supervision of the banking organization
as a whole--for example, for ensuring that the consolidated entity is
meeting consolidated capital requirements. The provincial regulator,
on the other hand, sets capital levels for the securities
subsidiaries and is responsible for ensuring that those capital and
other securities requirements are being met.
OSFI also supervises 18 trust companies that are not owned by banks.
In its role as an agent of CDIC, OSFI examines 5 of the 18 trust
companies that are provincially chartered and are CDIC members. As
an agent of the provincial regulators, OSFI examines the 13 other
provincially chartered trust companies that are not members of CDIC.
--------------------
\11 The permitted activities are specifically listed in the agreement
and include those relating to (1) sovereign debt, (2) money markets,
(3) debt securities of the institution, (4) secondary market trades
in corporate debt securities, (5) capital market activities in
syndicated or consortium loans, (6) portfolio management and
investment counseling to the extent permitted by law, (7) dealings in
mutual funds, and (8) trades for fully managed accounts.
\12 OSFI has worked with the other provincial regulators to establish
the same agreement concerning securities activities that OSFI has
with the Ontario Securities Commission.
OVERVIEW OF PARTICIPANTS IN
BANK REGULATION, SUPERVISION,
AND EXAMINATION
---------------------------------------------------------- Chapter 1:4
Although OSFI is the primary financial institution supervisor, the
Department of Finance, CDIC, and the Bank of Canada all play roles in
regulating or supervising financial institutions--either directly or
through committees.
OSFI
---------------------------------------------------------- Chapter 1:5
OSFI is headed by the Superintendent of Financial Institutions, who
is appointed for a 7-year renewable term by the Cabinet. The
Superintendent reports directly to the Minister of Finance.
OSFI is divided into three sectors: the Policy Sector, the
Operations Sector, and the Corporate Sector. The Operations Sector
includes the Deposit-Taking Institutions Sector, which is to
supervise banks, federally incorporated trust and loan companies, and
cooperative credit associations. At the end of June 1995, the
Deposit-Taking Institutions Sector had 130 employees, including 71
full-time examiners located in OSFI's regional offices--45 in
Toronto, 12 in Montreal, 8 in Vancouver, and 6 in Winnipeg.
OSFI activities are to be conducted on a cost-recovery basis, meaning
that its operations are paid for through industry assessments. For
1992 and 1993, deposit-taking institutions were assessed a total of
$14.8 million (Canadian).
DEPARTMENT OF FINANCE
-------------------------------------------------------- Chapter 1:5.1
The Department of Finance is headed by the Minister of Finance,
described to us by Canadian officials as the most influential member
of the government's Cabinet after the Prime Minister. The Bank Act
gives the Minister of Finance responsibility for financial
institutions, and the 1992 revision to the Bank Act allows for the
delegation of that responsibility. The Minister of Finance has
delegated many of the responsibilities over financial institution
policy to the Secretary of State (International Financial
Institutions).\13
The Minister of Finance has delegated to the Superintendent of OSFI
administrative matters relating to financial institutions, such as
incorporating new banks.
The branch of the Department of Finance that is responsible for
financial services industry issues is the Financial Sector Policy
Branch (FSP), which consists of three divisions: Financial Markets,
Financial Institutions, and Financial Sector Policy. It includes a
permanent staff of 55 people, as of January 1995, of whom half are to
be involved in policy formulation concerning financial institutions.
--------------------
\13 In 1980, the Canadian government created 11 Secretaries of State
to replace junior ministers.
CDIC
---------------------------------------------------------- Chapter 1:6
CDIC is a crown corporation\14 and was incorporated under the CDIC
Act in 1967 to provide deposit insurance. CDIC is run by a Board of
Directors and a Chairman, who report to Parliament through the
Minister of Finance. The Board of CDIC includes the Governor of the
Bank of Canada, the Deputy Minister of Finance, the Superintendent of
Financial Institutions and a Deputy Superintendent of Financial
Institutions, and four independent private-sector directors. The
Cabinet is to appoint the four private-sector directors for 3-year
terms and the Chairman for a 5-year term. The directors are to
represent a range of business experience, particularly in the areas
of banking, finance, real estate, accounting, auditing, insolvency,
corporate law, and management.
As of December 1994, CDIC had a permanent staff of about 90 people
headed by the Chief Executive Officer (CEO) and President, who is
also a government Cabinet appointee with a 5-year term.
--------------------
\14 A crown corporation is an entity formed by the Canadian
government to fulfill a public need.
BANK OF CANADA
-------------------------------------------------------- Chapter 1:6.1
The Bank of Canada is to be overseen by its Board of Directors, which
is composed of the Governor; the Senior Deputy Governor; 12
Directors; and the Deputy Minister of Finance, who is a nonvoting
member. The Directors are to be appointed for 3-year terms by the
Minister of Finance with the approval of the Cabinet. The Directors
are to appoint the Governor and Deputy Governor for 7-year terms,
again with the Cabinet's approval. Directors can be removed by the
Board with the Cabinet's approval.
The Board is to meet at a minimum seven times a year and is
responsible for the Bank's management, administrative policies, and
expenditures. In 1994, the Board established a Governing Council
made up of the Governor, Senior Deputy Governor, and four Deputy
Governors to manage the Bank.\15 An Executive Committee of the Board,
composed of the Governor, the Senior Deputy Governor, the Deputy
Minister of Finance as a nonvoting member, and four directors, is to
meet regularly and submits minutes from its meeting at the following
Board of Directors meetings. Monetary policy is to be formulated and
implemented by senior management of the Bank of Canada, who are to
report on monetary policy to the Board and the Executive Committee at
their regular meetings.
As of February 1, 1995, the Bank of Canada had 2,055 staff who
performed the 4 major functions of the Bank of Canada: monetary
policy formulation, banking activities, bank note issuance, and
management of the Government of Canada's debt. The Monetary and
Financial Analysis Department had a staff of 54 people responsible
for financial systems and analysis--focusing mainly on financial
analysis for monetary policy purposes. Within the Monetary and
Financial Analysis Department, the Regulatory and Payments System
Analysis Division is to do the analysis on regulatory and clearing
and settlement system issues. The Division is to include four
economists and one research advisor.
--------------------
\15 The Council is to decide on broad organizational and strategic
issues as well as on basic approaches relating to the Bank of
Canada's responsibilities in monetary policy and other areas.
EXTERNAL AUDITORS
-------------------------------------------------------- Chapter 1:6.2
All federal deposit-taking financial institutions in Canada are
required to have an annual financial audit. The big six accounting
firms\16 are the primary auditors for banks and trusts, although
there are one or two regional firms that also audit banks. Although
the Bank Act no longer requires banks to have two auditors, Canadian
officials with whom we spoke said the large Schedule I banks still
retain two audit firms.
--------------------
\16 These firms are known in the United States as Ernst and Young,
Arthur Andersen LLP, Deloitte & Touche, KPMG Peat Marwick, Coopers &
Lybrand, and Price Waterhouse.
FISC
---------------------------------------------------------- Chapter 1:7
The Financial Institutions Supervisory Committee (FISC) was
established by the Office of the Superintendent of Financial
Institutions Act of 1987 to enhance communication among the
participants in financial institution regulation and supervision.
The Committee is chaired by the Superintendent of Financial
Institutions and includes the Deputy Minister of Finance, the
Governor of the Bank of Canada, and the Chairman of CDIC. FISC is
not authorized any staff.
SAC
---------------------------------------------------------- Chapter 1:8
The four members of FISC also make up the Senior Advisory Committee
(SAC). The Committee is chaired by the Deputy Minister of Finance.
SAC is to meet when there are policy changes or legislative proposals
to be discussed.
A committee below SAC called "Sub SAC" is made up of deputies or
assistants and is to meet every few months. In addition, there are
working groups below Sub SAC that are to meet throughout the year.
The same issues and alternatives talked about at SAC are to be
discussed at Sub SAC and in the working groups, with discussions
generally involving specific details and their implications.
OBJECTIVES, SCOPE, AND
METHODOLOGY
---------------------------------------------------------- Chapter 1:9
At the request of Congressman Charles E. Schumer, we examined
various aspects of the Canadian bank regulatory system.
Specifically, our objectives were to describe (1) the Canadian bank
regulatory structure and its key participants, (2) how the banking
structure functions, (3) how banks are examined, and (4) how the
participants handle other financial system responsibilities. We
completed similar studies on the bank regulatory structure and
operations in several other countries.\17
To address these objectives we conducted interviews with officials of
the Office of the Superintendent of Financial Institutions, the
Department of Finance, the Canada Deposit Insurance Corporation, and
the Bank of Canada. They provided us with various documents,
including annual reports, guidelines for banks, standards of sound
business and financial practices, copies of legislation and proposed
legislation, and statistics on the banking industry.
We also met with senior executives of Canadian banks; senior
executives from external auditing firms; individuals from CBA, the
association representing banks in Canada; the Trust Association of
Canada, the association representing trust companies; the Toronto
Futures Exchange; CPA, the association that runs the payments and
settlements system; and several other experts on Canadian bank
regulation and supervision and bank audits in Canada.
Finally, we reviewed the Consolidated Bank Act and Regulations, the
law that relates most directly to bank regulation and supervision;
the Bank of Canada Act, and the CDIC Act; the guidelines and
standards of the regulators; and other documents that related to the
Canadian bank regulatory structure. This review does not constitute
a formal legal opinion on the requirements of the law, nor does it
include an evaluation of the efficiency or effectiveness of the
Canadian bank regulatory structure.
We conducted our review, which included two visits to Canada, from
August 1994 through February 1995 in accordance with generally
accepted government auditing standards. We gave senior officials at
OSFI, CDIC, the Department of Finance, and the Bank of Canada a draft
of this report for their comments. They generally agreed with the
facts as presented and provided primarily technical comments, which
have been incorporated where appropriate.
--------------------
\17 For information on GAO's already issued reports on the German and
British regulatory systems, see Bank Regulatory Structure: The
Federal Republic of Germany (GAO/GGD-94-134BR, May 9, 1994); and Bank
Regulatory Structure: The United Kingdom (GAO/GGD-95-38, Dec. 29,
1994). GAO is also preparing reports on the regulatory systems of
France and Japan.
BANK CHARTERING, REGULATION, AND
SUPERVISION
============================================================ Chapter 2
Since 1987, OSFI has been formally recognized in statute as the
primary supervisor of financial institutions in Canada.
Nevertheless, it shares certain regulatory and supervisory
responsibilities with others. By law, the Minister of Finance is
responsible for chartering or incorporating federal financial
institutions, although OSFI administers the application process. The
Minister of Finance also has the final decisionmaking authority over
key supervisory decisions. CDIC has a secondary supervisory role but
has increased its influence over supervision and regulation in recent
years by taking advantage of its authority to issue standards. A
less extensive role is played by the Bank of Canada that basically
involves information sharing. FISC and SAC are used to communicate
and coordinate regulation and supervision activities.
THE MINISTER OF FINANCE
CHARTERS FEDERAL FINANCIAL
INSTITUTIONS, BUT OSFI
ADMINISTERS THE APPLICATION
PROCESS
---------------------------------------------------------- Chapter 2:1
Financial institutions in Canada were initially permitted to
incorporate only by a special act of Parliament. Parliament
delegated this responsibility to the Minister of Finance, and in 1980
the Minister of Finance was given the power to issue "letters patent"
to charter or incorporate financial institutions in accordance with
the Bank Act.
Although, technically, it is the Minister of Finance that is to issue
letters patent, OSFI is responsible for the application process. The
application for letters patent is to be reviewed by OSFI, which then
makes recommendations to the Minister of Finance as to whether the
financial institution should be chartered. We were told that the
Minister of Finance has always accepted OSFI's recommendations.
The analysis that OSFI is to do on behalf of the Minister of Finance
includes assessing (1) the source of financial resources for the
financial institution, (2) the soundness and feasibility of plans for
the future development of the financial institution, (3) previous
experience of the owner of the financial institution, (4) the
competence and experience of the financial institution's management,
and (5) whether incorporating the financial institution is in the
best interest of the Canadian financial system.
CDIC and OSFI have an administrative agreement whereby both agencies
are to coordinate on the application for incorporation and deposit
insurance. Once incorporation is granted, CDIC then makes a decision
on approving the financial institution's application for deposit
insurance.\18 Before a financial institution is authorized to accept
insured deposits, CDIC normally requires that the applicant's
promoter, affiliates, or controlling entity provide CDIC with a legal
undertaking, which could involve a guarantee from the parent company.
In the last 5 years, CDIC has denied deposit insurance to three
applicants, all of which were provincial applicants.
--------------------
\18 CDIC members include provincial financial institutions, which are
outside of OSFI's purview, and the chartering and insurance approvals
for those institutions are to be made between the provincial
chartering authority and CDIC.
RESPONSIBILITY FOR FINANCIAL
INSTITUTION REGULATION FALLS
PRIMARILY TO OSFI AND CDIC
---------------------------------------------------------- Chapter 2:2
OSFI is responsible for administering and interpreting legislation
relevant to financial institutions by developing regulations and
guidelines, which must be approved by the Minister of Finance and the
Cabinet before they are issued. CDIC has the authority to issue
bylaws, which have the force of law.
OSFI IS RESPONSIBLE FOR
REGULATIONS AND GUIDELINES
-------------------------------------------------------- Chapter 2:2.1
OSFI is responsible for developing financial institution regulations,
but before regulations are issued they are to be (1) reviewed by the
Privy Council;\19 (2) published in the Canada Gazette for a 60-day
comment period, with comments incorporated as appropriate; (3)
approved by the Minister; and (4) approved by the Cabinet. OSFI
officials told us they generally issue guidelines because the process
of issuing regulations is long, complex, and less flexible. Although
guidelines do not have the force of law, the officials said they are
usually followed by all financial institutions.
Financial institution industry guidelines have included such subjects
as capital adequacy requirements, how assets may be securitized,
large exposure limits, and the classification of loans guaranteed by
a parent of the financial institution. OSFI's guidelines include
such information as definitions, limits, or procedures that should be
taken into account and the type of information that should be
provided to OSFI. Because OSFI regulates all federal financial
institutions, the guidelines generally address financial institutions
other than banks. For example, the guideline for securities lending
applies to insurance, trust and loan companies, and banks. In recent
years, OSFI has issued 17 guidelines relevant to the banking
industry. OSFI officials told us they do not issue interpretive
letters explaining the guidelines, they just revise the guidelines if
further clarification is needed.
In developing both regulations and guidelines, OSFI is to consult
extensively with the industry, principally with the institutions or
associations that the regulation or guideline affects. Although OSFI
has the primary responsibility for developing regulations and issuing
guidelines, the Minister of Finance has the primary responsibility
for developing and proposing financial institution industry
legislation. OSFI may, however, be involved in drafting such
legislation.\20
--------------------
\19 The Privy Council is a department that carries out the day-to-
day duties for the Prime Minister of Canada.
\20 CDIC and the Bank of Canada are also involved in drafting
legislation through SAC.
CDIC HAS AUTHORITY TO ISSUE
BY-LAWS
-------------------------------------------------------- Chapter 2:2.2
CDIC has the authority to issue by-laws, which have the force of law.
These by-laws pertain to the operations and functions of CDIC and its
members.
CDIC has made use of its authority by issuing new by-laws in the
areas of (1) standards of sound business and financial practices, (2)
deposit insurance applications, and (3) deposit insurance premium
surcharges. In addition, CDIC is in the process of developing
by-laws on consumer information and trust and joint accounts.
CDIC issued the Standards of Sound Business and Financial Practices
By-laws (Standards By-laws) on August 17, 1993, following 4 years of
extensive consultation with regulators, member institutions and their
associations, accountants, lawyers, and other interested parties.
The Standards By-laws stipulate that each member institution should
establish sound business and financial practices in eight areas:
liquidity management, interest rate risk management, credit risk
management, real estate appraisals, foreign exchange risk management,
securities portfolio management, capital management, and internal
controls. According to the CDIC Chairman, an important consequence
of the Standards By-laws "is to make clear the responsibility on
boards of directors and officers of deposit-taking institutions for
ensuring implementation and compliance with standards of sound
business and financial practice."
Each of the eight Standards By-laws has a standards document that
sets out what CDIC considers to be the minimum policies, procedures,
and control criteria that financial institutions need to have in
place. CDIC officials told us that banks and other insured
institutions are expected to effectively apply these standards in
order to manage their business activities on a sound basis and
prudently control their various exposures to risk. The standards set
out the "best practices," many of which CDIC officials said were
already being followed by CDIC's best-managed members. If applied
and followed, the standards are intended to reduce the likelihood of
an insured financial institution failing and reduce the risk of loss
assumed by CDIC. CDIC sees nonadherence to the standards as an early
indicator of potential problems, and it may terminate the
institution's deposit insurance. The standards, however, are new,
and CDIC officials expect to have a better idea of industry adherence
after the next cycle of annual examinations.
Compliance with CDIC's standards are to be measured through a
member's self-assessment process, which OSFI is to review during its
annual examinations of financial institutions. A member's
self-assessment requires the institution's management and Board of
Directors to confirm that the policies and procedures required in the
standards are (1) in place, (2) sound and prudent, and (3) being
followed by the institution. Each member is to submit a Standards
By-laws self-assessment report on the adherence to the standards to
CDIC by July 31 of each year. If CDIC does not consider the
self-assessment done by an institution adequate, the institution is
required to conduct a more detailed self-assessment.\21 An
institution is also required to submit a detailed report if it does
not meet all of the following conditions, based on its most recent
quarterly financial statements: (1) meet the capital ratio required
by the regulator; (2) have a ratio of net nonperforming loans to
capital of less than 1/2; and (3) have sufficient capital to
withstand a loss over the next 4 quarters equal to a loss sustained
during the last 4 quarters. Lastly, institutions that are new
members will be required to complete a detailed report. In addition,
if CDIC or OSFI, in the case of federal financial institutions, have
any concerns about the institution, a detailed report is also
required. (See app. I for more detailed information on the
Standards By-laws.)
In fiscal years 1993 and 1994, CDIC issued other by-laws dealing with
the Application for Deposit Insurance, Policy of Deposit Insurance,
and Premium Surcharges. The Application By-law introduced a new form
of application for deposit insurance and the Policy By-law requires
that members provide regular financial information and business plans
to CDIC on request and is designed to ensure that CDIC has access to
information about its members. The Premium Surcharge By-law, which
went into effect on January 26, 1994, allows CDIC to charge penalty
surcharges if an institution fails to (1) follow the CDIC Standards
By-laws, (2) comply with record-keeping and information requirements,
(3) comply with any provision of the Bank Act or other relevant law,
or (4) meet the terms of undertaking given to CDIC.
--------------------
\21 There are two kinds of standards self-assessment reports: a
simplified report and a detailed report. The simplified report
includes a representation letter that says that management has
followed the standards. The letter is followed by a description of
processes the institution followed in conducting the self-assessment
and then a resolution by the member's Board of Directors saying that
the Board is familiar with the standards, has considered the
management representation letter concerning adherence to the
standards, and has approved the report on behalf of the member. The
detailed report presents the criteria for the member's adherence to
each standard, the basis on which the member decided on the criteria,
and explains how the member met the criteria for each standard. As
with the simplified report, a letter and resolution statement are
included in the detailed report. If a member submits a simplified
report to CDIC, the member must retain evidence to support the
report, as the member will have to provide it to OSFI during its
annual examination of federal financial institutions in order for
OSFI to report to CDIC on the member's adherence to the standards.
OSFI AND CDIC ARE RESPONSIBLE
FOR ENFORCEMENT
---------------------------------------------------------- Chapter 2:3
OSFI and CDIC both have the authority to take enforcement action
against financial institutions for which they have responsibility.
However, OSFI has a wider range of enforcement actions, both formal
and informal, at its disposal than does CDIC.
OSFI RELIES PRIMARILY ON
INFORMAL ENFORCEMENT ACTIONS
-------------------------------------------------------- Chapter 2:3.1
Although OSFI has the authority to use a wide range of enforcement
actions, its officials told us they tend to rely principally on
informal actions. They said institutions usually comply with
informal recommendations, knowing that OSFI will not hesitate to use
more formal action if compliance is not forthcoming. For example,
after each examination of a financial institution, OSFI discusses
with the institution's management any problems that were found and
sends a management letter to the institution "recommending" actions
to be taken. OSFI officials said these recommendations are followed
because the institutions understand that more serious, formal
enforcement actions could follow if recommendations are disregarded.
According to OSFI officials, most of OSFI's enforcement is
accomplished through management letter recommendations.
If an institution's problems continue to escalate, OSFI officials
said they will take more formal enforcement actions. For instance,
OSFI may obtain a letter of undertaking from the institution. OSFI
may also do a follow-up examination on the financial institution in
the same year that it did the first examination, or commission an
external auditor to do an audit of the institution. In addition,
OSFI can order a financial institution to increase its capital, which
the official said is usually a precursor to forcing an institution to
be sold or to be liquidated. OSFI has ordered an increase to an
institution's capital twice since it was given the authority to do so
in 1992.
Although it has yet to use them, there are other formal actions that
OSFI is authorized to take. These include issuing a direction of
compliance or recommending that CDIC undertake a Financial
Institutions Restructuring Process (FIRP).\22 A direction of
compliance enables OSFI to direct a financial institution to stop
what OSFI considers to be an unsafe or unsound practice. FIRP can be
used when OSFI makes a determination that an institution "has ceased,
or is about to cease, to be viable" and reports the lack of viability
to CDIC. In such situations, CDIC may take control of the
institution.
According to OSFI officials, a financial institution may appeal an
OSFI determination or action either by taking OSFI to court or by
appealing to the Minister of Finance. According to OSFI officials,
under the normal right of appeal, the institution can take OSFI to
court, although this has never happened. In the majority of cases,
OSFI officials said, financial institutions have appealed to the
Minister of Finance who, while he has listened to the institutions'
concerns, has yet to alter in any way OSFI's enforcement actions.
All important actions taken by OSFI, such as a recommendation to
close a financial institution, are to be reviewed by the Secretary of
State (International Financial Institutions).\23
--------------------
\22 FIRP basically expropriates the rights of the shareholders.
Under FIRP, the ownership of the shares goes to CDIC, and CDIC can
then sell the shares to another financial institution without
shareholder approval. In order to use FIRP, CDIC has to have a
purchaser available.
\23 As noted in chapter 1, the Minister of Finance has delegated most
of the responsibility for financial institutions to the Secretary of
State (International Financial Institutions).
CDIC ALSO HAS ENFORCEMENT
AUTHORITY
-------------------------------------------------------- Chapter 2:3.2
Although CDIC may also take specific, narrowly defined enforcement
actions, CDIC officials said it exerts more influence through moral
suasion or by having OSFI put pressure on a financial institution.
If CDIC determines that these initial actions have not led to
satisfactory results, it may take enforcement actions that include
(1) levying a premium surcharge against an individual member if it
fails to abide by certain by-laws or other relevant statutes or (2)
terminating an insured institution's deposit insurance.
CDIC may also terminate an institution's insurance when the
institution is not following CDIC's by-laws, even when it is
otherwise solvent. CDIC has cancelled deposit insurance four times
in the cases of failed members, and it has terminated deposit
insurance as an enforcement action against one solvent member.
OSFI AND CDIC COORDINATE THE
RESOLUTION OF A FINANCIAL
INSTITUTION'S FAILURE
---------------------------------------------------------- Chapter 2:4
Until an institution reaches the point where it is declared
insolvent, or not financially viable, and is placed in liquidation,
OSFI has the lead in resolving the troubled institution but is to
coordinate its actions with CDIC. If a financial institution is
declared insolvent by OSFI, CDIC can terminate the institution's
deposit insurance. The Minister of Finance and the Bank of Canada
are kept informed about a troubled institution through FISC, but
their officials told us their roles take place behind the scenes,
providing input to OSFI, if necessary.
ATTEMPTS ARE MADE TO FIND
EARLY SOLUTION
-------------------------------------------------------- Chapter 2:4.1
Once a financial institution is put on the regulatory watchlist,\24
both OSFI and CDIC are to monitor the institution's situation more
extensively than is usual.\25 In the early stages of a problem
situation, OSFI is to be in frequent contact with the financial
institution and take enforcement actions to help get the
institution's management to rectify the problems. Depending on the
circumstances, OSFI may exert pressure on the institution's
management and board of directors to restructure the institution or
find an acquirer or merger partner. If the institution's condition
further deteriorates, OSFI may develop plans to take control of the
financial institution's assets, especially if conditions deteriorate
to the point at which its viability comes into question. According
to an OSFI official, once OSFI takes control of a financial
institution's assets, it usually intends to liquidate the
institution.
CDIC is also to work with OSFI to find solutions for problem
financial institutions at the federal level. When a CDIC member is
on the watchlist, OSFI is to continually update CDIC's Board on the
status of the financial institution. Once CDIC becomes aware that a
financial institution poses a high risk of loss-- generally from
information it has received from OSFI--CDIC may order a special
examination in order to (1) determine CDIC's financial exposure if
the institution were to fail; and (2) have a basis for intervening in
the situation, such as suggesting to the institution and OSFI a
purchase and assumption transaction (P&A) with a potential acquirer,
or suggesting to the institution that it voluntarily liquidate.
According to CDIC officials, both resolution alternatives are
normally considered at the same time.
When it is clear that the financial institution presents imminent
risk to the deposit insurance fund, CDIC officials said they
generally consider four options for resolving the institution: (1)
the institution is liquidated and CDIC pays depositors up to the
limit of their insured deposits; (2) a P&A transaction takes place in
which the failed institution is sold to an acquirer; (3) CDIC pays
another institution to run the failed institution; or (4) CDIC
provides direct financial assistance to the failing institution by
making advances, guaranteeing acquired assets, or making a deposit at
the institution. CDIC staff provide its Board with information on
the costs of each option, and the Board then makes a determination on
how to resolve the institution.
--------------------
\24 The watchlist includes financial institutions considered by OSFI
and CDIC to be problem institutions whose risk profiles are not
effectively managed and whose viability is of concern.
\25 CDIC and OSFI officials are to meet with the Secretary of State
of International Financial Institutions once a month to talk about
institutions on the watchlist and other problem institutions.
Basically, an institution is placed on the watchlist when its capital
is below required levels or it is operating in an unsafe and unsound
manner.
OTHER PARTICIPANTS HAVE A
ROLE
-------------------------------------------------------- Chapter 2:4.2
During the resolution process, the Deputy Minister of Finance and the
Governor of the Bank of Canada are to participate through CDIC's
Board of Directors in the decisionmaking process either to close a
financial institution, which is OSFI's responsibility, or to
terminate a financial institution's insurance, which is CDIC's
responsibility. The Secretary of State (International Financial
Institutions) is to be briefed by OSFI on the state of affairs of a
problem institution and is to become more involved if there is a
possibility that federal funding might be required.
Once OSFI determines a financial institution is, or is likely to
become, insolvent and should be closed, it is to make a
recommendation to the Secretary of State (International Financial
Institutions) about closing the institution. If the Secretary of
State (International Financial Institutions) agrees with OSFI's
recommendation, the Secretary is to ask the Attorney General's office
to start winding up the affairs of the financial institution.
Similarly, if CDIC recommends terminating the deposit insurance of a
financial institution, the Secretary of State is to decide whether to
agree with the recommendation, and, if he agrees, the termination
process begins. Although the Secretary has the authority to reject
an OSFI or CDIC recommendation, Department of Finance officials said
he has never done so.
THE BANK OF CANADA'S
SUPERVISORY ROLE IS LIMITED
-------------------------------------------------------- Chapter 2:4.3
The Bank of Canada's current role in banking supervision is
relatively limited. First, the Bank of Canada is a source of
information on the systemic implications of closing a financial
institution and is frequently asked for its judgment on that issue by
the other supervisory participants. Second, it is included in and
can initiate discussions with other participants in the regulatory
and supervisory structure about potential systemic issues and
initiatives to address those issues. This role is based principally
on its participation in the financial system as lender of last
resort. Third, the Governor of the Bank of Canada is an advisor to
the Minister of Finance on a broad range of issues and meets with the
Minister of Finance regularly. Finally, the Governor is an ex
officio member of the CDIC Board of Directors and a member of FISC
and SAC.
RELATIONSHIPS AMONG
PARTICIPANTS IN FINANCIAL
INSTITUTION REGULATION AND
SUPERVISION ARE COMPLEX
---------------------------------------------------------- Chapter 2:5
The relationships among the participants in financial institution
regulation and supervision in Canada are quite complex. Numerous
responsibilities overlap among the major participants involved in
regulation and supervision at the federal level, and decisionmaking
requires significant coordination. Committees have been created to
improve coordination and information sharing among the participants.
OSFI AND CDIC RELATIONSHIP
IS COMPLEX
-------------------------------------------------------- Chapter 2:5.1
According to Canadian financial institution regulatory officials, the
relationship between OSFI and CDIC has been complicated because of
differing philosophies stemming from their primary responsibilities
as supervisor and deposit insurer, respectively.
CDIC, as the deposit insurer, has been concerned about minimizing the
cost of failing institutions to the insurance fund, and consequently
it has preferred that an institution be resolved sooner rather than
later to reduce the likelihood of losses increasing over time. OSFI,
on the other hand, has been primarily interested in system stability
and thus has tended to pursue all avenues of addressing a problem
institution thought to be viable in order to maintain stability and
public confidence in the financial system. Because OSFI's
perspective can occasionally lead to increased losses, the different
philosophies have led to some disagreements between OSFI and CDIC.
In addition, CDIC has the authority to issue by-laws and has done so
in order to exercise its supervisory responsibilities. CDIC's
issuance of the Standards By-laws further clouded the regulator's and
insurer's jurisdictions.
PURPOSE OF COORDINATING
COMMITTEES IS TO IMPROVE
RELATIONSHIPS AND
INFORMATION SHARING
-------------------------------------------------------- Chapter 2:5.2
Several committees have been established, both in legislation and
more informally, to address the problems of coordination and overlap
among the participants in financial institution regulation and
supervision. FISC, as noted in chapter 1, was established in the
Office of the Superintendent of Financial Institutions Act of 1987 to
improve information sharing among the Committee's four members:
OSFI, the Department of Finance, CDIC, and the Bank of Canada. The
Committee was deemed necessary by Parliament because it was felt that
a lack of information and coordination contributed to the weaknesses
of the pre-1987 regulatory system. The Committee is not a
decisionmaking body or even an advisory body. Its purpose is "to
facilitate consultations and the exchange of information among its
members on all matters relating directly to the supervision of
financial institutions." The Committee is to meet on a regular basis
to discuss regulatory issues.
In addition to FISC, the same representatives also make up the
membership of SAC. As mentioned in chapter 1, SAC provides the forum
in which policy changes and other legislative changes are to be
discussed.
OSFI and CDIC have also established an OSFI/CDIC Liaison Committee
which, according to officials with whom we spoke, is an attempt by
the CDIC Chairman and the Superintendent of Financial Institutions to
improve the working relationship between the two organizations and
provide a forum to discuss issues. The Committee is to meet once a
month.
Although the establishment of these committees signals an
acknowledgement that better coordination is needed among the
participants in the financial institution regulatory structure, there
has been some dissatisfaction with how some of the committees work.
According to officials with whom we spoke, concerns have been raised
about the quality of information sharing, the frequency of meetings,
the manner in which the agendas are set, and the accountability of
the committee members.
WHITE PAPER PROPOSES TO CLARIFY
PARTICIPANTS' ROLES
---------------------------------------------------------- Chapter 2:6
In February 1995, the Secretary of State (International Financial
Institutions) proposed a White Paper or policy paper on Enhancing the
Safety and Soundness of the Canadian Financial System. The purpose
of the White Paper proposals is to help improve the supervisory and
regulatory system and alleviate tensions by further clarifying
participants' roles, providing for greater transparency in the
system, establishing an earlier intervention process, and increasing
supervision over the clearing and settlement system. The Secretary
of State (International Financial Institutions) expects the White
Paper proposals to be placed in legislation as soon as possible.
OSFI AND CDIC'S ROLES TO BE
CLARIFIED
-------------------------------------------------------- Chapter 2:6.1
During the course of developing the White Paper, the Secretary of
State (International Financial Institutions), in consultation with
the other participants, looked at the financial institution
regulatory structure--specifically at merging, separating, or keeping
OSFI and CDIC the way they are now. The Secretary decided to keep
both organizations as they are now, recognizing that some overlap
between the two can provide for healthy checks and balances. For
example, the independent assessments CDIC makes appear to provide a
constructive second look at the supervisory practices of OSFI, and
the access and interactions OSFI has with the financial institutions
provides CDIC with better insights to the safety and soundness of
various banking practices.
Nevertheless, the White Paper clarifies the roles of OSFI and CDIC in
the regulatory and supervisory intervention process in three
principal ways. It proposes that (1) the Superintendent of Financial
Institutions is to be given a clearly defined legislative mandate
that would clarify OSFI's role and the manner in which it is to carry
out its role, (2) the actions and respective roles of OSFI and CDIC
are to be further clarified to provide each organization with a range
of regulatory measures that it may take, and (3) the Superintendent
of OSFI is to be given the authority to take control of an
institution earlier than can be done under current legislation.
ROLES OF THE MINISTER OF
FINANCE AND THE BANK OF
CANADA MAY ALSO CHANGE
-------------------------------------------------------- Chapter 2:6.2
In addition to the clarification of OSFI and CDIC roles, the White
Paper also proposes redefining the roles of the Minister of Finance
and the Bank of Canada. The proposal formally assigns most of the
Minister of Finance's current administrative decisionmaking
responsibilities to OSFI. Currently, OSFI supports the Minister of
Finance's decisionmaking through its analysis. The proposals also
give the Bank of Canada direct regulatory responsibility for clearing
and settlements, which the Bank of Canada had already informally
assumed.
Currently, under the authority of the Minister of Finance, the
Secretary of State (International Financial Institutions) has the
final say on whether a financial institution should be closed, its
deposit insurance terminated, or whether regulators can undertake a
FIRP or otherwise take over an institution. The White Paper proposes
that the role of the Minister of Finance be refocused by requiring
the Superintendent of Financial Institutions, as opposed to the
Minister of Finance, to make the decision regarding the financial
condition of an institution. Under the proposal, the Minister of
Finance would still be able to prevent an institution's closure in
exceptional circumstances, if the Minister of Finance determines that
the closure is not in the public's interest.
In addition, the White Paper proposals specify legislatively a more
explicit role for the Bank of Canada in the oversight of the clearing
and settlements system in order to help control systemic risk. In
part, this means that the private sector operators of the clearing
and settlements system would obtain the Bank of Canada's approval
regarding how they monitor and control for systemic risk. (See ch.
4 for more information.)
SUPERVISORY INFORMATION IS
OBTAINED THROUGH MONITORING,
EXAMINATIONS, AND EXTERNAL AUDITS
============================================================ Chapter 3
In order to fulfill its supervisory role of identifying emerging
problems in financial institutions at an early stage, OSFI relies on
information obtained through oversight, annual examinations, and
annual audits performed by external auditors. CDIC relies primarily
on OSFI for information on institutions it insures. While somewhat
removed from the supervisory process, the Bank of Canada nevertheless
collects detailed reports on financial institutions that are used
principally for monetary policy purposes. These reports, along with
its Governor's membership on FISC, keep the Bank of Canada informed
in case of a financial crisis.
MONITORING PROVIDES ONGOING
SUPERVISORY INFORMATION
---------------------------------------------------------- Chapter 3:1
OSFI, CDIC, and the Bank of Canada have developed a shared reporting
system through which financial institutions are required to report
data concerning their activities and operations. This data reporting
system is designed to meet the supervisory and deposit insurance
information needs of OSFI and CDIC, as well as the monetary policy
information needs of the Bank of Canada.
FINANCIAL INSTITUTIONS FILE
PERIODIC REPORTS WITH OSFI
-------------------------------------------------------- Chapter 3:1.1
Financial institutions in Canada are required to submit a variety of
data to OSFI, including annual consolidated financial statements,
quarterly income statements, allowances for loan losses, holdings in
subsidiaries and associated companies, and geographical distribution
of assets and liabilities--both inside and outside of Canada.
According to OSFI officials, if OSFI needs more specific information
than that reported, it requests that the institution provide it.
The information on bank activities helps OSFI assess a financial
institution's risk profile and helps OSFI examiners in scoping their
examinations.
CDIC RELIES ON OSFI FOR MOST
OF ITS INFORMATION ON
FINANCIAL INSTITUTIONS
-------------------------------------------------------- Chapter 3:1.2
CDIC relies primarily on OSFI for information on the financial
condition of its federal members and normally has access to
comparable information other CDIC members routinely submit to their
provincial regulators. CDIC also receives OSFI's examination results
through copies of management letters and examination reports from
OSFI. The management letter provides CDIC with a description of the
issues OSFI has identified as needing the attention of the
institution's management along with the actions management has
committed to taking to address those issues. CDIC automatically
receives all examination reports on problem institutions from OSFI
and can request examination reports on other institutions. The OSFI
Section 29 report reflects the examination results for the period
examined. Specifically, OSFI confirms in the report that (1) the
CDIC premiums are correct, (2) the institution is in satisfactory
financial condition, and (3) that CDIC's standards are being
followed.
CDIC may also obtain specific information on a financial institution
from OSFI, or directly from the institution. CDIC also receives the
equivalent of call report data\26 from the data reporting system and
gets annual financial statements directly from its members.
All of the information that CDIC receives is to be used to do risk
assessments of the member and to assess the member's risk management
policies and procedures. CDIC also compares the information that it
receives directly from financial institutions in the annual financial
statements with the information received from OSFI examiners.
--------------------
\26 These data typically provide a statistical depiction of the
bank's financial activities, such as the types of loans or securities
holdings.
THE BANK OF CANADA GETS
FREQUENT INFORMATION
-------------------------------------------------------- Chapter 3:1.3
Although the Bank of Canada has no direct statutory responsibility
for supervision, Bank officials told us they receive current
information about the financial system and individual institutions
through the data reporting system in order to fulfill its monetary
policy and lender of last resort responsibilities, as well as to be
able to assist in any financial crisis (see ch. 4 for additional
information). The Bank of Canada is to receive the fully
consolidated monthly balance sheets from financial institutions, as
well as weekly liquidity reports from selected financial
institutions. It is also to receive quarterly reports from financial
institutions on loan concentrations, securities, and deposits. In
addition, the Bank of Canada is to get information and intelligence
from market sources, such as money market and foreign exchange data,
and it has contacts with investment banks and other financial
institutions that provide information on financial market
developments.
According to Bank of Canada officials, all the information collected
in the data reporting system is processed by the Bank of Canada,
which downloads the data to databases maintained by both OSFI and
CDIC.
MEETINGS WITH FINANCIAL
INSTITUTIONS ALSO PRODUCE
INFORMATION
-------------------------------------------------------- Chapter 3:1.4
The financial information reported by financial institutions is
essential to an ongoing understanding of an institution's activities
and financial condition. However, an OSFI official said that the
reported information alone is not enough to give OSFI a complete
picture of a financial institution's operations. The reported
information, therefore, is supplemented with informal meetings and
discussions with institutions.
During informal meetings and discussions, OSFI is to sit down with
the senior management of a financial institution and go over the
institution's risk management policy--what the institution defines as
risk and how the institution controls the risk. These meetings
provide key information on what an institution is doing, according to
an OSFI official, and also help OSFI examiners scope their annual
examinations, i.e., focus OSFI's information collecting on the risks
inherent in the institution's activities and on those activities
where an in-depth look is required. For instance, according to OSFI
officials, during an informal meeting with a bank, the bank
management told OSFI that it was planning to undertake more extensive
derivative activities. As a result, OSFI examiners made a point of
looking hard at the bank's treasury department. An OSFI official
said that OSFI has also established good relationships with the chief
inspectors of the institutions' internal audit departments, generally
a good source of information, because the internal audit departments
of large financial institutions generally have extensive audit
programs, such as for assessing internal controls.
The informal meetings with OSFI are to be held as needed rather than
being held on a set schedule. An OSFI official said that OSFI staff
basically have ongoing discussions with institution staff. The
number of meetings varies, but at a minimum OSFI is to meet with the
larger financial institutions quarterly. If a financial institution
is on the watchlist, OSFI is to meet with the institution monthly to
discuss its situation.
In addition to informal meetings, OSFI officials told us they have
formal meetings with financial institutions. OSFI holds a formal
meeting with the financial institution after every examination. It
has separate meetings with the institution's Audit Committee,
management, and external auditors. In addition to meeting with the
Audit Committee, OSFI has a private meeting with the independent
Board members. At these meetings, which are held to discuss OSFI's
examination findings, any concerns that the Board members wish to
raise are to be discussed. In such meetings Audit Committee members
often want to ask OSFI questions that they can not comfortably ask
during the formal meeting with the financial institution.
OSFI officials also said they meet with financial institutions under
the auspices of CBA to discuss emerging issues in the industry. CBA
meetings usually entail discussions on general issues concerning
financial institutions and are not institution- specific.
MARKET
INFORMATION--PARTICULARLY
THAT PROVIDED BY THE LARGEST
BANKS--IS OBTAINED BY OSFI
AND THE BANK OF CANADA
-------------------------------------------------------- Chapter 3:1.5
The Canadian banking system is relatively unique in the concentration
of banking assets in the six largest banks. We were told by both
bank and OSFI officials that these banks play an important role in
the Canadian economy and pay a large portion of the insurance
premiums. The bankers believe they have a special responsibility for
ensuring the stability of the financial system, as well as a
self-interest in that stability, and they take such systemic
responsibilities very seriously. Consequently, the bankers may
relate concerns to OSFI or to the Bank of Canada and may offer
comments on the trends in particular industries, geographical areas,
or products. However, the banks have no express responsibility for
informing regulators about specific problems with individual banks.
Despite the frequent formal and informal meetings financial
institutions have with OSFI, a senior OSFI official told us that OSFI
feels that it does not hear from them as frequently as it would like,
and the Bank of Canada is more likely to obtain earlier market
information than OSFI does. Bank officials told us that the Bank of
Canada meets formally with the six largest banks twice a year. These
discussions generally center around the economy and monetary policy.
The officials said that the CEOs of these banks know they can call
the Governor of the Bank of Canada if they are concerned about
issues, such as past concerns about the overall exposures of banks to
Latin America, or concerns with general market developments. These
banks also have meetings at lower levels with Bank of Canada
officials on such issues as the clearing and settlements system.
Coordinating committees such as FISC are also to provide regulatory
participants with information about problem institutions, industry
conditions, and emerging problems in the industry and economy.
OSFI USES INFORMATION GAINED
FROM EXTERNAL AUDITS
---------------------------------------------------------- Chapter 3:2
Although OSFI has legal responsibility for examining financial
institutions at the federal level, it relies on the institutions'
external auditors for assessments of the fairness of the
institutions' financial statements.
ANNUAL AUDITS ARE REQUIRED
UNDER THE BANK ACT
-------------------------------------------------------- Chapter 3:2.1
The Bank Act requires that all federal deposit-taking financial
institutions receive annual external audits and stipulates that the
auditors report on, among other things, institutions' annual
financial statements. The primary objective of an external audit is
to express an opinion on the financial statements prepared by an
institution's management. In fulfilling this objective, the auditor
is to issue a report that confirms that (1) the audit has been
conducted in accordance with generally accepted auditing standards;
(2) the accounting principles used by the financial institution and
significant estimates made by management have been assessed; (3) the
overall financial statement has been evaluated; and (4) the financial
statement fairly presents the financial condition, results of
operations, and changes in financial condition of the institution
being audited.
External auditors are to look at risks, such as treasury products,
capital markets activities, and the bank's ability to collect on its
loans. External auditors are also to report on any loans greater
than one half of 1 percent of the financial institution's capital
when, according to OSFI, a loss of capital is likely to occur.
According to external auditors with whom we spoke, they generally
rely heavily on the financial institution's internal audit
departments for information, because these institutions, especially
the large ones, have strong internal auditing departments. In many
cases, the work that the internal audit departments have done
dictates the degree to which the external auditors review
transactions. For instance, one external auditing firm that we
talked to said that it does not look at certain loans because it
relies on the internal auditors' review of them.
How an external auditor conducts an external audit is governed by
guidelines issued by the Canadian Institute of Chartered Accountants
(CICA), the accounting industry's national association. Although
these guidelines were developed by the industry, the Bank Act
specifies that financial institutions should operate in accordance
with generally accepted accounting principles (GAAP), and it gives
OSFI the power to modify GAAP through directives. OSFI officials
told us they have made use of their ability to modify GAAP, and thus
narrow CICA guidelines, by issuing their own directives or guidelines
on issues otherwise covered by GAAP. For instance, because GAAP
requirements are fairly broad, OSFI has tended to narrow what is
required under GAAP, forcing CICA standards to have tighter
definitions than exist in GAAP in some areas, such as goodwill.
Generally, CICA and OSFI have a good working relationship, but OSFI's
ability to issue its own directives on GAAP has resulted in some
tension between the two, according to officials of both
organizations.
EXCHANGE OF CORRESPONDENCE
CONFIRMS RESPONSIBILITIES OF
AUDITORS AND OSFI
-------------------------------------------------------- Chapter 3:2.2
OSFI generally does not have a direct client relationship with
external auditors, since auditors are appointed and paid for by the
financial institution being audited. Nevertheless, OSFI relies on
the work being done by the external auditors in undertaking its
supervisory responsibilities. According to OSFI, this means that
OSFI
"is dependent on the auditors applying professional standards to
express an opinion that the financial statements present fairly,
in all material respects, the financial position, results of
operations and changes in financial position of the financial
institutions in accordance with generally accepted accounting
principles, including the reporting requirements of the
Superintendent."
However, OSFI officials acknowledge that an audit of financial
statements does not provide absolute assurance as to the integrity of
the financial statements because of the use of judgment and testing
in audits, the limitations of internal controls, and the nature of
audit evidence.
Before every external audit of a financial institution, OSFI and the
institution's external auditor exchange letters confirming the
"reliance process." First, the financial institution is to send a
letter to OSFI notifying OSFI whom its external auditor will be.
Second, OSFI is to write a letter to each financial institution's
external auditor saying that OSFI is to (1) rely on the audit opinion
regarding the financial statements of the financial institution and
on the auditor's audit report, (2) require a copy of the
institution's audit report, (3) request access to the auditor's
workpapers\27 in order to establish the basis for reliance and to
minimize duplication of effort, and (4) advise the external auditors
of any matters that they should consider prior to the audit's report
date. The auditors are to respond in writing to OSFI giving OSFI
approval to review their workpapers and providing the date when they
will give OSFI a copy of their report on the audited institution.
OSFI's letter is also to remind the audit firm that it is the duty of
the auditor to report simultaneously to the institution's CEO and
OSFI anything that it discovers that might affect the well-being\28
of the financial institution. In addition, external auditors are
required to address in an annual letter to OSFI any issues that
affect the well-being of an institution. Because OSFI and the
external auditors have conversations at various times during the
year--specifically after OSFI's examination and the annual external
audit--to discuss issues that are regulatory in nature, such as the
well-being of a financial institution, the annual letter generally
does not present new information. An OSFI official said that neither
OSFI nor external auditors want surprises about a financial
institution so all the participants keep one another other informed.
External auditing officials we spoke to also described the Canadian
financial system as a system of no surprises in which external
auditors, OSFI, and the financial institutions are all open about
information concerning financial institutions.
There is also an auditors' advisory group, which is to meet three
times a year with OSFI in order to discuss systemic issues rather
than institution-specific issues. Through this type of dialogue, the
external auditors and OSFI seek to ensure their awareness of industry
trends as well as regulatory and operational issues affecting the
industry.
--------------------
\27 Workpapers are the records kept by the auditors of procedures
performed and their results and information obtained and conclusions
reached in performing the audit and preparing the audit report.
\28 Through CICA, and in close consultation with OSFI, external
auditors have defined well-being as the existence or viability of the
banks.
OSFI MAKES EXTENSIVE USE OF
AUDITORS' WORKPAPERS
-------------------------------------------------------- Chapter 3:2.3
OSFI officials described an arrangement it has with the auditing
profession whereby OSFI is given access to auditors' workpapers, even
though it has no express statutory right to such access. OSFI uses
these workpapers to (1) confirm that OSFI can rely on the auditor's
opinion of the fairness of the audited institutions's financial
statements; (2) highlight the areas of mutually defined risk so that
OSFI can use the auditor's work and not duplicate the work; (3)
identify the prudential concerns that auditors identify during their
audit; (4) provide an additional source of information in forming a
risk profile of a financial institution; and (5) learn from the
auditor's observations about the strength or weakness of a financial
institution's internal control systems, management, and audit
department.
According to OSFI guidance, examiners are to meet with the external
auditor before the actual review of the workpapers. The purpose of
meeting is to provide an overview of the audit in order to identify
the main areas of focus in reviewing auditors' workpapers. Possible
discussion items for the meeting include (1) general questions about
the audit process, the auditors' opinion of senior management and the
board of directors and their effectiveness, and the control culture
of the financial institution; (2) specific questions about the audit
plan and audit approach; (3) specific questions about the control
environment, management effectiveness, audit committees, business
conduct review committees, and the internal control systems; (4) the
relative conservatism of management and the auditors' views on the
risk profile of the institution; (5) significant audit findings; and
(6) specific transactions.
After OSFI examiners have completed a review of the auditor's
workpapers, using CAMEL\29 components they are to summarize the
important aspects they think should be followed up on in OSFI's
annual examination or that otherwise affect the scope of their
examination. This summary allows the examiners to use the auditors'
work to help develop the scope of their examination under each CAMEL
component. According to OSFI, there should be three sections under
each CAMEL component: (1) a summary of the external audit scope and
procedures, (2) a summary of the audit findings, and (3) a summary of
the implications for the examination scope.
--------------------
\29 CAMEL refers to the rating system used by supervisory agencies to
assess the financial condition of financial institutions. CAMEL
stands for Capital Adequacy, Asset Quality, Management Quality,
Earnings, and Liquidity.
OSFI CAN EXPAND AN EXTERNAL
AUDIT
-------------------------------------------------------- Chapter 3:2.4
OSFI has the authority to expand the scope of an external audit at
any time at the cost of the institution being audited. For example,
OSFI may ask the auditor to take a more detailed look at a financial
institution's loan portfolio or internal controls. The financial
institution is informed of an OSFI request for an expanded audit
since the institution must bear the additional cost. A senior OSFI
official said that although OSFI has requested expanded audits in the
past, it prefers to obtain information from other sources because of
its concerns about the independence of the relationship of the
external auditor to the financial institution.
According to OSFI officials with whom we spoke, OSFI may also expand
its own examinations by using an expert or independent external
auditor to get more in-depth information. According to OSFI
officials with whom we spoke, OSFI has used such expanded
examinations when it (1) believed the financial institution had a
problem, (2) did not have the expertise to examine a specific
operation of the institution, or (3) wanted to conduct an
across-the-system study of a specific aspect of banking. OSFI
believes that the across-the-system studies are particularly useful
because they provide an incentive for financial institutions that are
evaluated and ranked below their peers in the area examined to
improve their standing. OSFI is doing an across-the-system study on
corporate governance of consolidated institutions during its 1995
annual examinations. In addition, OSFI intends to do a major study
of treasury departments in all banks in 1996, again during its annual
examinations. OSFI is currently developing a pool of experts on
derivatives to include, for example, individuals from external audit
firms, who may then be available to direct special derivatives
audits. These individuals are to be hired as consultants to OSFI and
paid by OSFI. OSFI is then to be reimbursed for its outlays through
annual assessments to the industry, since OSFI is completely
industry-funded.
OSFI HAS SOME CONCERNS ABOUT
AUDITORS' WORK
-------------------------------------------------------- Chapter 3:2.5
External auditors, who are appointed by a financial institution's
shareholders every year, must meet certain legislative
qualifications. For example, a firm of accountants is qualified to
be an auditor of a bank if two or more members are accountants in
good standing with CICA, have 5 years of experience at a senior level
performing audits, reside in Canada, and are independent of the bank.
The requirement for auditing experience has resulted in the auditors
for most big financial institutions belonging to one of the big six
auditing firms, although one or two regional firms also audit
financial institutions.\30
When a financial institution changes its external auditor, the former
auditor is required to submit a written statement to OSFI and to the
new auditing firm explaining the circumstances and reasons for the
change. OSFI officials told us that OSFI has the right to disapprove
of an auditor but has never done so. In addition, the Minister of
Finance can revoke the appointment of a financial institution's
external auditor, but this also has never happened, according to
officials with whom we spoke.
According to a senior OSFI official, the degree of reliance OSFI
places on auditors' work is well-founded in 90 percent of the cases.
Generally, OSFI does not have trouble with the firms as a whole, but
with individuals working at the firms. Nevertheless, OSFI officials
believe that at times some auditors may not be as diligent in their
work, or perhaps not be as independent of their clients, as OSFI
would like them to be.
If OSFI is not satisfied with the work of an external auditor, OSFI
is to inform the auditor, and officials from the two will discuss the
problem. In addition, there is an industry auditor advisory
committee, which is a part of CICA, that meets three times a year.
If OSFI has a problem with external auditors, OSFI can raise the
relevant issue with the advisory committee at these meetings. If
OSFI thinks that an auditing firm is not doing something it should be
doing, OSFI can use its influence with the accounting industry to
point the firm in the right direction. According to officials with
whom we spoke, external auditors like to prevent problems and be as
cooperative with OSFI as possible, since OSFI comments on its
reliance on an external audit and can reject external auditors'
appointments.
--------------------
\30 Until the 1992 revision, the Bank Act required that institutions
be audited by two accounting firms. Although this requirement is no
longer in place, all of the largest banks have retained two
accounting firms to conduct their annual audits, at least one of
which is a "big six" firm.
EXTERNAL AUDITORS SUBJECT TO
UNLIMITED LIABILITY
-------------------------------------------------------- Chapter 3:2.6
The work of external auditors in Canada is subject to unlimited
liability. Auditors of failed financial institutions are
particularly vulnerable to lawsuits initiated by CDIC, given its
explicit policy of vigorously pursuing lawsuits against parties
culpable in a financial institution's failure when CDIC believes it
can recover losses incurred as a result of the failure. CDIC
officials told us that CDIC filed several suits against external
auditors in 1994, with two of those subsequently settled out of
court.
CDIC initially wanted external auditors to attest to management's
self-assessment of a financial institution's compliance with CDIC
standards. CDIC accepted the members' argument that this would be
too costly, since members would have to expand auditors' engagements
to audit the self-assessments. Therefore, according to officials,
external auditors will not be required to attest to compliance with
the standards.
OSFI DOES ON-SITE EXAMINATIONS
OF FINANCIAL INSTITUTIONS
---------------------------------------------------------- Chapter 3:3
The Bank Act requires OSFI to examine federal deposit-taking
financial institutions once a year. This responsibility was being
carried out by OSFI's 71 full-time examiners as of June 1993, who
must plan, conduct, and report the results of the examinations.
EXAMINATION OBJECTIVES AND
PLANNING
-------------------------------------------------------- Chapter 3:3.1
The purpose of an examination is to ensure that the financial
institutions observe the provisions of the Bank Act as implemented
and to determine whether the institutions are in sound financial
condition. To achieve this purpose, OSFI has established the
following objectives, which are included in its examination
guidelines: (1) to develop a thorough understanding of the financial
institution and its environment, (2) to detect solvency and
compliance problems on a timely basis, (3) to obtain information on a
systemwide basis, (4) to gather information on policy matters, and
(5) to help resolve detected problems promptly. More generally, OSFI
examinations also allow it to analyze trends and to make
recommendations on changes in legislation or regulations.
During the examination planning process, OSFI examiners are to review
the work of the external auditors to identify issues that should be
addressed in the on-site examination, to minimize duplication, and to
scope the examination. This review is to include a discussion with
the external auditors and a review of their workpapers. By the time
OSFI examiners review an auditor's work, the workpapers may be dated,
and OSFI guidelines advise examiners to take this into account.
EXAMINATION
-------------------------------------------------------- Chapter 3:3.2
OSFI is to conduct annual full-scope,\31 on-site examinations that,
according to the Superintendent of OSFI, "represent a de facto
assessment of management and its ability to manage." The scope of
OSFI's examinations is to include the financial institution's
activities and exposures to risk, the solvency of an institution, and
a financial institution's compliance with legislation, regulations,
and guidelines.
During its examination OSFI has the right to look at all records,
cash, assets, and securities held by the financial institution and to
obtain information from the institution's officers and auditors on
its condition and affairs. OSFI has historically focused its
examinations mainly on the financial institution's loan portfolio.
OSFI employs outside consultants to carry out the review of credit
files at all examinations. Loan review consultants are primarily
retired senior credit officers from the largest Canadian banks.
According to OSFI officials, this expertise has allowed OSFI to have
the respect of the institutions it supervises, with the result that
the credit consultants' findings and recommendations for provisions
are generally accepted without confrontation. Under the direction of
examiners, these experts are to look at (1) a sample of loans that is
large enough to ensure the integrity of the loan rating system and
the quality of the loans and (2) at all nonperforming loans. They
may also do an independent classification of loans for OSFI if the
financial institution's loan classification system is found
inadequate. Examiners are to check a financial institution's
prudential ratios, such as its capital-to-assets ratio.
In addition to examining a financial institution's loan portfolio and
ratios, OSFI is to look at (1) control processes, (2) the
independence and work programs of the institution's internal audit
function, and (3) treasury activities. In examining control
processes, OSFI is to assess policies the institution has put into
place and evaluate general risk management. OSFI's assessment of the
internal audit function is to include a review of the audit plan, the
quality of staff at the senior level, the independence of the staff,
and identify to whom they report. OSFI relies to a great extent on
the internal audit function of the financial institution to provide
examiners with information in such areas as subsidiaries and the
treasury department. According to OSFI and financial institution
officials, OSFI's meetings with a financial institution's personnel
during an examination are far-reaching and cover most aspects of each
area of operation. In addition, OSFI obtains information from
answers to written questions it provides a financial institution
before the examination.
During the examination process, OSFI also receives information from
the financial institution on large exposures. Because the exposures
identify the borrowers, financial institutions do not submit this
information in a report, which means that the Bank of Canada and CDIC
do not have access to this information through OSFI Section 29 or
other reports.
Annual examinations of the largest banks take about 2 to 3 months and
amount to one staff year each. The examination timetable for other
examinations is risk-based, and therefore the timetable is widely
divergent depending upon the perception of risk at the institution.
OSFI officials said they have done examinations of subsidiaries when
these subsidiaries are federally regulated deposit-taking
institutions, such as loan and trust companies. When a subsidiary is
provincially regulated, such as a securities subsidiary, OSFI is to
rely upon the provincial regulator but is to review the risk
management practices that exist at the parent level to monitor the
operations of the securities subsidiary.
--------------------
\31 Full-scope examinations include examining the asset quality of
financial institutions, assessing their systems and controls, judging
their capital adequacy and reserves, and assessing their compliance
with laws and regulations.
REPORTING AND FOLLOW-UP
-------------------------------------------------------- Chapter 3:3.3
Once OSFI has finished examining a financial institution, OSFI
officials are to meet with the institution's CEO, management, Audit
Committee, and external auditors to discuss the examination's
findings. OSFI then is to write a management letter--which in effect
is its final examination report--to the financial institution's CEO
and the Chairman of the Audit Committee. The financial institution's
external auditor also receives a copy of this letter.
OSFI's management letter is to outline the scope of OSFI's
examination and includes findings and recommendations that comments
on the financial institution's CAMEL components; discussions of asset
provisions and the financial institution's internal audit function;
assessments of the credit quality, corporate governance, operations,
and treasury activity; and comments on any findings or issues OSFI
wants to bring to management's attention. OSFI must also comment on
the financial institution's adherence to CDIC's standards of sound
business and financial practices. The length of the management
letter varies from 2 to 10 pages depending on what OSFI has to say.
According to OSFI officials, there are no surprises to senior
management of the financial institution because wrap-up meetings are
held before the examination is completed. The examination letter or
report is provided to the institution prior to meetings with the
institution's Board of Directors and Audit Committee.
According to regulatory and bank officials, bank management takes
OSFI's recommendations seriously. After the financial institution
receives the letter, the institution's management is to send a letter
back to OSFI articulating the agreements reached during the
institution's meeting with OSFI, including the actions the financial
institution is to take. OSFI is then responsible for following up on
its recommendations. For example, the implementation of an agreement
on the allowances for loan losses will be readily apparent in the
financial institution's year-end financial statements; a follow-up on
recommendations of an institution's internal controls can
realistically be assessed only during the next examination.
CDIC AND FISC MEMBERS MAY
REQUEST EXAMINATIONS
---------------------------------------------------------- Chapter 3:4
Although CDIC generally relies on OSFI for information, CDIC
occasionally feels it necessary to obtain first-hand information from
financial institutions. In such cases, CDIC has the authority to
have examinations performed. Other members of FISC may also request
special examinations, but they have never done so.
CDIC MAY HAVE SPECIAL
EXAMINATIONS OF ITS MEMBERS
-------------------------------------------------------- Chapter 3:4.1
If CDIC's Board of Directors so determines, CDIC may have a special
examination done on a member institution. Reasons for a special
examination may include, among other things, concern that the
institution poses a high risk of failure. According to CDIC
officials, some of these examinations are expensive but they provide
CDIC with information to assess failure resolution options.
The special examinations are to involve a review of the assets and
liabilities of the financial institution--assessing the performing
assets, loan loss provisions, spread analyses, financial projections,
and cash flow forecasts. The examinations also involve the
off-balance-sheet activities as well as the institution's system
technology, internal controls, and corporate governance. CDIC
undertook special examinations of three institutions in fiscal years
1993 and 1994, by hiring either its own consultants or using OSFI
examiners. According to officials with whom we spoke, all three
institutions subsequently failed.
SPECIAL EXAMINATIONS CAN
ALSO BE REQUESTED BY MEMBERS
OF FISC
-------------------------------------------------------- Chapter 3:4.2
All members of FISC have the authority to require a special
examination of any bank or federally chartered trust. Since OSFI and
CDIC already have the authority to conduct examinations, this
provision applies principally to the Minister of Finance and the Bank
of Canada, although their officials said neither has ever used the
authority.
OSFI, CDIC, THE MINISTER OF
FINANCE, AND THE BANK OF CANADA
PARTICIPATE IN OTHER FINANCIAL
SYSTEM RESPONSIBILITIES
============================================================ Chapter 4
OSFI, CDIC, the Minister of Finance, and the Bank of Canada have
other financial system responsibilities, such as providing liquidity,
resolving crisis situations, and participating in international
forums. The Bank of Canada and CDIC, to a limited extent, share
lender of last resort responsibilities.
LIQUIDITY PROVIDER
---------------------------------------------------------- Chapter 4:1
The Bank of Canada is to provide short-term liquidity or temporary
advances to financial institutions that have shortfalls in their
reserve balances due to such events as unexpected payment flows
associated with the daily clearing and settlements system. The Bank
of Canada Act allows the Bank of Canada to lend to all banks or to
any other member of CPA that has a deposit with it. Generally, the
Bank of Canada lends to direct clearers.\32 If there is a liquidity
problem, the Bank of Canada is to lend to a direct clearer or to an
indirect clearer through its direct clearer. Thus, financial
institutions other than banks, such as trust and loan companies, have
access to the Bank of Canada's discount window, whereby they can
receive funds to help with liquidity needs. The Bank of Canada is to
provide liquidity to financial institutions only on a secured basis.
--------------------
\32 Direct clearers are banks and nonbank deposit institutions that
settle their mutual obligations arising from the clearing and
settlement of payment items on the Bank of Canada's books. Indirect
clearers settle through direct clearers.
CRISIS MANAGEMENT AND
RESOLUTION OF FAILED FINANCIAL
INSTITUTIONS
---------------------------------------------------------- Chapter 4:2
Depending on the nature of the situation, each regulatory participant
in financial regulation and supervision plays a role in crisis
management. According to regulatory and bank officials, cooperation
among the participants in the Canadian bank regulatory structure has
historically been heightened in a crisis.
OSFI has primary authority for supervising financial institutions and
is usually in charge of a crisis until a financial institution fails.
At that point, CDIC usually takes over responsibility for resolving
the failed financial institution. The Minister of Finance is also
aware of potential crises situations because OSFI informs the
Secretary of State (International Financial Institutions) about
problem institutions, and because of the Deputy Minister of Finance's
role in FISC.
The Bank of Canada is also to be involved in a crisis from a systemic
risk standpoint. If a financial institution failure has systemic
implications, the Governor of the Bank of Canada may work behind the
scenes to quietly arrange a merger with the help of other regulators
or, as has been the case in some previous failures, arrange for
liquidity support from the six big banks in Canada. According to
regulatory and bank officials, the prestige carried by the Governor
of the Bank of Canada often lends credence to his views and support
for his proposals.
For example, when the Canadian Commercial Bank (CCB) was suffering
severe liquidity problems in 1985, the forum for finding a solution
was through the Bank of Canada.\33 The Bank of Canada played the
major role in getting all of the parties together and hammering out a
support package with the official approval of the government whereby
the six largest banks were asked to provide CCB with funding to serve
its liquidity needs. When CCB's liquidity problem became a solvency
problem, the government protected all of the bank's depositors and
creditors except for the six largest banks, since their liquidity
support was considered to be CCB bank capital rather than a provision
of credit.
There is still an ongoing lawsuit regarding the issue of repayment to
the six largest banks for their support of CCB. Some regulatory and
bank officials we spoke with felt that because the six largest banks
were not paid back after the CCB failure, given a similar situation,
they would not be as likely to participate in resolving another
crisis. Other banking officials with whom we spoke disagreed with
this assessment, stating that since the six banks have such a large
stake in the stability of the Canadian banking system, they would
find it in their best interests to participate.
--------------------
\33 Even though CCB represented only 0.6 percent of the assets held
by all banks in Canada, it was feared by the Canadian government that
the bank's failure would hurt the economy of western Canada.
INTERNATIONAL FORUMS
---------------------------------------------------------- Chapter 4:3
OSFI and the Bank of Canada both represent Canada on the Basle
Committee on Bank Supervision.\34 OSFI is to take a lead role in such
issues as capital requirements and most other supervisory issues.
The Bank of Canada is to take the lead in risk containment and other
systemic issues, such as market risk of foreign exchange activities.
The Bank of Canada is also to advise the federal government on
international financial matters and frequently represents Canada at
international meetings. For example, it participates in meetings of
the finance ministers and governors of the Group of Seven
Countries,\35 the Organization for Economic Cooperation and
Development (OECD), the Bank for International Settlements (BIS), and
the International Monetary Fund (IMF).
--------------------
\34 The Basle Committee on Bank Supervision was created in 1974 under
the auspices of the governors of the G-10 central banks and is the
main forum for central bankers and supervisors to reach agreement on
how best to supervise international banks. Its members meet several
times a year and consist of senior representatives of bank
supervisory authorities and central banks from 12 countries.
\35 Group of Seven Countries is a group of major industrial countries
where national leaders or their representatives meet occasionally.
The seven countries include the United States, United Kingdom,
Germany, Japan, Canada, France, and Italy.
LENDER OF LAST RESORT
---------------------------------------------------------- Chapter 4:4
The Bank of Canada has an important role in maintaining system
stability. This includes acting as lender of last resort to ensure
that a liquidity problem at a financial institution does not threaten
the viability of the financial system.
As lender of last resort, the Bank of Canada is prepared to make what
its officials call extraordinary advances to any institution
experiencing liquidity problems because it cannot meet deposit
withdrawals. The officials said that when acting as lender of last
resort, the Bank of Canada insists that institutions be solvent and
that lending be well-collateralized in order to protect the public
funds that are at risk. It monitors the value of an institution's
collateral or portfolio by relying on OSFI's assessments and has
never lost money on its secured lending.
CDIC can protect insured deposits by serving as a lender of last
resort. It can do this by making secured loans and unsecured
advances to member institutions and by purchasing assets from them.
Under the Investment Companies Act and the Co-operative Credit
Associations Act, CDIC can also act as an agent through which the
government of Canada can make short-term loans for liquidity purposes
to Canadian-controlled sales finance companies, cooperative credit
societies, and provincial organizations responsible for stabilization
and liquidity funding for credit unions.
Officials said that before CDIC lends they make an assessment about
whether the institution is likely to become insolvent. Some CDIC
loans have lost money; however, the advances were made as part of a
least-cost alternative, and in CDIC's opinion losses would have been
greater under other alternatives.
CANADIAN PAYMENTS SYSTEM IS
PRIVATELY RUN BUT HEADED BY A
BANK OF CANADA REPRESENTATIVE
---------------------------------------------------------- Chapter 4:5
The Canadian Payments Association (CPA) was created by an act of
Parliament in 1980 to "establish and operate a national clearings and
settlements system and to plan the evolution of the national payments
system." The management and operation of CPA are the responsibility
of a Board of Directors, the members of which are elected by CPA's
member institutions. The sole exception is the Chairman of the Board
of Directors, who is appointed by the Bank of Canada and is an
employee of that institution. This gives the Bank of Canada
significant influence over the management and operation of CPA.
The creation of CPA made the payments system available to all
deposit-taking financial institutions. In the system run by CBA,
before CPA was created, only banks had such access. However, CPA
members are required to have accounts with the Bank of Canada to
qualify as direct clearers, and this entails meeting certain criteria
specified by the Bank of Canada. Currently, there are four nonbank
deposit institutions that meet the criterion to maintain settlement
accounts at the Bank of Canada--one trust company, two cooperative
institutions, and one financial institution owned by the Alberta
Provincial Government.
The Canadian payments system does not provide for finality of payment
in the settlement of transactions. Thus, if a direct clearer were to
fail before all payments had been settled, the system would have to
be unwound: that is, all transactions completed that day involving
the failing direct clearer would have to be reversed and other
transactions not yet completed would not be processed. CPA is now
working toward a Large Value Transfer System in which payments are to
be irreversible and final settlement is to be made at the central
bank. The objective is to contain systemic risk and provide same-day
final settlement to CPA member institutions. The potential losses to
the system are to be shared among participants.
The Bank of Canada interacts with the payments system in two ways:
(1) it is responsible for the final settlement of balances for the
national clearing and settlement system, and (2) it acts as the agent
of the federal government by clearing government receipts and
disbursements. Furthermore, both bank and nonbank institutions that
participate directly in the clearing and settlement process are to
maintain settlement accounts at the Bank of Canada through which
daily clearing gains and losses are to be settled. Each direct
clearer has access to overdraft facilities at the Bank of Canada.
Apart from a provision of the CPA Act that requires the
Superintendent of Financial Institutions to report annually to the
Minister of Finance as to whether CPA is operating in conformity with
its act and by-laws, there is no statutory regulation or supervision
of the Canadian payments system. However, as noted in chapter 2, if
proposals in the White Paper are passed into legislation, the Bank of
Canada will have regulatory responsibility for systemic risk in the
clearing and settlements system, which, according to Bank of Canada
officials, the Bank of Canada has already informally assumed.
DEPOSIT INSURANCE IS PROVIDED
BY CDIC
---------------------------------------------------------- Chapter 4:6
Under the CDIC Act, CDIC provides deposit insurance against the loss
of part or all of deposits up to $60,000 (Canadian). All financial
institutions, other than credit unions and certain provincial
institutions, must become members of CDIC to qualify for its deposit
insurance. Members of CDIC's Board of Directors include the
Superintendent of Financial Institutions, the Deputy Minister of
Finance, and the Governor of the Bank of Canada.
CDIC provides for its coverage through a premium levied on the
insured deposits of its members. In 1994, the premium was 1/6 of 1
percent and was the same for all institutions regardless of size or
riskiness.
The major cost to the deposit insurance fund is the cost of
depositors' claims from previous CDIC member failures. As a result
of cumulative deposit claims paid from previous insured institutions'
failures and related loss provisions, CDIC had a deficit of $1.65
billion (Canadian) as of March 31, 1994. The deficit is the
difference between the amount that CDIC has had to pay depositors,
along with the cost of the financial assistance provided to the
failed institutions, and the amount that CDIC expects to recover when
the assets of the failed institution are liquidated.
STANDARDS OF SOUND BUSINESS AND
FINANCIAL PRACTICES
=========================================================== Appendix I
The CDIC Act provides for CDIC to be instrumental in the promotion of
standards of sound business and financial practices for member
institutions. In that capacity, CDIC has established by-laws called
the Standards By-laws of Sound Business and Financial Practices
(Standards By-law). The eight Standards By-laws are:
CDIC Interest Rate Risk Management Standards By-Law
CDIC Credit Risk Management Standards By-Law
CDIC Foreign Exchange Risk Management Standards By-Law
CDIC Securities Portfolio Management Standards By-Law
CDIC Liquidity Management Standards By-Law
CDIC Real Estate Appraisals Standards By-Law
CDIC Capital Management Standards By-Law
CDIC Internal Control Standards By-Law
For each Standards By-law there is a standards document that assists
member institutions in developing the policies, techniques, and
procedures required by CDIC to fulfill the standard. The CDIC Board
of Directors is to measure compliance with the standards document as
the basis for determining whether a member institution is following
standards of sound business and financial practices established under
the Standards By-laws. Compliance with CDIC's standards is measured
through a self-assessment process that OSFI reviews during its annual
examinations. The standards documents cover:
Standards of Sound Business and Financial Practices: Interest Rate
Risk Management. The standard sets out the minimum policies and
procedures for members' interest rate risk management programs. The
standard covers interest rate risk limits, how the interest rate risk
will be measured, the minimum criteria that the institution should
have in place to manage and control its exposure to interest rate
risk, and the role of the Board of Directors and management in this
area.
Standards of Sound Business and Financial Practices: Credit Risk
Management. The standard sets out the minimum policies and
procedures for members' credit risk management programs. The
standard covers the credit risk identification and risk management
policies needed in such areas as portfolio concentration limits,
credit granting, and documentation and collection processes; internal
credit inspection/audit procedures; and the roles of the Board of
Directors and management in this area.
Standards of Sound Business and Financial Practices: Foreign
Exchange Risk Management. The standard sets out the minimum policies
and procedures for members' foreign exchange risk management
programs. The standard covers foreign exchange risk management
policies in such areas as risk limits, control procedures, and
delegation of authority; foreign exchange risk management and control
procedures on the measurement and inspection/audit of foreign
exchange risk; and the roles of the Board of Directors and management
in this area.
Standards of Sound Business and Financial Practices: Securities
Portfolio Management. The standard sets out the minimum policies,
procedures, and criteria that member institutions need to have in
place and apply in order to manage their securities portfolios and
exposures to position risks. The policies under this standard cover
such areas as securities portfolio quality and return objectives,
selection of securities dealers and counterparties, securities
portfolio concentration limits as well as monitoring procedures, and
the roles of the Board of Directors and management in this area.
Standards of Sound Business and Financial Practices: Liquidity
Management. The standard sets out the minimum policies, procedures,
and criteria that member institutions need to have in place and apply
in order to manage their liquidity management programs. The standard
covers the liquidity and funding polices, management and control
procedures, and the roles of the Board of Directors and management in
this area.
Standards of Sound Business and Financial Practices: Real Estate
Appraisals. The standard sets out the minimum policies, procedures,
and criteria that member institutions need to have in place and apply
to ensure that real estate appraisals conducted in real
estate-related financial transaction are prudent and appropriate.
The standard covers the requirements for appraisals, engagement of
appraisals, contents of appraisal reports, the appropriate kinds of
appraisal valuation approaches, and the roles of the Board of
Directors and management in this area.
Standards of Sound Business and Financial Practices: Capital
Management. The standard sets out the minimum policies, procedures,
and criteria that member institutions need to have in place and apply
to ensure that they have adequate capital plans to manage their
capital. The areas that members have to cover under this standard
include capital management polices and procedures and the roles of
the Board of Directors and management.
Standards of Sound Business and Financial Practices: Internal
Control. The standard sets out the internal controls that member
institutions need to have in place and the control environment within
which the controls will be applied. The standard covers such areas
as the internal control environment, the responsibility of the Board
of Directors and management, organizational and procedural controls,
independent inspection/audit, and the role of the Board of Directors
and management in this area.
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II
GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C.
-------------------------------------------------------- Appendix II:1
Tamara E. Cross, Evaluator
Phoebe A. Jones, Secretary
EUROPEAN OFFICE
-------------------------------------------------------- Appendix II:2
Maja C. Wessels, Evaluator-in-Charge
OFFICE OF GENERAL COUNSEL,
WASHINGTON, D.C.
-------------------------------------------------------- Appendix II:3
Paul G. Thompson, Attorney