Title:
1 A Characterization of the Canadian Financial
System
- Lecturer
- Professor Gilles Bernier, Ph.D
- Industrial-Alliance Insurance Chairholder
- Department of Finance and Insurance, Laval
University - Participants
- Undergraduate students from
- Bellarmine U. and Western-Illinois U.
Quebec City, May 29, 2003
2My Biography
- Professor of finance and insurance at Laval since
1978 - Holder of the Industrial-Alliance Insurance Chair
since 1999 - Education
- Post-doctoral studies in risk and insurance at
the Wharton School, U of Pennsylvania, 1987-88 - Ph.D in finance, U of Toronto, 1984
- MBA-Finance, Laval University, 1978
- BBA, Laval University, 1976.
- Other responsibilities
- Ph.D program director in 1991-92
- Associate dean, Academic Affairs, 1992-96 (AACSB)
- Host of different U.S. schools Lynchburg College
(Va) UNH
3Part 1 Introductory Concepts
- Content
- Definition and Purposes of a FS
- Do FIs Add Value? An Example
- Governance of FIs Comparing Models
- Forces of Change Impacting FIs
- Why Regulate FIs?
41. Definition and Purposes of a Financial
System
- A combination of institutional structures and
regulatory framework that facilitates the
following - Inter-temporal transfer of cash
- Inter-temporal transfer of risk
- Two basic/fundamental economic functions
- Facilitated by markets institutions
- Creates innovative financial instruments
5Financial System A Schematic View
6Financial vs. Market Intermediaries
- Financial Intermediaries
- Commercial banks other Near-banks
- Insurance firms (LH PC)
- Mutual funds
- Market Mediaries
- Investment banks
- Financial markets (TSX, NYSE, etc)
7Financial Intermediation
- Asset transformation / Portfolio Intermediation
- Raising funds by issuing financial liabilities
- Secondary securities
- Financial claims on financial assets
- Bank deposits, Insurance policies and annuities,
MF shares/units - Investing in financial assets
- Primary securities
- Financial claims on real assets
- Bank loans, Corporate bonds equity
82. Do FIs Add Value? The Case of LH
Insurers
- LH Insurers create value by providing 3
principal services - 1. Risk-pooling and risk-bearing
- Risk reduction through a pooling mechanism
- Actuarial and underwriting activities are a major
source of value added - Risks are also borne by shareholders (stock co.)
or by previous policyholders (mutual co.) or by
other parties holding the debt of the insurer
(for both types of firms) - This creates value added by increasing economic
security - 2. Real financial services relating to insured
losses - Financial planning and counseling for individuals
and administration of pension and benefit plans
for businesses - 3. Intermediation function
- Funds raised are invested until withdrawn or
needed to pay claims - The net interest margin (difference between rate
earned on assets and rate credited on products)
is the value added here
93. Governance of FIs
Comparing Models
- Anglo-American Framework
- Shareholder wealth maximization
- Separation between banking insurance
- Separation between commercial and investment
banking - Separation between the financial the real
sector - Euro-Japan Framework
- Stakeholder wealth maximization
- Japan Kieretsu network focuses on increasing
market share - Bancassurance
- Universal banking
- Cross-ownership between commercial financial
firms
104. Forces of Change Impacting FIs
- Disintermediation
- Convergence
- Integration
- Consolidation
- Technological revolution
- Financial innovation
- Customer sophistication
- Globalization
11Product Convergence
- Very significant within Canadas FS sector,
resulting in large financial groups - Banks in insurance, funds management
- LH Insurers in banking, funds management.
- Wide array of products being offered by those
groups both directly and through subsidiaries. - Emerging monoline companies focusing on one or
a few business lines.
12Convergence and Integration Strategies
- Distribution alliances
- Agreements w/r to production distribution
- Joint ventures
- Joint production distribution
- Mergers acquisitions
- Integration both within and between industries
- Greenfield / De novo entry
- Entry into a new industry
135. Why Regulate FIs?
- Safety Soundness
- Supervision examination of solvency
- Transparency disclosure
- Market power, concentration competition
- Level playing field
- Fair pricing
- Contagion effects
- Conflict of interest Tied-selling
- Consumer protection
14Part 2 An Overview of Canadas Economy
- Content
- 1. A Few General
- Statistics
- 2. The Relative
- Importance of the
- Financial Services
- Sector in the
- Economy
151. A Few General Statistics
- As of 2001 (Swiss Re, Sigma No. 6 / 2002)
- Population of Canada 31 million
- GDP 705 billion USD
- Smaller Economy Among G7 Countries With Currently
Best Real Growth - Inflation Rate 2,5 (vs 2,8 for the US)
- Exchange Rate 1,376 per USD ( 5/22/2003)
162. The Relative Importance of the Financial
Services Sector in the Economy
- As of 2001
- Significant contributor to Canadas economic
growth - Number of employees Over 500 000 people
- Yearly Payroll About 24 Billion CDN
- Sector represented over 5 of GDP.
- Sector contributed approximately 9 billion CDN
in taxes to all levels of government.
17Part 3 Tracking the Evolution of Canadas
Financial System
- Content
- 1. Canadas FS
- Before 1990
- 2. Canadas FS
- After 1990
- 3. Assessment of
- Canadas FS
- 4. Analysis of the Difference
- in Solvency Experience of U.S
- and Canadian LH Insurers
181. Canadas FS Before 1990
- Four pillars
- Banks, trust companies, investment firms,
insurance firms - Two bank failures in mid-eighties
- Deregulation in mid-eighties
- Banks take over securities firms (1987)
- Banks take over trusts companies (1990)
- Banks gain limited entry into insurance, and
vice-versa (1992) - Strong growth of the mutual funds industry during
the 90s
192. Canadas FS After 1990
- 3 LH failures in early 90s
- Major demutualization wave (n 5) in the LH
sector (1999-2000) - Two recent mergers in the LH sector
- Sun Life Clarica in 2002
- Great-West Canada Life in 2003
- Two large pillars
- Domestic Chartered Banks and L H Insurers
- Other smaller players
- Property Casualty Insurers
- Credit Unions and Caisses Populaires, Savings
Loans Companies - Foreign Banks
203. Assessment of Canadas FS
- In 2000, the IMF undertook The Financial Sector
Stability Assessment and concluded that
Canadas FS is - stable and highly advanced
- and,
- among the soundest in the world.
214. Analysis of the Difference in Solvency
Experience of U.S and Canadian LH Insurers
- Kleffner Jorgensen (1997) did compare this
sector in both countries over the period 1976-91. - They conclude that both industries are
- Similar in many ways
- Shifting from protection-type to
accumulation-type product - Intensely regulated and very competitive.
- On critical area where Canada did perform better
over this period Insolvency (2 vs 12) - Main reason given federal regulation of
insurers in Canada is more consistent than
regulation of insurers on a state by state basis
in the U.S.. Canadian regulation also appears to
have been more timely and proactive than in the
U.S., particularly with respect to risk based
capital standards
22Part 4 A Quick Glance at Canadas Banking Sector
- Content
- Number of banks
- The Six Largest Domestic Banks
- Banking Concentration and Profitability
- Canadian Banks Abroad
- Delivery Mechanisms Used by Canadian Banks
- Is Size Important for Canadian Banks?
- Should Banks Be Allowed to Merge?
231. Number of Banks (OFSI)
- Banks (69)
- Domestic Banks (16)
- Foreign Banks (32)
- Foreign Bank Branches- Full Service (17)
- Foreign Bank Branches-Lending (4)
242. The Six Largest Domestic Banks (by asset size
in decreasing order)
- Royal Bank of Canada
- Canadian Imperial Bank of Commerce
- Bank of Nova Scotia
- Bank of Montreal
- National Bank of Canada
- Laurentian Bank of Canada
- Note No Canadian banks appear among the Top
25 Worlwide - (Source The Banker, July 2002)
253. Banking Concentration and Profitability
- Banks account for over 70 per cent of the total
assets of the Canadian Financial Services Sector. - The six largest domestic banks account for over
90 per cent of the assets of the
banking industry. - Typically, the largest banks target ROEs of
about 17. Realized ROEs have been lower in 2001
and 2002 (range of 14-16)
264. Canadian Banks Abroad
- The six major domestic banks also have a
significant presence outside Canada, in areas
such as the United States, Latin America, the
Caribbean and Asia. - International operations accounted for
approximately 33 of their gross revenues
in 2001. - BMO, Scotia CIBC were (in 2000) among the Top
30 worldwide w/r to the relative importance of
their international activities (The Banker, 2001)
275. Delivery Mechanisms Used by Canadian Banks
- Banks with significant branch networks rely on
the Bricks and Clicks strategy - Increasing use of technology to handle low-margin
acounts - Focus on advisory services and sale of
high-value products. - Use of branches and e-networks to sell products
of 3rd-party producers (best price/service) - Use of excess capacity in distribution channels
- Realized savings from not developing and market
own products (e.g., mutual funds, term
deposits).
285. Delivery Mechanisms (cont)
- Banks are also developing Web sites to facilitate
access by their customers to a wide variety of
products and services. For example - Web auction facilities for small-business
financing - B2B Web sites to facilitate purchase of supplies
- Credit scoring techniques more widespread which
make standard loans less costly.
296. Is Size Important for Canadian Banks?
- Recent banking literature seems to suggest that
SE in a number of business lines extend further
than previous empirical work had indicated. - The prevalent view here is that even the largest
Canadian banks need to be North Amerian entities
in order to operate at an efficient scale in
certain lines of business (See Freedman Goodlet
pp.12-13 for examples)
307. Should Banks Be Allowed to Merge?
- Major deals were announced back in 1998
- Royal Bank and Bank of Montreal
- CIBC and TD Bank
- As Professor L. Booth of U of T said at the time
- What the government has to decide is whether
allowing the banks to merge will generate gains
in highly competitive markets, like international
and coporate lending and investment banking, that
more than outweigh the losses caused by less
competition in the areas that matter most to
Canadians, namely retail and commercial
lending . - Both deals were rejected by the Federal
Government in 1999. - Recently, Manulife announced a plan to acquire
CIBC. The Federal government has put the question
to a Senate Committee which will review such an
option in the Fall.
31Part 5 A Quick Glance at Canadas Insurance
Sector
- Content
- A Few Macro Comparative Statistics
- The Canadian LH Market
- The Canadian PC Market
- Current Issues in the Canadian Insurance Industry
321. A Few Macro Comparative Statistics
- As of 2001 (Source Swiss Re, Sigma No. 6 /
2002) - Total premium volume (in USD)
- Canada 45.3 billion USA
904.021 billion - Overall weighted share of world insurance market
- Canada 1.88 (8th) USA
37.54 (1st) - Insurance density (total business per capita in
USD) - Canada 1460 (17th) USA 3266
(4th) - Insurance penetration ( of GDP for total
business) - Canada 6.42 (9th) USA 8.97
(10th)
332. The Canadian L/H Market
- 1.46 of the world market (9th)
- Currently, 110 companies are monitored for
financial soundness by OSFI (49 Canadian, 61
Foreign). - Increasing concentration due to consolidation
(MS of Top 5 68 in 2002 vs. 47 in 1994). - The market is dominated by 5 large stock groups
- Great-West / London / Canada Life, Sun
Life/Clarica, Manulife, Desjardins Financial
Security and the Industrial-Alliance Group - Market is shifting away from exclusive sales
forces (45) towards independent producers (55).
34 Demutualization in the Canadian L/H Insurance
Industry
- Major wave in 1999-2000 (largest wealth transfer
in Canadian history) - Insurer
IPO Date - Clarica
July 21, 1999 - Manulife
Sept. 30, 1999 - Canada Life
Nov. 5, 1999 - Industrial-Alliance
Feb. 10, 2000 - Sun Life
March 23, 2000
35 IPO PERFORMANCE ANALYSIS
- Evidence of significant underpricing of L/H IPOs
- Offer-to-close 9 on average.
- Most short-run returns achieved during first day
of trading. - Evidence of strong returns even if first day
excluded. - Evidence that a secondary market investor holding
those shares would have outperformed the market
Wealth Relative Index Ritter (1991)
Day 1 to 6 months 1.31
Day 1 to 1 year 1.33
Day 1 to 2 years 1.55
Here, the market is proxied by the TSE
Financial Services Sub-Index.
Source Babin Bernier, 2001, Assurances
363. The Canadian P/C Market
- 2.51 of the world market (7th)
- Currently, 198 companies are monitored for
financial soundness by OSFI (93 Canadian, 105
Foreign). - P/C is a less concentrated market than L/H
- Specific regional markets or specific product
lines. - Top 5 MS in 2002 36 (CGU Group Canada, ING
Canada, Co-operators Group, Royal Sun Alliance,
Economical Ins.Group) - Broker Cos still have a dominant MS of 67 (24
for Direct Writers and 9 for Reinsurers only)
374. Current Issues in the Canadian Insurance
Industry
- In the L/H market
- Aging of population and increase in life
expectancy - Shift from life insurance products to savings
products (e.g. Segregated funds) and health
products (e.g. Dread disease insurance). - LTC and LTC / DI hybrids are also starting to
appear in the Canadian L/H market. - A.M.Best expects that the major Canadian life
stock insurers will seek to expand in the USA.
Sources Journal de lassurance and A.M.Best
Report, 7/17/2002
384. Current Issues (contd)
- In the Canadian P/C market (Similarities with
USA) - All time low industry profits in 2001 (Avg. ROE lt
3) - High Auto bodily injury claims mostly in Ontario
Atlantic Provinces - Low investment returns and excessive capital
- Lack of support by provincial governments for
auto insurance reform. Québec wants to review its
No-fault System. - Slightly improving operating results since
2002-Q1 and also in 2003 - Increased prices and tighter underwriting terms
- Significant Shortage of Management Talent
- Great opportunities for business university
graduates.
Source IBC, Canadian Underwriter and Canadian
Insurance
39Part 6 A Quick Glance at Canadas Securities
Industry
- Content
- Our Stock Markets
- Our Mutual Funds Industry
- The Regulation of our Securities Markets
- Governance of Publicly-Traded Companies in Canada
401. Our Stock Markets
- Since 2000, Canada has 3 specialized
exchanges - The Toronto Stock Exhange (TSX) where
securitities issued by more senior companies
(n1,500) are being traded (e.g. large cap
stocks) - The TSX Venture Exchange where securities of more
junior firms are being traded. Born after the
1999 merger of the Alberta Vancouver Stock
exhanges, it is owned by the TSX but operates out
of Vancouver. - The Montreal Exchange trades mostly Options
Futures contracts, and stocks of small
Quebec-based public companies.
412. Our Mutual Funds Industry
- Palltrack (a MF tracking service) lists about
6,000 funds for Canada compared to 15,000 in the
US - Crowded out market
- Choosing among competing funds is an increasingly
challenging exercice for consumers. - The Investments Funds Institute of Canada (IFIC)
is the self-regulatory body overlooking the
practices of the MF industry (www.ific.ca)
423. The Regulation of our Securities Markets
- In Canada, the regulation of the securities
industry is under 10 provincial securities
commissions (versus only one in the US, the SEC).
- The 2 most important commissions in Canada are
the OSC and QSC. - The provincial commissions also collaborate with
self-regulatory bodies such as IFIC and the
Investors Dealer Association (IDA).
434. Governance of Publicly-Traded Companies in
Canada
- Currently, the TSX has the power to set corporate
governance standards for public companies - Voluntary guidelines but no mandatory rules.
- Strong lobby by the new Canadian Coalition for
Good Governance to sort things out in this
area. - Enforcement should be expressed in legislation,
and carried out by securities regulators C.
Lamoureux, CEO, Ontario Teachers Pension Plan,
May 22, 2003. - Mr Lamoureux feels that Canada is no different
from the US. We need to adopt the same standards
that were included in the U.S. Sarbanes-Oxley Act
following the major financial scandals (Enron,
WorldCom. etc.,).