An Accountability System For Financial Institutions in Canada: How To Ensure They Meet a High Standard of Performance

CCRC Position Paper #5

(December 1997)

"Canadian banks do not operate in an unregulated environment. Over the years, they have benefited a great deal from the protection of the Bank Act. . . .
I believe it is time for the banks to give something back. The time has come for the government to exercise leadership and to challenge the banks to sit down and develop concrete ways to help small and medium-sized Canadian businesses find the capital they need."

Excerpt from a speech by the Rt. Hon. Jean Chrétien
(February 11, 1993)

"Canada's chartered banks are community-based banks. Their branches are located in towns, cities and rural areas throughout the country. Branch services are structured to meet the different needs of their communities."

Small Business: Annual Report,
Canadian Bankers Association
(June 1995, p.13)

I. Background

(a) What Canadians Do For Our Banks

Canada's big five banks are the largest corporations in Canada (based on total value of their assets, in order of size: the Royal Bank, CIBC, Bank of Montreal, Scotiabank, Toronto Dominion). These assets include loans which borrowers have to pay back to the bank, government bonds, shares in other companies, buildings, property etc.

However, the basis of all these assets is the money over 20 million Canadians deposit in the banks. According to the Canadian Bankers Association, the deposit accounts of individual Canadians make up the largest single bank deposit category, both in number and total amount. When individual deposits are combined with the deposit accounts of businesses, they total $676 billion and make up 93% of the total capital base of the big five banks at the end of April 1997. In contrast, shareholders investments in banks total only $46 billion.

Without the capital base that these deposits provide, the big five banks would not have been able, at the end of 1996, to have developed the following asset base:

Also, without the capital base that depositors provide, the big five banks would not have reaped the following benefits in 1996:

A comparison (set out below) of total assets, deposits and total loans of the big five banks compared to total revenues of Canada's federal, provincial and territorial governments gives a sense of just how big our big banks are. Each of the big five banks' assets, the Royal Bank's deposits alone, and Royal Bank and CIBC's total loans are greater than the federal government's annual revenues. And three of the big five banks' assets and deposits are greater than the combined annual revenues of all of the provinces and territories, as follows (See CHART 1):


(b) What Canada's Governments Have Done for Banks: Decades of Privileges and Protection

Canada has one of the most highly concentrated banking sectors in the world. We have half as many banks as Japan, one-fifth the number of banks as Germany, one-seventh the number of banks as France, one-eighth the number of banks as Britain, and the United States has 200 times as many banks as Canada.

Our banking sector is so concentrated because our banks have, since 1967, enjoyed legal protection from competition by foreign banks, and very high costs are an effective barrier to anyone trying to start a new bank. Up until very recently, there was a 10% individual, and 25% collective, limitation on the foreign ownership of Canadian-controlled, federally-regulated insurance companies and trust and loan companies; a 25% collective limitation on the foreign ownership of chartered banks; and a 12% ceiling on the size of the foreign bank sector in Canada. As a result, there are only approximately 50 foreign banks in Canada. Despite not facing these limitations anymore, foreign banks still have to raise millions in capital in order to open a subsidiary, need approval of the Minister of Finance to open branches, and no one can own more than 10% of a chartered, domestic bank (e.g. the big five banks and a few, much smaller banks).

Almost all the foreign banks in Canada operate solely as investment banks specializing in financing large corporations because, as their representatives stated in the May/June 1996 issue of Canadian Banker, they feel that the costs of trying to compete head-to-head for personal and small business lending and service are so high as to make it futile.

As a result of protection from foreign competition, and that the federal government has allowed them to operate in almost every area of the financial services industry, the big five Canadian banks have grown enormously, as detailed above, and they now control many areas of the financial services industry, as follows:

Taxpayer dollars totalling $4.5 billion facilitated bank takeovers of several failing trust companies in the past several years (especially 1991-92), so that banks now own over 15 trust and loan companies (the only large independent trust company left is Canada Trust). Between 1984 and 1993, the total assets of trust and loan companies associated with the banks increased from $36 billion to $150 billion. In addition, even though the federal government allowed banks unrestricted access to the mutual fund industry only nine years ago, the list of the 10 largest mutual fund companies in Canada already includes five banks and these banks control 30% of the total industry assets.

In the area of access to capital for business, the banks are by far the largest source of loans and other forms of credit. At the end of 1996, the total authorized business credit of the seven largest banks was $456 billion, of which $31 billion (6.9%) was authorized in loans of under $250,000 (and therefore assumed to be small business loans).

In contrast, total assets for the trust company sector is about $275 billion, and trust companies' business lending activities are limited by legislation in many jurisdictions (total business lending figures are not available from the Trust Companies Association of Canada, but a reasonable estimate based on their assets is $68 billion).

The total assets of the 2,300 credit unions (or caisse populaires) in Canada is only $95 billion, and in many provinces credit unions' business lending activity is limited by legislation (total business lending figures are not available from Credit Union Central of Canada, or the caisse populaires, but a reasonable estimate based on their assets is $20 billion total). In addition, overall in "English Canada", credit unions have only a 6% market share. Despite the high level of awareness of their existence and purpose, labour sponsored venture funds had by 1995 invested only about $2 billion, much of it in larger businesses. The total amount available for venture capital in Canada is estimated to be at most $5 billion.

The federal government's Community Futures program, aimed specifically at non-metropolitan areas, loans out at most $200 million each year (but this amount includes payment of Employment Insurance to program participants). According to the Public Accounts 1997, the business granting and lending of the federal government's regional development agencies will be $890 million this fiscal year (Atlantic Canada Opportunities Agency: $263 million; Regional Development-Quebec: $355 million; Western Economic Diversification: $267 million; grants for local entrepreneurial development: $5 million). Finally, the federal government's Business Development Bank of Canada (BDC) only invested about $125 million in venture capital in 110 companies between 1983 and 1993 (which generated another $400 million in investment) and the BDC is limited by its capital base to total loans and liabilities of $3.2 billion.

Altogether, the business lending and investment of deposit-taking financial institutions in Canada other than the big seven banks amounts to only about 20% ($97.5 billion) of the banks total business lending. Federal government lending and granting programs, totalling at most $4.5 billion, and venture capital (at most $5 billion) are not sufficient to close this gap. It is clear that the total non-bank lending available to business, particularly to job-creating small businesses trying to start-up or expand, is miniscule compared to the resources of the chartered banks. In order for small businesses to be globally competitive and to continue creating jobs, banks must be accountable to serving the needs of this key sector of our economy (See CHART 2).

Through their lending and investment activities, Canada's big banks enjoy the privilege of a government-sanctioned key role in the creation of the money supply. And this role has been subsidized in the past several years by federal government guarantees for small business loan defaults under the federal Small Business Loans Act (SBLA). The total cost to the federal government of guaranteeing defaults under the SBLA has been $258 million since 1992 (or 2.5% of loans) according to the federal Auditor General, who has criticized the program's poor cost to job created ratio. A similar system in Quebec (known as the Paillé), in place since December 1994, has resulted in a reported total cost of $116 million as the provincial government has covered loan defaults for banks and caisse populaires, mainly due to lax safeguards to ensure that the financial institutions were lending to viable businesses.


(c) Record Bank Profits: A Result of Privileges and Protections

These privileges and protections have helped Canada's big five banks reach record profit levels in the past three years. In 1995, the big five banks were amongst the seven corporations with the highest profits in Canada, their profits have almost doubled since 1993, and in 1996 the Royal Bank recorded the highest profit ever by a Canadian company ($1.43 billion). The banks' profits for 1997 increased significantly, up 19% over 1996 to $7.5 billion, as the Royal Bank broke its own record profit level (up to $1.68 billion) and the CIBC and Bank of Nova Scotia registered the second and third highest profit levels ever (at $1.55 billion and $1.5 billion respectively). Three of Canada's big five banks (Royal, CIBC and Bank of Montreal) are amongst the top 16 most profitable banks in the world (See CHART 3).

Banks would have reached their record profit levels years ago if they had not over-exposed themselves to speculative real estate investments in the late 1980s. In 1992 the big five banks total loan losses were almost $7 billion, close to $4 billion more than in 1991. This huge increase in losses occurred mainly because they lost about $2 billion on loans to Olympia & York, a huge real estate company that went bankrupt in 1992. As a result of these losses, bank profits decreased from $3.8 billion in 1991 to $1.5 billion in 1992. By 1995, the big five banks' loan losses decreased to their lowest level in five years, to a total of $2.3 billion for 1995, as they finally disposed of their major losses from bad real estate loans. Largely as a result of the decrease in losses, their 1995 profits increased to the record total of $4.9 billion.

As mentioned above, several trust companies were also over-exposed to risky real estate investments in the early 1990s, which lead to several failures that cost taxpayers billions in bailouts. In one case, taxpayers (through the Canadian Deposit Insurance Corporation (CDIC)) underwrote the takeover of Central Guaranty Trust by Toronto-Dominion Bank at a cost of $1 billion. In another, the losses of Confederation Trust were a main cause of the collapse of the 123-year old Confederation Life Group of Companies.

(d) Privileges and Protections Mean Greater Responsibility

Bankers like to characterize Canada's big banks as private corporations which should give priority regard to shareholders interests, with employees and customers coming second and third.

However, given that the banks would not be as large or as profitable as they are without individual Canadian's deposits and the privileges and protections granted them by Canadian governments, banks are much more like public utilities.

Public utilities such as hydro-electricity, water, telephone, and cable-TV are granted the significant privilege of usually almost exclusive rights to generating and exploiting a natural resource. Similarly, banks have been given the significant privilege of playing the major role in generating and exploiting an human-created resource, namely money. Both utilities and banks are in a position of public trust with regard to the resources they manage.

The decision in 1967 to protect Canada's banks from foreign competition was made because it was believed that Canadian banks could best serve the national market. Even though this decision essentially gave the banks a monopoly on provision of banking services, they were not required in return to meet any standards of service or other formal obligations to serve Canadians and the Canadian economy well. In contrast, public utilities are required to meet service standards, supply services across the country, and provide detailed statistics concerning their costs and revenues whenever they want to change the rates they charge customers.

Some commentators, the banks included of course, argue that if consumers are unhappy with banks there are other sources of banking services, including access to capital. This argument ignores the fact that in the Canadian financial system banks are the major source of financial intermediation, as detailed above concerning the banks control of various sectors of the financial services industry.

Given that the banks have enjoyed extensive privileges and protections for decades, allowing them to gain a significant level of asset and market control of financial services in Canada, and placing them in a position of public trust, banks should face higher standards in many areas of their activities than do other corporations.


(e) Problems for Borrowers and Consumers

According to the Government of Canada, 98% of all businesses have less than 50 employees (90% have less than five employees), 53% of all Canadians working in the private sector are self-employed or employed by a business with less than 100 employees), small businesses created over 80% of all growth in employment in the past 15 years, and small businesses created 38% of Canada's gross domestic product in 1991.

It is widely agreed, based upon both Canadian Bankers Association (CBA) and Canadian Federation of Independent Business (CFIB) surveys, that small businesses need at most $250,000 in business credit. According to the CBA business credit reports:

CFIB member surveys have shown "access to capital" to be an ongoing problem, especially when compared to the U.S. It is consistently ranked in respondents' top 10 concerns, and the number of small businesses reporting problems with access to capital doubled from 20% in 1990 to 40% in 1996 (their June 1996 survey ranked "access to capital" as the 6th concern). In contrast, respondents to the U.S. National Federation of Independent Business (NFIB) surveys over the past 10 years have never ranked access to capital higher than 43rd (in their 1996 survey it ranked 63rd).

A comparison of CBA statistics concerning authorizations to small business at December 31,1995 with December 31, 1996 reveals that support for small business in 1996 decreased overall, as follows (complete figures for 1997 are not yet available):

This means that the small business sector, while creating over 35% of Canada's gross domestic product, is receiving at most 7% of the total business credit extended by the banks. None of the big five banks lend more than 8% of their total business credit in small business loans of under $250,000 (ranging from Toronto-Dominion Bank at 3% to Bank of Montreal at 8% of total credit). And each of the big five lend at most 17% of their total business credit in small- and medium-sized business loans of under $1 million (ranging from Toronto-Dominion Bank at 8% to Bank of Montreal and Royal Bank at 17% of total credit).

In addition, although at the end of 1996 there were about 620,000 businesses with bank loans of under $250,000, according to the Government of Canada there are about 2.1 million small businesses with less than five employees (including the self-employed, 700,000 of which are run by women), representing 90 percent of the businesses in Canada. The question is, what are Canada's banks doing to provide access to capital to the 1.48 million small businesses in Canada without bank credit?

Overall, given these figures, the banks' 1996 lending figures illustrate a persistent unwillingness to support the job-creating small business sector. At a time when federal government is claiming to be encouraging microenterprises, and when demographers are theorizing about self-employment significantly increasing in the future as a job market sector, the end result is that banks are preventing jobs from being created in Canada.

In contrast, of the $18 billion increase in total business credit in 1996, $15 billion (83%) of the credit was loaned out in amounts in excess of $5 million (an increase in this loan category of 4.8%). However, during the year customers with credit in excess of $5 million declined by 13%. As a result, as of December 1996 customers with credit authorizations in excess of $5 million represented only 1.25 % of total customers, but received 75% of extended credit (compared to 1.47% of total customers and 74% of total credit as of December 31,1995). In essence, the banks extended more credit to fewer big business clients in 1996 (See CHARTS 4 and 5).

In the area of consumer problems, the results of surveys of over 8,000 Canadians concerning customer satisfaction with various Canadian industry sectors conducted in 1996 and 1997 by the National Quality Institute placed banks in the bottom five of 21 industries along with regulated monopolies such as cable-TV companies and Canada Post. In contrast, respondents ranked credit unions as the third best industry sector for customer satisfaction, and trust companies ranked ninth. The survey measured courtesy, promptness of service, product information, after-sales service and complaint-handling service.

In addition, a study released in June 1996 by ACEF-Centre of Montreal concluded that 3% of Canadian adults do not have an account with a financial institution. Other surveys have shown that low-income Canadians are even less likely to have an account. A Environics poll, conducted in 1995, found that eight percent (8%) of consumers with an annual income of less than $25,000 (which according to 1994 Statistics Canada data would mean at least 400,000 Canadians) do not have an account.

These surveys have prompted requests for more detailed disclosure by the banks of key information in the small business lending and consumer services areas, which to date the banks have refused to disclose, and the federal government has refused to require disclosure of the information. Another key problem is that financial consumers are not organized overall to be able to hold the banks and other financial institutions accountable for poor service, mainly because of systemic barriers to consumers banding their resources together to form broad-based and well-resourced industry watchdog groups. (See the CCRC's Position Paper #4: A Financial Consumer Organization for Canada: Balancing the Financial Services Marketplace for details).

(f) Government Actions to Date: Insufficient to Hold Financial Institutions
Accountable or Solve Problems

A major reason for the lack of effective action recently by Canadian governments, the federal government in particular, on issues of concern to financial consumers has been their orientation concerning regulating business, and specifically the federal government's misguided belief in self-regulation and voluntary codes. Proposed federal government legislation is now accompanied by a "Regulation Impact Assessment Statement," which is based in part on the results of a "Business Impact Test" (BIT) consultation. The BIT was developed by business in cooperation with the Canadian Manufacturers' Association, the Treasury Board of Canada and Industry Canada. It is aimed at ensuring that legislative and regulatory changes do not hinder Canadian business competitiveness. To quote the preamble of one BIT statement, the BIT "solicits businesses preferred policy choices" and "provides [businesses] with an opportunity to influence the Government's policy making process.

The BIT raises a fundamental question: Where is the corresponding Consumer Impact Test and consultation process that gives consumers "an opportunity to influence the Government's policy making process"? The answer, unfortunately, is that there is no corresponding test.

The federal government has been using the BIT and, as a result in part, favouring voluntary codes as the sole means of so-called regulation in many areas over the past few years. Voluntary codes have been favoured also because the government has believed that spending on enforcement must be cut, and that these cuts will save money in the long run.

However, voluntary codes have not been confirmed as an effective form of regulation, and most of the evidence states that they work only in very limited, specific situations. As the May 1994 report by the Public Interest Advocacy Centre (Voluntary Codes: A Viable Alternative to Government Legislation) concluded, even the adaptation and adoption by the Canadian Bankers Association of the Canadian Standards Association's Model Code for the Protection of Personal Information will provide little assurance that consumer privacy will be adequately protected in the marketplace. The existence of other voluntary codes in the financial services industry likewise provide little assurance to consumers. Voluntary codes, on their own, are simply inadequate means of ensuring compliance with rules, as pointed out by Canada's Privacy Commissioner in his submission to the Standing Senate Banking, Trade and Commerce Committee (April 25, 1995).

To take an example from another issue area, the 1994 KPMG Environmental Management Survey revealed that, for 95% of company respondents, the motivating factor for developing and adhering to an internal environmental management system was compliance with regulations. Without regulations, the number one motivation for adhering to voluntary internal codes would have been absent for the industries surveyed, which included financial institutions.

After years of embracing voluntary compliance in lieu of regulation, the federal government finally, in 1995-96, studied whether they work under the Voluntary Codes Project undertaken by Industry Canada's Office of Consumer Affairs (OCA) and the Treasury Board Secretariat's Regulatory Affairs Directorate (RAD). The conclusions of these various studies are that voluntary codes only work in very specific situations that meet all of the following conditions:

  1. Is the code and enforcement system developed jointly by consumer,
    government and industry representatives?
  2. Is there detailed and effective disclosure of the businesses activities in the
    areas covered by the code?
  3. Is there public, independent and fully-resourced auditing of whether the
    businesses meet the standards in the code by an enforcement body that is
    accountable to the public?
  4. Are there sanctions for violations of the code sufficient to discourage the
    prohibited practices?
  5. Are appeal mechanisms available for unsatisfied consumers?
  6. Does the government support the code and enforcement system?
  7. Is there a periodic review and updating of the code, involving consumer,
    government and industry representatives?

It should be noted that these conditions, taken together, amount to the conditions for effective legislation or regulation of any area of business activity. An important difference between regulations and voluntary codes, however, is that regulations usually apply to all busineses active in a particular area, while a voluntary code only applies to businesses that volunteer to have the code apply to them. As a result, many businesses can avoid scrutiny of their activities if government relies only on voluntary codes to restrict the activities of an industry sector.

The federal government has recognized the need for regulation of the financial services sector. The discussion paper on the 1997 Review of Financial Sector Legislation (released in June 1996) stated: "There is no question that regulations are required in the financial sector. Regulations not only protect the consumer, they set out the rules of the game so that the sector can operate smoothly." (p. 19) The June 1997 Discussion Paper of the Task Force on the Future of the Canadian Financial Services Sector also stated that the financial services sector has traditionally been a segment of the economy where regulation is accepted and expected. (p. 6)

However, the federal government's actions have contradicted the recognition of the need for regulation of the financial services sector. As a result, the federal government has failed to develop and enact effective measures to enable governments and individual Canadians to hold financial institutions accountable to consumer, small business and community interests on key issues of concern.

For example, during the consultation period on changes to the Bank Act and other financial institutions legislation between April 1995 and July 1996, Doug Peters, then Secretary of State for International Financial Institutions and responsible for the changes, held 45 meetings, all with industry representatives, and gave nine speeches, all to industry associations. During this consultation period, Mr. Peters did not meet with any consumer groups.

The federal government's proposed changes to the Bank Act and other laws that were introduced after the consultation period (in February 1997) reflected the bias in Mr. Peters consultation process. The government did not require financial institutions to do very much at all to protect consumers and instead allowed the banks to develop their own ineffective, voluntary, self-enforced measures in several areas, as follows:

In the area of small business lending the federal government has also relied on a voluntary system that has been ineffective for holding the banks accountable because it is significantly flawed, as follows:

First, the Canadian Bankers Association (CBA) discloses the data in their own quarterly reports, with their own summary presenting the banks' analysis of the statistics in the most positive light.

Second, the lowest loan size category for which lending statistics are presently available is less than $25,000, which comprises 40% of the banks' business customers. Clearly, this category is too broad to be statistically useful for analyzing the different types of small businesses that have these small credit needs.

The third flaw with the current lending disclosure system is that CBA statistics reveal the supply of credit but not the demand, either by amount of customers or total credit requested. Knowing how much credit has been extended by the banks tells us very little unless we know how much businesses of different sizes demanded. For example, according to the Canadian Bankers Association, $2.9 billion in new money has been specifically committed over the past four years to small business loan programs. However, the banks have not disclosed how much of this amount has actually been loaned out to small businesses, nor how much new money has been applied for by the small business sector. As a result of this flaw, when faced with statistics showing stagnation in lending of loans under $100,000 through 1996, the banks can simply respond that demand must have remained constant, and that they just continued to meet the demand. The federal government cannot respond in any way to this claim because the banks are not required to disclose statistics either to prove or disprove the banks' claim concerning demand for loans.

The fourth flaw with the current lending disclosure system is that Canada is divided into only eight (8) regions for reporting purposes. This is clearly not sufficient for analyzing whether banks are serving the credit needs of communities (or even some provinces) from which they accept deposits. The fifth flaw with the current lending disclosure system is that key information, such as loan application approval / rejection rates (categorized by number of employees, sales and gender of loan recipient) is not collected systematically, but instead through CBA-commissioned surveys. These surveys, conducted by Thompson, Lightstone & Company of Toronto on behalf of the CBA in 1995 and 1996, have proven to be flawed in several ways. A final flaw with the current disclosure system is that the statistics collected and disclosed by the banks to the federal government, and the CBA's raw survey data and survey summaries, are not made available in electronic format so that they can be easily analyzed by the federal government or other interested parties (See the CCRC's Position Paper #3, Disclosure By Banks Of Business Lending Statistics: How to Correct the Flaws in the Current System for details).

With all the problems associated with small business lending data it should be noted that it remains the only sector of banking activity for which even minimally effective information disclosure exists. Clearly there is a lack of necessary information for anyone interested in determining whether the chartered banks are providing a high level of service to Canadians, let alone other measures to ensure that banks take corrective actions to address problems revealed by information disclosure.



Federal Party Policies and Platforms: Accountability Through Disclosure

At the Liberal's national policy convention last October in Ottawa, priority resolutions proposed by three provincial party associations were passed by over 2,000 delegates from across Canada. Reinforcing the statements by Prime Minister Chrétien quoted at the beginning of this Position Paper, the resolutions proposed enacting legislation in Canada based on existing U.S. federal legislation that was specifically mentioned in one of the resolutions.

The U.S. legislation, the Home Mortgage Disclosure Act and the Community Reinvestment Act requires financial institutions to collect and publicly disclose information that enables the public to judge whether the institutions are meeting the legitimate demand for loans, investments and services from business sectors and communities across the country, and sets out requirements that the institutions meet these demands or face penalties under specific circumstances (as detailed in the next section of this Position Paper).

The Liberal's 1997 election platform states that, beyond increasing the capital base and lending capacity of Crown financial institutions such as the Business Development Bank of Canada and the Farm Credit Corporation (which focus on small business lending), the Liberals will "facilitate a dialogue between the non-profit sector and financial institutions on concrete ways to promote community economic development, including support for micro-lending initiatives."

Aimed at addressing the same concerns, the Conservatives' 1997 federal election platform pledged to require banks to publish detailed records on small business lending on a regional basis to "enable Canadians to compare the performance and commitment of their financial institutions to the creation of loan capital for new and small businesses." The NDP's and Bloc Québecois' election platforms also contained similar proposals concerning disclosure of data on bank lending patterns and practices, as well as pledging to enact requirements for banks to reinvest in communities and job-creating businesses if the data reveals that banks are not meeting their legitimate demand for capital.



The U.S. Financial Institution Accountability System: A Model for Canada to Adapt and Adopt


(a) Detailed Disclosure is Essential

The U.S. has two main federal laws that form the financial institution accountability system, the Home Mortgage Disclosure Act (HMDA) and the Community Reinvestment Act (CRA). Over $210 billion has been committed by financial institutions in targeted investments in low- and moderate-income, and visible minority neighbourhoods and communities across the U.S., investments which would not have been made if the U.S. did not have these laws.

Under the HMDA, first enacted in 1975, almost all of the 10,000 U.S. banks and other financial institutions and companies that provide mortgages are required to disclose:

The financial institution also has the option of providing a reason why a loan application was rejected. Only the smallest companies, in terms of size of assets (under $10 million) and number of mortgages made each year (less than 100), are not required to disclose this information.

In addition, recent changes to the U.S. federal CRA, which was first enacted in 1977, have extended some of these disclosure requirements to small business, small farm, and consumer loans, and several states have their own disclosure laws that, in some cases, extend the requirements to other areas as well. In all cases, information that would allow anyone to identify a loan applicant is not disclosed, to protect the privacy of borrowers.

The HMDA was enacted, as the law states, so that federal regulators and the public would have information from banks, savings and loans, credit unions, other savings institutions and mortgage companies needed to:

The CRA was amended to include disclosure in other lending areas for essentially the same reasons. The U.S. system has been effective overall because it tracks loan demand and rejection rates, and also tracks loans by other criteria. As a result, regulators have been able to determine that, nation-wide, if you are black you are twice as likely to be rejected when applying for a mortgage loan, even if you have the same income level and live in the same neighbourhood as other applicants. Regulators, along with citizens and community groups, are also able to track banks' performance in lending in specific neighbourhoods.

In contrast, under the current Canadian bank business lending disclosure system the federal government cannot determine whether banks are meeting the demand for business or other types of loans, whether small business loan applicants are rejected at a higher rate than big business applicants, or whether businesses in certain communities or industry sectors are rejected at a higher rate than others.

(b) Performance Standards and Review Based On Statistics Disclosure

To help ensure a high standard of service to all customers and neighbourhoods, under the CRA financial institutions have responsibilities to the communities which their corporate charter allows them to serve. In essence, financial institutions must satisfy the service and credit needs of the communities in which they are located, in a manner consistent with the safe and sound operation of the institution.

Large financial institutions (for CRA purposes defined as having assets greater than $250 million) can choose either to submit a strategic plan or to face three performance tests (lending, investment, service). Under the strategic plan option, the financial institution must develop a plan containing measurable goals that addresses each of the three performance test categories. The plan can be up to five years in duration but must have annual, measurable performance goals that include details on how credit needs of low- and moderate-income persons and neighbourhoods are to be met.

Once a plan is developed it must be submitted for public comment. This involves at a minimum formally soliciting public comment for at least 30 days by publishing notice in at least one newspaper with general circulation in the community the financial institution wishes to serve. Additionally, copies of the plan must be made available to members of the public, if requested. Once the public involvement process is finished the plan must be submitted for regulatory approval. Once in operation, the financial institution receives a CRA rating based on whether it meets the annual performance standards in their strategic plan. The financial institution must maintain a 'satisfactory' rating and this rating can be altered on any evidence of discriminatory credit practices.
As mentioned above a financial institution can, instead of submitting a plan, choose to be tested annually by regulators on its lending, investment and service practices. For its lending activities in small business and small farm loans, the five areas on which it is judged are as follows:

  1. overall amount of loans (number and total loaned) and number of applicants,
    approvals and rejections;
  2. geographical distribution (by census tract within the community, and outside
    the community);'
  3. borrower characteristics (income level);
  4. community development loans (number and total loaned), and;
  5. flexibility of lending practices (particularly as they relate to meeting the credit
    needs of low- and moderate-income individuals).

The four elements of the investment test are as follows:

  1. the dollar value;
  2. how innovative or complex the investments are;
  3. the responsiveness of the investments to community development needs,
  4. whether the investments are routinely provided by private investors.

The four elements of the service test are as follows:

  1. distribution of branches among different income geographies;
  2. the bank's record of opening and closing branches in low- and moderate-
    income neighbourhoods and communities;
  3. the availability of alternate service systems (such as extended office hours
    and electronic banking) in different neighbourhoods and communities, and;
  4. whether the range of services provided in different income neighbourhoods
    or communities is tailored to meet the distinct needs of each of the
    neighbourhoods or communities.

In both the strategic plan and annual testing processes, financial institutions are to some extent judged on how they satisfy community economic development in the communities they serve. Essentially, the CRA defines community economic development as consisting of: affordable housing; community services targeted to low- and moderate-income individuals; financing small business and farms and revitalizing low- and moderate-income neighbourhoods and communities.

An important recent change to the CRA allows financial institutions to partner with other financial service and lending institutions that may specialize in serving particular neighbourhoods or groups of people. As a result, a large, national bank can, instead of attempting to correct problems internally with its lending practices to particular neighbourhoods or communities, provide loan and investment capital to a community loan fund, credit union or other community development financial institution and the loans made with that capital are counted as part of the bank's lending and investment record for the purpose of a CRA review.

Each year, the regulatory agencies (Federal Reserve Board, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation and Office of Thrift Supervision) are required to prepare a CRA Disclosure Statement for each financial institution being reviewed. The statement includes the statistics set out above, along with the information gathered under the HMDA, and the results of the regulators' evaluation.

(c) Meeting Needs Within the Context of an Efficient System and the Safe and Sound Operation of Financial Institutions

It is important to note that the purpose section of the CRA explicitly states that lending and investment must be done within the bounds of safety and soundness, and that regulators should take into account a financial institution's size and financial condition, legal impediments and local economic conditions, as well as the performance of other financial institutions in the same communities, when evaluating an institution's CRA performance.

A 1996 study by the Federal Reserve Bank of Kansas City (part of the U.S. government's Federal Reserve system) which involved a survey of 600 financial institutions across the U.S. found that 98 percent of the institutions that responded reported that their lending in response to the legislative requirements (HMDA and CRA) was profitable, and all reported that losses on these loans were comparable to losses on their conventional loans, that the loan default rates were comparable to conventional loans, and that overall their risk level on these loans was manageable.

Also, a study by the U.S. federal General Accounting Office undertaken during the Bush Administration concluded that the HMDA and CRA requirements met the test of minimal regulation and did not impose a significant paper burden on U.S. financial institutions.


(d) Public Access to Review and Sanctioning Process: Incentives and Requirements

Each financial institution must also maintain a public file. The public file must consist of: a copy of the latest CRA Performance Evaluation; a list of bank branches with their addresses and census tracts; a list of services provided at each branch (hours of operation, loan and deposit services and transaction fees), and; a map of the community the bank purports to serve. If the bank does not have a satisfactory CRA rating it must include the current efforts designed to meet this target and this part must be updated quarterly. Furthermore, the file must contain all public comments regarding the bank in question submitted during the previous three years.

The failure to register a satisfactory grade in the CRA review process can result in a denial of a request to expand, either by opening additional branches or through a merger or an acquisition. Therefore, the banks have a commercial incentive to meet their CRA targets, although this incentive has been viewed a fairly ineffective to date, mainly because federal regulators have only rarely denied an expansion application even if a financial institution has a poor CRA rating.

One of the most important features of the CRA is that it provides citizens with standing to intervene in the review process by regulators. Local community groups, small business associations and public agencies are given an opportunity to raise their concerns, and in the over 360 CRA expansion application reviews to date there have been far more negotiated agreements between financial institutions and community groups than required action by regulators.

Through these negotiated agreements, over $210 billion has been committed in targeted investments in low- and moderate-income, and visible minority neighbourhoods and communities across the U.S., investments which would not have been made if the U.S. did not have a financial institution accountability system enacted in law (including more than $30 billion each year over the past five years).



Competition in Financial Services: Insufficient to Ensure Accountability and a High Standard of Performance

Most economists generally hold the view that a competitive marketplace maximizes consumer benefits. However, classic economic theory recognizes that there are market imperfections. The U.S. banking industry prior to the introduction of the CRA is an example of a industry that, despite being competitive, was not serving certain sectors of society well. Studies at the time documented that poor and non-white neighbourhoods were not having their banking needs met. Redlining (a practice by some banks of drawing lines on maps around specific neighbourhoods and then refusing to service those neighbourhoods) was at first suspected and then proven in the early 1970s. Therefore, in spite of a competitive marketplace, legislation was required to ensure that those victimized by market failures would be adequately served.

Some view the current World Trade Organization (WTO) negotiations on financial services agreement as a panacea to contemporary banking problems in Canada, because the WTO agreement will likely lead to Canada lowering the barriers to foreign banks entering the Canadian market to serve Canadian borrowers and consumers. However, even if a comprehensive agreement is reached, the U.S. experience to date illustrates that an accountability system will be required to ensure that foreign deposit-taking institutions, along with our domestic institutions, serve Canadian interests well.
In addition, the federal government's position on lowering the barriers to foreign bank entry, as set out on September 25, 1997 in a Department of Finance discussion paper, is to prohibit foreign banks in Canada from accepting deposits of under $150,000.

This would preclude most consumers and small businesses, who do not have deposits of this size, from having the same choices as big business and wealthy individuals in the marketplace. Further, to maintain their market share and profit levels, Canada's banks would likely have to cut their prices for large and wealthy customers, while increasing prices for small businesses and low- and moderate-income customers. Can anyone argue that competition in this form maximizes consumer benefits? And who will protect consumer interests as Canada's banks create a two-tier banking system by withdrawing services or increasing prices for smaller depositors in order to maintain their overall record profits?

The federal government has recognized the need for regulation of the financial services sector, in order to protect consumers and ensure that the sector operates efficiently and well even if it is competitive. However, as detailed above in section I(f) of this Position Paper, and in the CCRC's four previous position papers, the federal government has failed to date to develop and enact effective measures to enable governments and individual Canadians to hold deposit-taking financial institutions accountable to consumer, small business and community interests on key issues of concern, and to ensure that Canada's financial institutions meet a high standard of performance. The next section of this Position Paper details just such an accountability system.



A Made in Canada Financial Institution Accountability System

(a) U.S. Compared to Canada: Canada's Banks Operate in the U.S. and the U.S. System is Applicable Here

Canada's chartered banks have made inaccurate statements that enacting requirements in Canada similar to those in the U.S. would have dire consequences. These statements are based upon false claims concerning the requirements of the U.S. Community Reinvestment Act (CRA). For example, in its submission to the Task Force on the Future of the Canadian Financial Services Sector and in several public statements, the Canadian Bankers Association (CBA) has claimed that the U.S. CRA requires matching of the amount of "lending and deposit-taking within a specific region or community" and that the CRA requirements could not apply to our banks because they are chartered to serve the country, nor could they apply to virtual banks, which do not have branches (p. 35). In the Bank of Montreal's submission to the Task Force, the bank states that "regulation may dictate that credit be made available to specific groups; such is the case under the Community Redevelopment Act in the US" [p. 19; italics in original]. Obviously, the bank doesn't even know the title of the U.S. legislation, let alone its requirements.

First of all, everyone knows that banks lend out more than their cash deposits, although the recording of loans to customers as deposits in any bank means that the overall amounts match, and further that the liabilities and assets in any bank's overall financial statement must be equal. Secondly, as set out in detail above, the U.S. CRA requires financial institutions to meet the needs of the communities "in which they are chartered consistent with the safe and sound operation of such institutions." There is no reference to deposits, nor to matching lending or any other activity of the financial institutions with deposits taken from a specific community. Third, part of the sound operation of a financial institution is to meet legitimate credit demands of all customers.

Therefore, the CBA's claim that specific Canadian communities and provinces would suffer restrictions on credit if a law similar to the U.S. CRA was enacted here is simply false. In essence, the only possible effect of the CRA is that if service or credit needs are not being met (as determined through the disclosure requirements), and these needs could be met in a safe and sound manner, then the financial institution could be required to meet these needs. As a result, the only possible effect would be an increase in investment and lending in a community or province, if the disclosure of details about the banks' performance revealed that the banks were not meeting the safe and sound needs of businesses and consumers in the community or province. In addition, as in the U.S., under a Canadian system each bank branch could be required to define its "community" or market, and then meet that communities needs.

For virtual banks, it would be similarly simple to require them to define the communities they are serving, and then to meet the needs of those communities.

The most obvious difference between the U.S. and Canada's deposit-taking financial institutions are that many of the 10,000 financial institutions in the U.S. have branches only in a single community. However, again despite claims from the CBA, the difference in financial institution structures is no impediment to detailed data disclosure for Canada's financial institutions. The CBA has claimed, as quoted at the beginning of this Position Paper, that Canadian banks are "community-based banks" and that "Branch services are structured to meet the different needs of their communities." And, in fact, given that most American deposit-taking financial institutions are smaller than the Canadian chartered banks, the cost of disclosure would have more dramatic consequences for many U.S. banks.

It is important to note that, the existence of the U.S. requirements has not dissuaded either the Bank of Montreal or the Toronto Dominion Bank from acquiring deposit-taking institutions in the U.S. and, therefore, having to comply with the U.S. laws.

Under the U.S. system, Harris Bank of Chicago (owned by the Bank of Montreal since 1993) signed an agreement in 1994 with the National Training and Information Center (a Chicago-based community group) pledging, as follows:

All of these steps have been taken by a subsidiary that the Bank of Montreal has publicly projected will generate half of its profits by the year 2000. In addition, the Bank of Montreal has announced that it is expanding its operations into Florida, where it will have to meet the U.S. CRA requirements.

This gap between Canadian banks' rhetoric and their actions in the U.S. makes it clear that there is no justification for Canadian banks claiming that they could not meet the disclosure and other requirements of the U.S. financial institution accountability system.

(b) Designing a Made in Canada System: The Key Elements of Accountability

The CCRC proposes a financial institution accountability system for Canada that contains all of the following five elements, based upon the system that exists in the U.S.:

(i) Definition of Community

Given that many of Canada's financial institutions have branches across the country, the first issue to determine is what constitutes a "community" for data disclosure and regulatory review purposes. The CCRC proposes three definitions we believe would serve the purposes of making the financial services sector more accountable to Canadians, as follows:

(ii) Data Disclosure Requirements

What types of information should be disclosed? The CCRC's Position Paper #3 (Disclosure By Banks Of Business Lending Statistics: How to Correct the Flaws in the Current System) details our position on what is appropriate disclosure with respect to lending to business. Incorporating this disclosure into an overall system for Canada, the CCRC proposes that the disclosure requirements for the system should include the following:

Each chartered bank in Canada, should be required by law to collect and disclose annually to the federal government the following information for each branch of the bank concerning their business lending and investment activities:

In addition, banks should be required by law to collect and disclose to the federal government annually the following information for each branch of the bank about community development lending and investments (such as for co-op and low-income housing, worker cooperatives, worker buy-outs, non-profits agencies, community development financial institutions (e.g. loan funds, micro-credit funds) and other similar types of lending and investment):

In addition, deposit-taking financial institutions should be required by law to disclose annually to the federal government:

Under the current Canadian Payments Association system, deposit-taking financial institutions disclose the location of branches and automatic banking machines across the country each year. The CCRC proposes that financial institutions disclose where branches have been opened and closed during the year.

Each financial institution's raw data should be provided to Statistics Canada to be compiled into reports for regulatory review purposes. Statistics Canada would annually release data for each bank by Parliamentary riding, province, region and aggregate national totals, following Statistics Canada guidelines to ensure that the privacy of specific borrowers is protected.

(iii) Performance Standards

Financial institution branches within each "community" could choose either the strategic plan option or annual evaluation based on the lending, investment and service tests as in the U.S. (see list in section II(b) above). Each financial institution would not be limited to one option on a national basis (i.e. an institution could choose to be evaluated by strategic plan in some communities and by the three tests in other areas). Under the strategic plan option, the financial institution should be allowed to develop a plan containing measurable goals that addresses each of the three performance test categories. The plan should be at most five years in duration, but should have annual, measurable performance goals that include details on how credit needs of low- and moderate-income persons and neighbourhoods are to be met.
If a branch is being evaluated under the three tests process, the criteria of the review should be as follows. For its lending activities in the area of small business and community development, the areas for which financial institutions should be judged are as follows:

  1. number of applicants, approvals and rejections, and change in overall
    amount of loans (number and total amount) for each category (including
    number of loans called during the year), and;
  2. flexibility of lending practices (particularly as they relate to meeting the
    credit needs of low- and moderate-income individuals trying to start
    businesses, of small businesses, and of community development projects).

If the review of the data revealed a pattern of rejecting certain categories of loan applicants (for example, by size of business, gender or the business owner, location of the business, or type of loan), and the loan default and loss rates were similar for these applicants as for other applicants, then the bank would receive a lower grade than if all borrowers of similar risk were treated equally.

For its investment activities in the area of small business and community development, the areas for which financial institutions should be judged are as follows:

  1. number of applicants, approvals and rejections, and change in overall
    amount of investments (number and total amount) for each category
    (including number of investments withdrawn during the year), and;
  2. flexibility of investment practices (particularly as they relate to meeting the
    needs of low- and moderate-income individuals trying to start businesses,
    of small businesses, and of community development projects).

Investments should be reviewed on the same basis as lending, as set out above, so as to ensure that financial institutions do not arbitrarily reject specific investments that meet criteria of reasonable risk and return.
The six elements of the service test for financial institutions should be as follows:

  1. the bank's record of opening and closing branches, especially in low-
    and moderate-income neighbourhoods and communities, and the
    overall distribution of branches;
  2. the availability of alternate service systems (such as electronic or telephone
    banking) especially in communities in which there are no branches;
  3. whether an independent audit of the financial institution's provision of
    basic banking services (as proposed in the CCRC's Position Paper #2,
    Access To Basic Banking Service: Ensuring A Right to This Essential
    Service ) reveals that the institution has lowered the barriers to access to
    services (as most of the chartered banks promised to the federal
    government in February 1997);
  4. overall, whether the range of services provided in different income
    neighbourhoods or communities is tailored to meet the distinct needs
    of each of the neighbourhoods or communities (for example: by providing
    essential services such as cheque-cashing at special service branches,
    or by providing extended hours, assistance in adapting to electronic
    banking, or financial planning services);
  5. the number of complaints received by branch of the financial institution,
    and the rate of resolving the complaints; and
  6. the number of lawsuits initiated by or against the financial institution,
    and the rate of resolving the lawsuits, broken down by province and

If the review of the data on service issues reveals patterns of, for example: closing branches in low- and moderate-income areas (and the closings could not be justified based upon disclosure of the branches profit and loss record); denying access to basic banking service; not providing alternate services to meet the distinct needs of the community, and; a high rate of unresolved complaints or successful lawsuits against the institution, then the financial institution would receive a lower grade than if all customers were treated fairly and equally.

As in the U.S., the tests set out above are a mix of quantitative and more qualitative analyses, with an emphasis on quantitative analysis. The aim of the system is to set performance standards that are definable and measurable, so that financial institutions will know what they must do to obtain a passing grade. At the same time, the tests set out above are not meant to set quotas that the banks must meet, and so are designed to measure demand for lending, investment and services, and whether the demand is legitimate (e.g. not too risky), and then whether banks are meeting the legitimate demand in communities across the country.

(iv) Regulatory Review of Performance

As in the U.S., in meeting the performance standards set out above, actions undertaken by financial institutions should be consistent with the safe and sound operation of the institution.

When assessing a bank's performance, as in the U.S., regulators should take into account a financial institution's financial condition and size, as well as legal impediments and local economic conditions when evaluating an institution's CRA performance, as well as the performance of other financial institutions in the same communities.

As a result of the mix of quantitative and qualitative disclosure requirements and tests, for the first review of a financial institution the institution should not be penalized for poor performance in order to give regulators time to develop and specify the performance standards for each community or area of Canada. For the second review, the financial institution should only be penalized if its grading has not improved since the first review. After the first two reviews, each financial institution branch should be judged based on its overall grade.

The overall grading of each financial institution branch, and each institution in total, should be based upon a weighting of the three tests, as follows: 40% lending test grade; 40% service test grade; 20% investment test grade. This weighting acknowledges that deposit-taking financial institution's core businesses are lending and providing services to small business and individuals, not investment. The branches of each financial institution should be assigned grades of outstanding, satisfactory, marginal or unsatisfactory. Branches should be required to maintain a satisfactory rating overall. One marginal grade should be offset by an outstanding grade. The grades should be required to be posted in each branch. Additionally, the raw data by census tract should be available for any group or individual on the basis of a formal request to Statistics Canada.

Who should have regulatory responsibility? The Office of Superintendent of Financial Institutions (OSFI) should maintain its role as the regulator of financial prudence. The Department of Finance should be responsible for examining the data and evaluating it for each of the three tests, with a final decision concerning rating and penalties by the Minister of Finance. The review of the data in accordance with the three tests should be conducted annually.

In addition, for either the strategic plan option or the three tests evaluation process, banks should be allowed to meet part of their obligations by partnering with local financial institutions. This would involve helping capitalize a community-based institution and having that institution lend and invest funds, or provide services locally. This is also allowed under the U.S. system, where banks have helped capitalize Community Financial Development Institutions (CFDIs). By offering banks the opportunity of partnering with a local financial institution, the overall system should work well for banks, locally based financial institutions and communities.

(v) Community Participation in Performance Review

The enacted legislation should also clearly set out an adequate period of time (e.g. 60 days) in which individuals, community groups, small businesses, local governments and others would have the opportunity to do three things:

(vi) Incentives to Improve Performance

The CCRC proposes that the following sanctions should apply for a financial institution that receives a failing grade for any branch, or overall.

First, local and provincial governments should be explicitly permitted to determine their financial dealings with any financial institution based upon the institution's performance under a the accountability system set out above. Governments should be explicitly permitted to withdraw funds from, as well as cancel financing and investment services contracts with, financial institutions whose branches fail in their jurisdictions. Governments should also be explicitly permitted to make a satisfactory performance rating a mandatory condition that must be met before the government will contract out any services to the financial institution.

Second, if a financial institution proposes to expand within its sector (e.g. a trust company taking over another trust company) or outside its sector (e.g. a bank taking over a trust company) the government that regulates the expansion should be explicitly permitted to deny the right to expand if either financial institution has an overall failing grade.

Third, a representative of senior management and a member of the board of directors of a financial institution should be required to give at least two weeks public notice and then hold a well-publicized public meeting in any community where that financial institution's branch has a failing grade. At the meeting, the institution's representatives should be required to take written and oral submissions from members of the community concerning the performance of the branch, and to detail the institution's plans for obtaining a passing grade in the future.

Fourth, the Minister of Finance should have the right to impose the fines specified by the financial institution legislation if he or she believes such action is warranted. For example, under the Bank Act, where guilt can be established an individual is liable to a fine not exceeding $100,000 and/or imprisonment of up to 12 months and an entity (in this case, the bank) can be fined up to $500,000.

Finally, in its 1996 budget the Ontario government imposed a corporate surtax on the chartered banks, combined with a tax credit that could be applied to the surtax for banks demonstrating support for small business. All provinces should consider enacting similar legislation as an incentive for financial institutions to maintain a satisfactory rating in their overall performance in the province in terms of serving not just small businesses, but all customers. The federal government should, based upon Ontario's example, also convert its current surtax on chartered banks into an incentive for all financial institutions to maintain a high level of performance in providing services to Canadians. At the federal level, tax credits applied to the surtax should be granted proportionally based on the performance of a financial institution on a jurisdiction-by-jurisdiction basis, so that good performance in some provinces does not outweigh poor performance in other provinces and result in financial institutions avoiding the surtax while still performing poorly in some jurisdictions.

VI. CCRC Recommendations

  1. A financial institution accountability system, based upon the existing U.S. federal system and applicable to Canada's domestic chartered banks, should be enacted in Canada as set out in section V(b) above.
  2. Other domestic deposit-taking financial institutions should also be required by law, by the government which regulates their activities, to disclose statistics on their lending, investment and service activities and to be evaluated based upon their performance in these activities, in a manner similar to the system set out above for the chartered banks. The time it may take to enact these requirements should not in any way delay enacting requirements for Canada's chartered banks, because of their dominant position in the financial services industry.
  3. As in the U.S., the size of financial institutions should be taken into account in designing each system, and smaller financial institutions should not be required to meet as detailed disclosure requirements or performance reviews.
  4. An independent ombudsman for the financial services industry should be established by the federal government, with funding required from federally-regulated financial institutions and with the power to make binding rulings, as part of the overall financial institution accountability system in Canada (See the CCRC's Position Paper #1, Bank Ombudsmen: Why They Must Be Independent for details).
  5. All persons able to prove that they are residing in Canada, upon proof of status that does not require extensive identification, should be guaranteed an account with a deposit-taking financial institution, including the option of a low-cost, no-frills account, and protection from arbitrary and excessive holding of cheques (See the CCRC's Position Paper #2, Access To Basic Banking Service: Ensuring A Right to This Essential Service for details).
  6. Canada's federally-regulated bank, trust, and life and health insurance companies should facilitate the start up of a Financial Consumer Organization (FCO) by enclosing the FCO's flyer in their mailing envelopes sent to their customers. If they do not do so voluntarily, the federal government should legislate the FCO's right to enclose its information and solicitation flyers periodically in mailouts that federally- regulated bank, trust, and life and health insurance companies send to their customers (See the CCRC's Position Paper #4: A Financial Consumer Organization for Canada: Balancing the Financial Services Marketplace for details).
  7. Should the World Trade Organization financial services agreement lead to greater liberalization of the Canadian market in financial services, the\ government should adjust the requirements of the financial institution accountability system to ensure that foreign banks comply, and their customers are protected, by the system.


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Canadian Community Reinvestment Coalition
P.O.Box 1040, Station B,
Ottawa, Canada K1P 5R1

Tel: (613) 789-5753
Fax: (613) 241-4758

Email: cancrc@web.net

Copyright 1997 CCRC