History of Banking and Trust Companies in Canada

History of Banking and Trust Companies in Canada

Executive Summary

We can argue that the changes in Canadian financial institutions have been happening since the introduction of formal banks around two hundred years ago. For the last six decades, there have been changes at the legislative level to correct the situation. However, the process of change has been slow compared to other countries like the United States that had liberal financial institutions. The government laws that outlawed foreign ownerships or individuals having more than ten percent shares had several implications. Firstly, they greatly affected expansion and subsequent economics of large scale that was usually enjoyed by their foreign counterparts. Secondly, these inhibited their competitive advantage for a long time at local and international levels.

In recent times, there has been a myriad of positive steps that have fostered progress in the financial systems triggered by government efforts to loosen control and the forces of globalization. One of the notable changes is encroachments of the big five financial institutions into each other’s core operations. For example, banks have moved to trust companies services such as executioners and managers of properties, on the other hand, trust companies have started lending services to their members. This strategy has led to the expansion of financial institutions as they have led to acquisitions and opening of subsidies that deal with new roles they have acquired. For example, banks opening subsidies to deal with the selling of life insurance or other services that they did not do traditionally.

On the other hand, globalization has led to efficiency that is associated with fierce competition. International banks have come into the country and revolutionized technology in the financial sector forcing the local banks to adapt to remain competitive. Another implication is the fact that now it is not enough to just invests in the country as other institutions continue to venture to foreign banks to increase their market base. All these factors have in the long run led to improved performance of Canadian institutions in the country and abroad.

Introduction

The banking system in Canada started in the mid-seventeenth century. Canada as a colony of France suffered from the policies of mercantilists. The mercantilist policy had provisions that encouraged administrators of colonies to move resources to their mother countries. These policies simply led to siphoning of wealth from the colonies by colonizers. Most economic systems had largely depended on precious metals as the foundations of their financial system. It was also the time when most countries in the world were adapting to the gold standard monetary system, hence Canada lacked enough gold or silver. The mercantilist policy, therefore, led to an adequate unit of exchange since money became simply worthless, hence causing a complete collapse of the monetary system in 1690. The government responded by issuing promissory notes. These notes were given to French traders who started to print their notes leading to an informal banking system. However, the French were replaced by the British in Canada and the former embarked on more changes in the banking system and other monetary policies (Canada, 1904).

In the early eighteenth century, the bank of Montreal was issued with a charter and it became the first official bank. It was also granted the right of issuing promissory notes, hence acting as a central bank of Canada. The government also chartered other banks in the subsequent years. However, each bank functioned independently printing its notes, which brought other complications to the economy. One of the problems was inflation, which skyrocketed as each bank injected its currency into the economy. This prompted the government to take control of the banking sector by introducing various laws. The authorities started by withdrawing the printing of currency mandates from the banks and restored those powers entirely in the government. All different currencies, which were in circulation, were replaced with one single currency across the country – the Canadian dollar. The banks continued to work independently until the 1930s when the Bank of Canada was opened as equivalent, hence becoming the official central bank in response to economic challenges caused by the great depression (Kniffin, 1912).

Trust companies started emerging with the first being established in 1864 in Ontario.  The company by name of Huron and Erie was later changed to Canada Trust Inc. However, the first formal trust company was incorporated in 1882; with encouragement from the government, the number rose to 14 by the 1900s. The aim was to have different financial entities from the bank to avoid conflict of interest. The primary aim of trust companies was to hold and manage assets on behalf of individuals or institutions. However, these trust companies experienced tremendous growth and they started offering some services that had been previously solely offered by banks (Bpaus, 1904).

Conversely, in the 1980s, some trust companies engaged in unscrupulous businesses that led most of them to run bankrupt while others were acquired by banks and other institutions. Since 1954, there have been systematic amendments, which have continued to redefine the roles of chartered banks. These laws have been made to enable the financial institutions of Canada to be competitive internally and on a global scale. Some of these amendments have made banks establish their trust services or acquire existing ones. On the other hand, most trust companies have acquired most rights of banking such as the offering of loans (Canada, 1963).

Functioning

Some of the charted banks' main functions include collecting deposits from the general population. These deposits can be fixed, current, recurring, or saving. Firstly, fixed deposits are savings that are deposited for the long term and they yield higher interest. Secondly, current accounts are often set specifically for a business class where individuals deposit and withdraw at will. These accounts are charged with operation costs by the banks. The aim of these accounts is primarily to make it convenient for the business community to carry their business safely. Thirdly, recurring deals occur with small traders or employed people who have a regular income. They make agreements with banks about the period of maturity and they normally attract considerable interest rates. Finally, savings are specifically set to encourage savings from the public and yield some interest, though it is not high. Savers are also allowed to withdraw under certain circumstances, which are normally negotiated with the banks (Canada, 1961).

Moreover, the bank grants advance loans to public and other business institutions. These loans are used for investments or other purposes. The banks, therefore, act as an agent of providing capital for individuals and business communities. The advances are mostly given to employed people who may need money urgently before their salaries are due. These loans also act as revenue-generating instruments for banks. To get profits banks usually lend money at a higher rate than they give interest and the difference acts as profit. Some of the bank loans and advances include loans to purchase bills of exchanges. Loans deal with payments, which are based on installments and spread over a certain period. Overdrafts are a scenario where the clients are allowed to withdraw more than what they have and they are then charged interest on the overdraft. Finally, cash credit happens when the client has an agreement with the bank about the amount of money they should withdraw as credit. If they exceed the agreed credit amount, then they are charged a certain percentage (Durnik, 2008).

Other functions of banks are not usually directly connected to convectional banking and they are therefore known as second functions of the bank. The banks usually perform various tasks on behalf of their customers, hence acting like agencies. Some of the functions include periodic collectors where the commercial banks are granted rights to collect money on behalf of their clients. These monies include salaries when employers deposit their workers’ salaries to the banks. They also receive pensions from trust companies and pensioners withdraw directly from the banks. The firms also deposit dividends of their shareholder in the banks.

The banks also perform portfolio duties on behalf of their clients. A portfolio generally deals with the selling and purchasing of shares or debentures. They are principal agents in the collection of cheques and bills of exchange money. Finally, they transfer funds from individuals or institutions through direct deposits from one account to another. They also move money from one region to another. Banks also perform the following functions on behalf of their customers; they also act like executors, advisers, and administrators. Other functions include general utility when they deal with the preparing of project reports on behalf of their clients, issue of letters of credit, which is crucial when dealing with import trade, underwriting of various shares, with foreign exchange, locker facility of valuable things like gold or documents, and social welfare programs, which mainly deal with giving back to the community (Rhea, 1968).

On the other hand, the primary function of a trusted company is usually to manage resources on behalf of individuals or institutions. They mainly handle resources of a business nature and they manage them on behalf of the owners too who they are legally accountable. This works in such a way that they are given inclusive rights of handling the business and consequently deal with the following functions: collecting dividends, leases, interests, and rents, executing contracts on behalf of the owners, and paying taxes. Some of the dealings include managing pension schemes and mutual funds. The accumulated profit is usually reinvested in the business or they diversify and invest in other projects. This acts to broaden their profits base and also to make the business safe from collapsing in case one business fails. One of the business areas they have heavily invested in is real estate where they are involved in individual and corporate mortgagees. They also invest from time to time in government bonds and securities due to their lucrative returns. These investments are paramount to deal with inflations and also to generate interest for pensioners and other stakeholders (Sa? nchez & Shadlen, 2008)

They also pay dividends to the owners according to speculated rules in their agreement. They offer continuity of the business even after the demise of the owner. This is simply because they are institutions, hence continuity of them running the business under their custody is always guaranteed. They offer expertise in the business in question, which the owners might not generally have at their disposal. This can be attributed to the fact that they hire professionals in running the business activities. Professionalism makes sure that these businesses are well managed. The fact that these trust companies are closely monitored by the government to make sure there is accountability and constant auditing by independent bodies makes sure there are checks and balances and protection of clients and their properties from abuse by these companies. Trust companies also issue loans, deposits of trust, cash, and offer checks. In recent years, they have ventured into territories that were previously considered bank territories. The banks have also ventured into the trust companies' business by opening subsidies, buying shares, or by acquisition (Cohn, McBride, & Wiseman, 2000).

Government Roles in the Bank

Since the incorporation of the banking system in the colonial government, the authorities have always played significant roles in shaping the financial system. Although chartered banks are privately owned, the government has played a regulatory role. These regulations have been made to shape economic policies or to simply shape the banking sector in a certain way by defining the roles of the bank. The government, therefore, influences the banks through legislation of various laws or the bank of Canada. Some roles of the government have been discussed here below: the government incorporates and supervises charted banks. They, therefore, approve the establishment of the banks and also make sure that banks adhere to rules that have been set (Beckhart, 1954). Some of the rules are usually made by the legislative arm of the government. In fact, since 1957, there have been several amendments that have dealt with the regulations of the banking systems. For example, the 1967 act abolished the interest rate ceiling that had been set by the government to deal with lending. These enable banks to set interests rates that generally benefit them and at the same time attract consumers.

 The government also defines the functions of charted banks. They add the roles or change them appropriately to help the banks keep up with emerging trends in the banking sector. This to some extent is to help charted banks have a competitive ability and also to deal with the logistics of globalization. The act of 1987 also granted charted banks authority to engage in activities that were primarily for trust companies. These enabled banks to broaden their market base and also increase their capital like their foreign bank counterparts, hence incorporating the benefits of large scale. The government also does auditing of the banks, especially those that deal with other businesses such as trust and life insurance to make sure there is accountability. The government also approves the foreign banks that venture into the Canadian market and sets rules for them. For example, before the 1960s, the government prevented foreign banks from venturing into the country. The aim was to protect local government from the competition. Moreover, subsequent years have made government abandon this policy due to the effects of globalization (Per & Bengt, 1997).

Other significant roles of the government are played by the bank of Canada, which is the central bank and an arm of government to some extent. The government, therefore, uses the bank to influence chartered banks to implement monetary policies and at the same time deal with the challenges of the economy. One of the roles in determining the interest rate, which is solely set according to the influence they want to make in the economy. If they want to boost growth, they lower interest rates, which consequently make the charted banks lower theirs. The impact is that it makes it cheaper to get loans for businesses to operate or capital for investing fostering the economy in the process. Lower interest rates also reduce the burden of households in terms of paying mortgages and they can spend more, which is an ingredient of economic growth. The interest rates are also used to curb inflations by making sure they tighten money in circulation (Goldsmith, 1963).

In times of economic crises like the 2008 credit crunch, the government plays an important role by stimulus packages, which involve injecting money into the economy to promote growth. They also come to the rescue in case the banks go into bankruptcy where they act in the interest of the public. For example, they may rescue the bank by bailing it up to keep the bank running. This to some extent can be to protect the public who has their investment such as savings in the bank. The move is motivated by the will of the government to protect the employees of the bank in question from losing their jobs (Cote, 2004).

The bank of Canada also stabilizes the country’s currency against other foreign currencies. This helps the Canadian dollar to remain competitive in terms of exports and imports. This is because if the Canadian dollar gains much, it will disadvantage Canadian goods against other goods of other countries. After all, they will appear cheaper, hence making local goods less competitive. On the other hand, if the dollar loses value much, it will generally make imports more expensive. Increases in the price of imports like gas will generally increase the cost of production causing inflation and hurting consumer spending. The central bank, therefore, buys the Canadian dollar when there is excessive supply to add its value and consequently sells it when its value increases excessively to lower its value (Bank of Canada, 1994).

The bank also acts as the bank of the last resort for charted banks. The law requires that all chartered banks deposit a certain percentage with the bank. This acts as a backup system and makes sure the banks do not engage in unscrupulous practices that might have economic repercussions or simply hurt their clients. It also acts to maintain public confidence in terms of monetary terms. This is manifested by the fact that the bank is the only body granted inclusive rights to print money and it, therefore, puts enough measures to deal with counterfeits. It is also the bank of Canada that the government participates in through its dealing with financial matters. For example, the bank acts as the agent of the government in selling and redemption of government securities and bonds. The bonds and securities are traded with banks and other institutions like trust companies that deal directly with the public (Bank of Canada, 2003).

Changing Roles of Banks

  The Canadian monetary and financial system is mainly engulfed by five institutions. These institutions are securities dealers, chartered banks, life insurance brokers, credit cooperatives, and loans and trust companies. These five forces deal with their core agendas under the laws of the federal or provincial government. For the last thirty years, there have been substantial changes in the Canadian financial system at the institutional level. The changes have focused on the functions of these financial institutions in terms of the roles they play. For example, the 1992 Act of the parliament that allowed banks to venture into the trust business has led to several changes in the banking sector roles. The banks have ventured into the market through acquisitions of these trust companies and have consequently started offering various services. Some of these services are managing the property as the trustee. They also reinvest money generated by these institutions they manage and at the same pay dividends to their clients (Shaw, 1972).

The banks have also joined the insurance market where they are involved in selling insurances. The selling of life insurance was previously restricted to insurance companies. However, they have set other subsidies to deal with selling insurance because they have been prohibited by law. This is to prevent the banks from using the information about the financial situations of their clients to their advantage. The law argues that they can be used to track down people and sell them insurance, which can disadvantage other insurance companies who do not have the same information. Their entry into the insurance sector has made them assume the roles that were done by the insurance companies. They are also involved in the residential mortgages and the management and setting up of real estate properties. They are involved in mutual fund business of which they offer those services in their branches all over the country. This means they have started performing those activities that were mainly done by the mutual funds such as actively participating in the stock market. The money market business has increased due to its advantages when it comes to marketing (Menipaz & Menipaz, 2011).

The entry of small banks into the market has changed mortgage practices as they now offer different products that were not there before. In 1987, amendments were made that allowed charted banks to venture into the securities business. The charted banks could now engage insecurities, although there were some exemptions. They, therefore, started engaging in corporate securities. The banks were also granted rights to distribute and sell government bonds. The banks were also granted rights to engage in portfolio business from 1992 onwards. The way of borrowing and lending has also changed in recent years. In the previous times, the role was played by the banks that dealt directly with the borrowers and lenders, but now those duties have been taken up by brokers who act as intermediaries. Most people who are looking for mortgages use brokers who take commissions from the bank for every customer they bring to the fold. Chartered have banks previously dealt with commercial loans, but now they have significantly changed to deal with individual loans. On the other hand, banks have also started offering credit for mortgages (Lerner & Schoar, 2010).

However, the most significant changes concern their participation in globalization. Although they have held a conservative approach to the matter for several decades, changes in the banking dynamics have made them venture into foreign countries. This has been largely facilitated by previous laws that encouraged mergers in the banking sector. The merger led to the establishment of around six banks with branches across the country. The subsequent laws that have enabled them to venture into other sectors of finance have made them accumulate capital to venture into foreign markets. Finally, international markets have ventured into the Canadian markets leading to fierce competition and hence the necessity to expand to widen their market bases (Naylor, 1957).

On the other hand, trust companies concentrated on mortgages’ operations in terms of deposits. For the last thirty years, they have been implementing vigorous policies, which have made them expand their operations. They have acquired some bank status such as lending money to commercial institutions and individuals. They also offer discretionary fiduciary services over which they have held inclusive rights until recently. Cooperatives, trust companies, and chartered banks have in recent times been competing fiercely for deposits. Life insurance dealers hold a substantial difference from other financial institutions. They generally deal with investments in bonds, stocks, and mortgages. The government has restricted them to provide convectional bank services, but they sell other services such as premiums, which is almost the same as fixed deposits that are offered in banks and other financial institutions (Polakoff & Ketchum, 1970).

Securities dealers generally deal with offering advice on stocks and bonds as well as participating in the second sales of the same. However, legislations, which have been developed for the last six decades, have been harmonizing the distinctive roles of these institutions. The difference between them is about what they can offer and it is diminishing, which means they are sharing to a large extent the same market base. These have led to fierce competition between these institutions as their roles keep on changing. In the long run, the changing roles of the banks are merely the incorporations of functions that were traditionally executed by other financial institutions like trust companies (Stern, 2007)

Globalization

The banking system of Canada continued to grow uninterrupted until the 1960s when the government allowed a foreign bank to venture into the country. This opened fierce competition in the sector, which for over one hundred years was dominated by few banks that had spread their tentacles across the country. Globalization was slow to penetrate the Canadian financial system mainly due to its conservative laws. However, it has finally been incorporated with significant changes in the financial systems of Canada. Regrettably, Canadian banks have been adversely affected by this encroachment of foreign banks as their profits dwindle at an alarming rate. The foreign banks have completely nullified measures that were in place to deal with issues like economies of scale and the general size of the institutions (Konh, 1994).  

Therefore, authorities were forced by circumstances to increase the functions of the bank to give them a competing ability with their foreign bank counterparts. This is simply because most countries have for a long time allowed their banks to venture into other areas like insurance and trustee business. Unfortunately, Canadian laws have for a long time separated the venture between different players. The implication was that Canadian banks lacked competing powers because they did not have a substantial market base like their foreign counters, hence diminishing their growth potential. Some of the changes include the laws that dealt with investment counseling. These changes were made to deal with globalization dynamics. The increased usage of the internet in the country coupled with the fact that Canadians have a highly adapted internet usage means that the financial institutions have been forced to incorporate it. This can be attributed to the fact that international institutions that largely enjoy advantages of large scale have introduced the technology, which has a considerable appeal to the consumers, hence making it a necessity for the local institutions to adopt the same to compete effectively (Ketikidis, 1986).  

Most countries at the time had adopted a system where companies used different methods to raise capital for expansion or innovation. Traditionally, companies could seek capital from the banks in terms of loans. This was always a lucrative deal on the part of the banks because of the returns in terms of interest rates. However, these changes led corporations to raise their capital using alternative methods. Instead of taking loans, corporations now looked for partners to raise capital. They could float their shares in the stock exchange to raise funds, hence cutting a considerable revenue channel for banks. Foreign banks had adapted accordingly to venture into other areas like money funds to maintain their income advantage (Deloitte & Touche, 2011).

In the 1967 bank amendment, the government outlined that individuals or institutions should own more than ten percent of the shares in the banks. This policy was introduced to make sure that all Canadian banks remained domestically owned. The policy was also intended to make sure the banks are controlled by the locals and their decisions would not be influenced by principal owners. However, the policy hurt the Canadian banks in terms of limiting their expansion. The problem was aggravated in the 1980s when foreign banks were granted the right to open their subsidies, but they still faced restrictions in terms of size. Although these worked to the advantage of the Canadian banks, subsequent treaties like that of Canada and the United States allowed the American banks to expand prompting authorities to change their policies to maintain competition capabilities. In the 1990s, the authorities changed rules and allowed the banks to expand and merge to effectively compete on the local and international markets (Johnson, 2002).

Globalization has also changed how financial institutions of Canada carry their business to some extent. The success of the institutions has to be based on their performance in foreign countries. This is because international institutions have heavily ventured into Canada and adversely affected the market share that was inclusively enjoyed by the Canadian banks. This has forced Canadian institutions to venture into other countries to maintain their profit margin and at the same time spread the spectrum of their income base. Venturing into other international markets has altered their structures and functions (Bhattacharyay, 1995).

Another aspect of globalization is the fact that it has become inevitable to prevent foreign ownership of Canadian financial institutions. In fact, for the last two decades, foreign ownership has increased tremendously. There is also a high influx of non-Canadian executives in the financial institutions and this has consequently erased the protection laws that have been in place for decades. The Canadian institutions have also acquired foreign institutions to step up the competition. To pool the best talents available, Canadian institutions are increasingly hiring foreign executives to boost their competitiveness. This is because Canadian institutions are also venturing into other markets and they need diversity, which is paramount for innovation (Berger, 1998).

The government has also changed financial institution policies to deal with the changes that are being posed by globalization. The approach of formulating policies has also changed significantly over the last three decades. The laws, which are being made nowadays, are formulated in the context of globalization implications. More emphasis is made on how these changes will affect the institutions’ performance on local and international levels (Canada, 1986).