Discussion Paper/Document danalyse

2012-7
Canadian Bank Balance-Sheet
Management: Breakdown by Types of
Canadian Financial Institutions
by David Xiao Chen, H. Evren Damar, Hani Soubra and
Yaz Terajima

2
Bank of Canada Discussion Paper 2012-7
September 2012
Canadian Bank Balance-Sheet
Management: Breakdown by Types of
Canadian Financial Institutions
by
David Xiao Chen,
1
H. Evren Damar,
2
Hani Soubra
2
and Yaz Terajima
3

1
Data and Statistics Office
2
Financial Stability Department
3
Canadian Economic Analysis Department
Bank of Canada
Ottawa, Ontario, Canada K1A 0G9
chex@bankofcanada.ca
edamar@bankofcanada.ca
hsoubra@bankofcanada.ca
yterajima@bankofcanada.ca
Bank of Canada discussion papers are completed research studies on a wide variety of technical subjects
relevant to central bank policy. The views expressed in this paper are those of the authors.
No responsibility for them should be attributed to the Bank of Canada.

ISSN 1914-0568 2012 Bank of Canada

ii
Acknowledgements
TheauthorswouldliketothankIanChristensen,SamiAlpandaandVirginieTracletattheBank
ofCanada,andanumberofourcolleaguesinotherOttawaagenciesfortheircomments,
suggestionsandinputs.
iii
Abstract
Theauthorsdocumentleverage,capitalandliquidityratiosofbanksinCanada.Theseratiosare
important indicators of different types of risk with respect to a banks balancesheet
management. Particular attention is given to the observations by different types of banks,
includingsmallbanks thathistoricallyreceivedless attention. In addition, the authorscompare
leverageandcapitalratiosforbanksinCanadaandtheUnitedStatesintheperiodleadingupto
the recent crisis. They find that in Canada, most of the risks indicated by these balancesheet
ratiosareconcentratedamonglargebanksthataremorelikelyabletowithstandshocksdueto
their diversified portfolios. Some smaller banks, however, reveal vulnerability against liquidity
risks.RegardingaCanadaU.S.comparison,smallU.S.banksshowmorevulnerabilitythantheir
largercounterparts,aswellasanincreasingtrendinvulnerabilitypriortothecrisis.Incontrast,
theratiosforsmallCanadianbanksshowincreasingresilience.
JELclassification:G21,G28
Bankclassification:Financialinstitutions;Financialstability;Financialsystemregulationand
policies
Rsum
Lesauteurstudientlesratiosdelevier,defondspropresetdeliquiditdesbanquesauCanada.
Ces ratios sont dimportants indicateurs des diffrents types de risques du point de vue de la
gestion des bilans bancaires. Les auteurs prtent une attention particulire aux observations
concernant diffrents types dtablissements, notamment les banques de petite taille
auxquellesonesthistoriquementmoinsattentif.Parailleurs,ilscomparentlesratiosdelevieret
defondspropresdesbanquesauCanadaetauxtatsUnisaucoursdelapriodequiaprcd
la crise rcente. Ils constatent quau Canada, la plupart des risques signals par ces ratios de
bilanseconcentrentdanslesgrandesbanques,qui,dufaitdeleursportefeuillesdiversifis,sont
plussusceptiblesdersisterauxchocs.Certainesinstitutionsdepluspetitetailleservlentpar
contre vulnrables face aux risques de liquidit. Pour ce qui est de la comparaison entre le
Canada et les tatsUnis, les auteurs notent que les petites banques amricaines affichent plus
devulnrabilitqueleurshomologuesdegrandetailleetquecettefragilittendaitaugmenter
avant la crise. Dans le cas des petites banques au Canada, les ratios examins dnotent au
contraireunersiliencecroissante.
ClassificationJEL:G21,G28
ClassificationdelaBanque:Institutionsfinancires;Stabilitfinancire;Rglementationet
politiquesrelativesausystmefinancier

1. Introduction
Asafeandefficientfinancialsystemcontributesto efficientallocationsofresourcesinan economy,
given that financial services are an essential input in all sectors.
1
A bank failure not only can
potentiallydisruptfinancialservicestoeconomicagents,butalsocanpotentiallyleadtootherbank
failuresthroughcontagion.Arguably,thelargerthebank,thegreateritssystemicimplications.Thisis
mainlywhypolicymakershavelongbeenconcernedwith,andfocusedon,thefinancialstabilityand
soundness of the large, internationally active banks. However, smaller banks tend to have less
diversified portfolios and moreconcentrated operations geographically.
2
Thus, they may be more
vulnerable to sectorspecific or regionspecific shocks than larger banks with welldiversified
portfolios located within a broader geographic area. Concurrent small bank failures could also be a
sourceofinstabilitytothefinancialsystem.
3,4

In order to assess risks arising from different types of financial institutions, it is important to first
understand the similarities and differences among them. This paper examines data on different
financial institutions to document and analyze indicators of balancesheet risks, such as leverage,
capital and liquidity ratios. We take two separate approaches in achieving this goal. First, using
Canadian data, we explore the similarities and differences in risks to the balance sheets of various
financialinstitutions,groupedbytheirbalancesheetsize,chartertypeandrelianceonmarketbased
funding.Second,wecomparebalancesheetriskindicatorsofCanadianandU.S.financialinstitutions,
payingparticularattentiontotheperiodleadinguptotherecentfinancialcrisis.
Our main findings regarding the first objective are summarized as follows. First, risk indicators have
decreased during the past three decades for most nonBig Six financial institutions, and have
remained relatively unchanged for the Big Six banks.
5
As a result, a divergence between nonBig Six
and the Big Six banks is observed, especially in leverage and capital ratios. Second, heterogeneity
among nonBig Six financial institutions has increased, especially in capital and funding ratios. The
observedoveralldeclineandincreased heterogeneityintheriskindicatorsfollowcertainregulatory
changes,suchastheintroductionofliquidityguidelinesonfundingin1995andtheimplementation
of bankspecific leverage requirements in 2000. This suggests that regulatory changes have had
significantandheterogeneouseffectsonthemanagementofbalancesheetsbyfinancialinstitutions

1
Formoredetailsontherelationshipbetweenthebankingsectorandeconomicgrowth,seeKingandLevine
(1993);Levine(1997);Northcott(2004).
2
Bergeretal.(2005),forexample,arguethatsmallbankstendtofollowamodelthatinvolvesrelationship
lending,whichrequiresmoreinformationthansimplywhatcreditscoresandfinancialrecordsreveal.Thismodel
makesiteasierforsmallbankstolendtocertaintypesofborrowersthatmayotherwisefinditdifficulttoobtain
credit.
3
Despitetheirsmallsize,theCanadianCommercialBank(CCB)andNorthlandBankfailuresin1985wereseento
havehadthepotentialtoadverselyaffectthebroaderCanadianbankingsystem(IllingandLiu2003,9).
4
SeeAllenandGale(2000);ChanLau(2010).Also,Gauthieretal.(2011)arguethatasmallbankcanpotentiallybe
systemicallyimportantduetoitscentralityintheinterbanknetworkofcounterparties.
5
TheCanadianbankingsectorisdominatedbythelargestsixbanks,sometimesreferredtoastheBigSixbanks.
SeeAppendixDforalistoftheirnames.

and,giventhattheseregulationsrequiredmorebalancesheetriskmanagement,theycontributedto
theincreasedresilienceofthebankingsector.
Third, some noteworthy observations are made among nonBig Six financial institutions. In the size
category, large nonBig Six financial institutions are found to be similar in balancesheet ratios to
those of the Big Six, due to their similarities in asset and liability portfolios. Regarding the charter
type category, nonBig Six domestic banks persistently exhibit low assetliquidity ratios relative to
other charter types and relative to the Big Six banks. When we look at the funding category, high
wholesalefundingfinancialinstitutionshaveahistoricallyveryhighaveragefundingratio,at70per
cent.AlthoughthisnumberisbydefaulthigherthanthatofallothernonBigSixfinancialinstitutions,
itisinterestingtonotethattheaveragefundingratiooftheBigSix,whichhouseinvestmentbanking
businesses,isonlyabout46percent.However,thisdifferencehasshrunkovertime,suchthatinthe
2000s, nonBig Six high wholesale financial institutions funded 52 per cent of assets by wholesale
funding,comparedto46percentfortheBigSixbanks.
Regarding our second objective comparing Canada and the United States we find that the
leverageratiosofsmallbankshadbeenincreasinglylowerthanthoseoftheirlargerpeersinCanada
leading up to the crisis, while small banks in the United States had higher ratios than their larger
peers. Thus, in the United States, the risk associated with high leverage was more concentrated
amongsmallerbanksthataretypicallymorevulnerabletoawiderrangeofadverseshocksthanthe
largerbanks.
OurpaperisrelevanttoothersstudyingthespecificsoftheCanadianbankingsector,aswellasthose
analyzing dynamics of bank heterogeneity. Recent literature discusses differences that potentially
contributedtolessseverestressamongbanksandinthebankingsysteminCanadaduringthecrisis.
Brean,KryzanowskiandRoberts(2011)arguethattheregulatoryandstructuraldifferencesbetween
the Canadian and American banking systems can help explain the different outcomes in bank
performance during the crisis. Most notably, they argue that the greater stability of the Canadian
systemstemsfromthestringentandprudentbankingregulationsovertheyears.Also,Ratnovskiand
Huang (2009)assesskeysourcesoflargeCanadian banksresilience duringthefinancial crisis.Their
paper analyzes whether precrisis conditions at global banks in terms of three structural balance
sheetratios(capital,liquidityandfundingratios)wereasignificantdeterminantofbankperformance
during the crisis, and whether they required government assistance. They argue that the funding
structureofCanadianbanks,combinedwithstringentandprudentregulatoryoversight,wasthekey
sourceoftheirresilienceduringthecrisis.Wagster(2012)arguesthattheCanadianbanksfaredwell
during the Great Depression due to close supervision by regulators that required the banks to raise
and maintain high capital ratios during good times. Also, he argues that there are similarities
between the banks capital structure in the 1930s and the Basel III requirements. In addition to a
doubleliability feature (similar to contingent capital), the banks capital in the 1930s comprised
mainly common equity, similar to the Basel III common equity Tier 1 ratio. Moreover, bank note
issuance regulations, which are directly linked to the level of capital that banks hold and to credit
growth,mirroredfeaturesthatthecountercyclicalbufferofBaselIIIistryingtoachieve.

Regardingtheheterogeneityofbanks,Ennis(2001)arguesthatbanksizeheterogeneityisaresultof
anexplicitequilibriumchoiceratherthanatransitoryphenomenon,asthelifecycletheoriesoffirms
prescribe. But regulations concerning branching restrictions also played a role in the large numbers
of small banks in the United States, in contrast to the Canadian financial system, where no such
regulationswereinplace.
Therestofthispaperisorganizedasfollows:section2describesthedataandthemethodologyused
in this study. Section 3 discusses the heterogeneity in balancesheet ratios among the Canadian
banksandsection4comparesCanadianandU.S.banks.Section5offerssomeconclusions.
2. DataandMethodology

This section discusses the data source, the definition of the banking variables and the methodology
forgroupingthebanks.

2.1. Datasource
Our database for the Canadian financial institutions is based on financial regulatory reports, jointly
owned by the Bank of Canada, the Office of the Superintendent of Financial Institutions (OSFI) and
theCanadianDepositInsuranceCorporation(CDIC).
6

The database is organized by returns, which represent regulatory reporting forms for all federally
regulated deposittaking institutions (DTIs).
7,8
Those returns have evolved over the years to reflect
the changes to the Bank Act, accounting rules and regulations. The first returns date back to 1976,
but were replaced by new returns packages in 1981
9
as a result of the Bank Act revision. Again, in
1991, the Bank Act was revisited but it was not until 1994
10
that major reforms were made to the
returns packages (see Appendix A for more details on regulatory changes). Since the number of
reportinginstitutionsstabilizedaftermid1982,welimitouranalysistotheperiodstartingin1983.
Asof2010,thedatabasecomprises25differentregulatoryreturns(seeAppendixCforthecomplete
list of returns).
11
There are four core returns: the Basel Capital Adequacy Return (BCAR), the
QuarterlySupplementaryReturnforForeignBankBranches(K3),theIncomeStatement(P3)andthe
BalanceSheet(M4/L4).Theotherreturnscorrespondtoadditionalinformationonselectedbalance
sheet items (e.g., nonmortgage loan breakdowns by industry (A2), and loans in arrears (N3)). The
reportedfrequencyisnotidenticalacrossallreturns.Theyarereportedmonthly,quarterly(fiscalor

6
Datasince1996areavailablefromOSFIat<http://www.osfibsif.gc.ca/osfi/index_e.aspx?ArticleID=554>.
7
Inthispaper,weusebank,deposittakinginstitutionandfinancialinstitutioninterchangeablyunless
otherwisespecified.
8
ThereportingformsareavailablefromOSFIat<http://www.osfibsif.gc.ca/osfi/index_e.aspx?DetailID=520>.
9
Formoredetailonthechanges,seeBankofCanadaReviewDecember1982andearlierissues.
10
Formoredetailonthechanges,seeBankofCanadaReview19931994winterissueandOSFIreporting
instructions.
11
Thesereturnsareavailableat<http://www.osfibsif.gc.ca/osfi/index_e.aspx?DetailID=520>.

calendar)orannually.Moreover,thereportingrequirementforeachreturndependsontheDTItype.
Forinstance,foreignbankbranchesarenotrequiredtoreporttheBCAR.
The database contains 244 active and inactive DTIs that can be categorized as domestic banks (and
their subsidiaries), foreign bank subsidiaries, foreign bank branches (lending branch or fullservice
branch)andtrustandloancompanies(subsidiariesandnonsubsidiaries).Toavoiddoublecounting,
weeliminatebanksandtrustandloancompaniesthatareconsolidatedsubsidiariesofanotherDTIin
the dataset (since 1980, subsidiaries that are owned with more than a 50 per cent voting share are
consolidated with their parent company financial reports using the acquisition method). However,
banksandtrustandloancompaniesthatexistedasanindependententitybeforebeingacquiredand
consolidatedwiththeparentcompanyasasubsidiaryweretreatedasaseparateobservationduring
the period in which they were independent.
12
Moreover, we exclude foreign bank branches, since
they are not required to hold equity which is a necessary item for calculating the leverage and
capitalratios
13
orrequiredtosatisfyOSFIsliquidityrequirements.Wehavemonthlybalancesheet
data over the period January 1983 to August 2011. This leaves us with a sample of 156 DTIs, which
make a dataset of 22,899bankmonth combinations. On average, there are 67 active banks at each
timeperiod.
14

The U.S. banking data are collected from the Federal Reserve Bank of Chicago (FRBC) bank holding
company(BHC)database,whichcontainsquarterlyfinancialdataonaconsolidatedbasissince1986.
Thedatabasehas14,615activeandinactiveBHCs.Weconsideronlybankswithatleast$500million
intotalassets;assuch,oursamplevariesbetween346and937observationsateachtimeperiod.
15

2.2. Bankgroups
First, we divide our sample into two broad categories: the Big Six banks and other financial
institutions,nonBigSixbanks.Thelattergroupisfurthersubdividedinthreeways:bytotalassetsize
(large, medium and small); by charter type (foreign subsidiary, other domestic bank, and trust and
loancompany);
16
andbyfundingsource(high,lowandnowholesalefunding).
17

12
Therewere13suchcases.
13
Instead,OSFIrequiresthattheforeignbankbranchesholdacapitalequivalencydepositwithanapproved
financialinstitutioninCanada.Therequirementsandinstructionsareavailableat<http://www.osfi
bsif.gc.ca/app/DocRepository/1/eng/guidelines/capital/guidelines/a10fbb_e.pdf>.
14
Weexcludeoutliers,includingthosechangingleveragemorethan100percentinamonth,thosewithnegative
equityorthosewithaTier1capitalratioabove500.
15
Between1986and2006,theFRBCdatabasecollecteddataonBHCswithatleast$150millionintotalassets.As
ofMarch2006,thisminimumthresholdhasbeenchangedto$500million,mainlyduetoindustryconsolidation.
16
OtherdomesticbanksareCanadianbanks,whileforeignsubsidiariesareforeignbankswithaCanadiancharter.
Trustandloancompanieshavetraditionallyconcentratedonresidentialmortgagesandtermdeposits,atleast
untilthe1990s(Freedman1998).SeeAppendixDforalistofactivefinancialinstitutionsineachcategoryasat
August2011.
17
Categorizationbybusinessline(e.g.,theriskinessofassetportfolio)correlateswiththatbyfundingtype,and
henceisnotincludedinthispaper.

For the size category, at each month we sort nonBig Six banks by size and divide them into three
groupsofequalnumbers:large,mediumandsmall.
18

Similarly,forthefundingsourcecategory,wedividenonBigSixbanksintothreegroupsaccordingto
their use of wholesale funding (i.e., the sum of nonpersonal deposits and repos divided by total
assets): high wholesale funding (high WSF), low wholesale funding (low WSF) and no wholesale
funding(noWSF).Ineachperiod,thenumberofbankswithapositiveamountofwholesalefunding
is equally divided between the high and the low. As for charter types, we directly apply OSFIs
definitions: foreign subsidiaries, domestic banks (excluding the Big Six banks), and trust and loan
companies.

18
InAugust2011,thelargefinancialinstitutionswerethosevaluedatmorethan$2.2billion;themediumsized
financialinstitutionswerethosevaluedatbetween$0.2billionand$2.2billion;andthesmallwerethosevaluedat
lessthan$0.2billion.

Table1givessummarystatisticsofoursample.
19
InAugust2011,thecombinedtotalassetsoftheBig
Six made up about 90 per cent of all the institutions studied. Among nonBig Six banks, the large,
foreign subsidiary, high and low wholesale funding groups are relatively large, with combined total
assetsof$284,$166,$154and$124billion,respectively.Averagebanksizesinthesegroupsarealso
relativelylargeamongnonBigSixbanks.
Regarding the number of banks in each group, the monthly average numbers are equal in the size
categorybydesign.Inthechartertypecategory,therearemoreforeignsubsidiarybanks,at41,than
eitherintheotherdomesticcategoryorinthetrustandloancategory(with7and23,respectively).
There are equal numbers of the high and the low wholesale funding banks by design, but, at the
same time, we observe a sizable number of banks in the no wholesale funding category, with 11
banks on average. The minimum number of 1 within the no wholesale funding category occurred
during the earlier period in the dataset when the use of wholesale funding was more prevalent
amongbanks.
Finally, the last two rows in Table 1 list the average number of Canadian provinces (out of 10 total
provinces) in which banks in each category operate, and the percentage of total assets located in
Ontario,respectively.HighernumbersofoperatingprovincesandlowpercentageofassetsinOntario

19
Financialinstitutionsfromeachchartertypearerepresentedamongthelargefinancialinstitutions.See
AppendixD.
Table1:SummarystatisticsoftheCanadianfinancialinstitutionsinoursample

BigSix
banks
NonBigSixbanks

Large Medium Small

Foreign
subsidiary
Other
domestic
bank
Trustand
loan
company
a

High
wholesale
funding
Low
wholesale
funding
No
wholesale
funding
Assets(inbillions),August2011
Total 3,076.1 284.2 16.3 1.5 165.8 73.6 62.6 154.1 123.5 24.4
Average 512.7 14.2 0.8 0.1 8.7 4.9 2.4 7.7 6.5 1.2
Numberofbanks,January1983August2011
Average 6 20 20 21 41 7 23 25 25 11
Standard
deviation 0 1.1 1.1 1.1 15.6 3.9 3.7 4.9 4.8 8.4
Max 6 24 23 24 59 15 29 33 32 26
Min 6 17 16 17 18 2 17 16 16 1
Geographicalconcentration,January1983August2011
Numberof
provincesin
whichassets
arelocated 10 6 4.4 2.7 3.8 6.7 6.2 3.8 5.2 5
Percentageof
assetsin
Ontario(%) 20 33.8 41.5 38.4 41.6 24.7 32.9 41.3 37.5 24.8
a
Dataonthenumberandgeographicalconcentrationoftrustandloancompaniesdatefrom1996.
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanada

imply higher degrees of geographical diversification. The Big Six banks are more diversified
geographicallythanother institutions, asshowninthelast tworowsofthetable;theyare activein
all10provincesand,asagroup,havethelowestpercentageoftheirtotalassetslocatedinOntario,
thelargestprovince.
20
Incontrast,theothergroupsofinstitutionsareactiveinasmallernumberof
provinces and hold a higher proportion of their assets in Ontario. These include small, foreign
subsidiaryandhighwholesalefundingbanks.Thisisespeciallytrueforforeignsubsidiaries,whichare
theleastgeographicallydiversifiedamongthethreechartertypes,despiteaccountingformorethan
halfoftheassetsinthenonBigSixcategory.
FortheCanadaU.S.comparison,wedefinethetop30banksateachtimeperiodaslargeU.S.banks
andcomparethemtotheBigSixbanksinCanada.Similarly,therestoftheU.S.banksaredefinedto
besmallbanksandcomparedtononBigSixbanksinCanada.
21

2.3. Definitionsoffourmeasuresofriskstobankbalancesheets

Our analysis focuses on four important ratios that capture different balancesheet risks.
22
Currently,
banks are required to comply with several regulatory requirements, including leverage, capital and
liquidity ratios. These minimum requirements are set and regularly monitored by OSFI. In this
section, we briefly describe these balancesheet ratios. A detailed summary of the regulatory
changesrelatedtotheseratiosisprovidedinAppendixA.

a) Leverageratio

A leverage ratio measures risk associated with noncapital funding of overall balance sheets. It is a
simpleandtransparentmeasureofbalancesheetrisk,notsubjecttomodelandmeasurementerrors
associated with assetrisk calculations. All else equal, a higher ratio is associated with greater
vulnerability to adverse shocks that reduce the overall value of assets or funding liquidity.
23
The
regulatoryleverageratiowasintroducedinCanadain1982anditismeasuredasfollows:
24

20
ThepercentageofBigSixassetsinOntario(20percent)mayappearverylow,sincetheirassetsaremore
geographicallydispersedinotherprovincesandinforeigncountriesthanarethoseofnonBigSixinstitutions.In
addition,someassetsarenotassociatedwithaparticularlocation(suchasintangibleassets),loweringthe
percentagesoflocationspecificassets.
21
WetrieddifferentwaysofcategorizingU.S.banksintolargeandsmallbanks(e.g.,top10percentasthe
threshold);theresultsarerelativelyindependentofthelargebankdefinition.
22
Acompleteassessmentofbankriskrequiresafullrangeofanalyses(including,forexample,abanksprovision
forloanlossesandmismatchesofassetliabilitymaturity).Inthispaper,however,wefocusonlyonthefourratios
thatreflecttheriskdimensionsconsideredintheBaselIIIframework.
23
Excessivelyhighleveragecouldincreaseabanksrelianceonpotentiallyvolatileshorttermsourcesoffunding
andexposeittohigherfundingliquidityrisk(Bordeleau,CrawfordandGraham2009).
24
Netonandoffbalancesheetassetsaredefinedasbalancesheetassets+directcreditsubstitutes+
transactionrelatedcontingencies+shorttermselfliquidatingtraderelatedcontingencies+offbalancesheet
exposurestosecuritizations(atnotionalprincipalamounts,excludingliquiditylines);Totalregulatorycapitalis
definedasTotaladjustednetTier1andTier2capital.Startingin2013,whenCanadianbanksbeginimplementing

Regulatoryleverageratio=Netonandoffbalancesheetassets/Totalregulatorycapital.

Unfortunately, data on the regulatory definition of leverage did not exist before 1992. In order to
have a longer time series, we use the alternative measure of leverage ratio, referred to as the
balancesheet leverage ratio. This definition is close to the regulatory leverage ratio used by OSFI,
which is based on Basel II total regulatory capital, including subordinated debt, and is calculated as
follows:
25

Balancesheetleverageratio=Totalassets/(Totalshareholdersequity+subordinateddebt).

Thisalternativemeasureofleveragecanbeobtainedforourdataperiodonamonthlybasis.

b) Capitalratio

In contrast to leverage ratios, capital ratios capture risks associated with different types of assets.
DTIs are required to maintain an adequate level of capital proportionate to their asset exposure to
different types of risks. All else equal, a higher capital ratio implies that a bank has relatively high
capital holdings or relatively low holdings of risky assets, and is associated with less vulnerability to
adverse shocks. Even if their balance sheets are the same size and they have the same amount of
capital i.e., their leverage ratios are equal two institutions with different asset mixes can have
differentcapitalratios.
Inourdiscussion,wefocusontheTier1capitalratio,whichreflectshigherqualitycapitalthanthat
ofthetotalcapitalratiosandisdefinedas:
Tier1capitalratio(%)=100xAdjustednetTier1capital/Totalriskweightedassets.
26

Data for the Tier 1 capital ratio have been available only on a quarterly basis. Since no consistent
alternativemeasurecoveringalongertimeperiodisavailable,wewillusethisregulatorymeasure.

theBaselIIIrules,thecalculationoftotalregulatorycapitalwillbeslightlyaltered.Forexample,itwillinclude
deductionsofdefinedbenefitpensionfunds,mortgageservicingrightsanddeferredtaxassets.
25
ThisdefinitionisclosetotheregulatoryleverageratiousedbyOSFI,whichisbasedontotalregulatorycapitalas
definedinBaselII,includingsubordinateddebt(seeBordeleau,CrawfordandGraham2009).Startingin2013,
whenCanadianbanksbeginimplementingtheBaselIIIrules,thecalculationoftotalregulatorycapitalwillbe
slightlyaltered.Forexample,itwillincludedeductionsofdefinedpensionfunds,mortgageservicingrightsand
deferredtaxassets.
26
AdjustednetTier1capitalgenerallyincludes,butisnotlimitedto,equityanddisclosedreserves,including
retainedearnings.Totalriskweightedassetsareassetsthathavebeenadjustedtoreflecttheirriskaccordingto
theBaselframework.DatafortheTier1capitalratiohavebeenavailableonaquarterlybasisonlysince1994,
aftertheimplementationofBaselattheendof1992.WiththeBaselIIframework,calculationofthetwo
componentsoftheTier1capitalratiohasbeenmodifiedtoincludeconsiderationofmarketrisksince1997andan
optionforfinancialinstitutionstousetheirownriskassessmentmodels(withOSFIsapproval)since2008.Under
BaselIII,calculationofthetwocomponentsoftheTier1capitalratiowillbemodifiedtoincludeanewdeduction
tocapital(refertofootnote24)andhigherweightingformarketriskcomponentsintheriskweightedassets.

c) Assetliquidityandfundingratios

Boththeleverageratioandthecapitalratiofocusonwhetherabankhassufficientcapitaltosupport
its assets. The recent financial crisis also highlighted that having sufficient capital alone is not a
preconditionforstability.Fundingliquidityandassetliquidityarealsoimportantdeterminantsofthe
ongoingviabilityofabank.
27
Wethereforeconstructedratiosthatcapturetheassetliquidityriskand
funding liquidity risk of banks. Because of constraints on the data available for a historical analysis,
these ratios are different and less complex than those proposed in the Basel III liquidity
requirements.
28

Unlike the other two regulatory measures, liquidity regulation took the form of guidelines and
directives to be applied at the discretion of the banks themselves. Hence, no specific definition for
liquidityratioisavailable.However,OSFIsguidelinecharacterizesthestockofliquidassetsashigh
quality securities for which there is a broad and active secondary market that can be liquidated
throughtheirsaletoawiderangeofcounterpartieswithoutincurringasubstantialdiscount,thereby
securing their status as dependable sources of cash flow.
29
In line with OSFIs guideline, a broad
measureforassetliquidityratiocanbedefinedusingmonthlybalancesheetdata,asfollows:
30

Assetliquidityratio(%)=100x(cashandequivalent+publicsecurities+securedshorttermloans)
/Totalassets.
Thehighertheassetliquidityratio,themoreabletheinstitutionistowithstandadverseshocksthat
increasetheneedtoliquidateassets.

To better assess a banks liquidity profile, one should also analyze their funding structure. A bank
witharelativelylowassetliquidityratiocombinedwithahighrelianceonstablesourcesoffunding
may be more resilient to a liquidity shock than a bank with a relatively high assetliquidity ratio
combined with a high dependency on marketbased funding. High dependency on marketbased
funding exposes banks to rollover risk,as seen during the recent crisis. The OSFI liquidity guidelines
require banks with more than 10 per cent of marketbased funding to actively manage their short

27
Duringthecrisis,liquidityinshorttermfundingmarketsdriedupintheUnitedStates,theUnitedKingdom,the
euroareaand,toamuchsmallerdegree,Canada.Consequently,banksfounditdifficulttofundtheirassets.An
assetfiresaleresultedasbankssoldoffassetstheycouldnolongerfund.WiththeintroductionoftheBaselIII
requirement,bankswillhavetoreportandsatisfycertainlevelsofregulatoryliquidityandfundingratios,knownas
theLiquidityCoverageRatio(LCR)andtheNetStableFundingRatio(NSFR).Theliquidityrulesareaimedat
measuringbanksresiliencetoshorttermliquiditystress,withrequirementssettoensurethatbankshaveaccess
tostablefundingsources.Formoredetails,seeBCBS(2010b);GomesandKhan(2011).
28
Ourassetliquidityandfundingratiosseparatelycaptureliquidityriskoneachsideofthebalancesheet.In
comparison,theproposedliquiditystandardsinBaselIIIconsiderbothsidesofthebalancesheettogetherand
incorporatemorecomplexassumptionsonfundingrunoffs(e.g.,thesuddenwithdrawalofbankliabilities)and
haircuts(i.e.,apercentagedifferencebetweenthemarketvalueofanassetanditsvalueascollateral).
29
SeethedocumentB6,Guideline:Liquidity,OSFI,December1995,updatedin2012.
30
Thisratioreflectsaliquiditybufferanddoesnotaccountforhaircutsorinterestandprincipalcashflows,as
currentlyprescribedintheLCR.

10

term funding within internal limits set by the banks management.

31
We define funding ratio as the
proportion of a banks total assets that are funded by wholesale funding, a relatively less stable
fundingsourcethanretail(personal)deposits,asfollows:
32

Fundingratio(%)=100x(Nonpersonaldeposits+Repos)/Totalassets.
33

Ahigherfundingratioindicatesthatabankreliesongreatermarketbasedfundingandistherefore
moreexposedtoadverseshocksinthemarketthatcoulddisruptcontinuousfundingofitsassets.
Although these indicators are informative regarding bank balancesheet risks, caution should be
taken when using these ratios to measure relative risks across groups of institutions. High risk, as
indicated by a particular ratio, may also reflect regulatory or supervisory latitude granted to an
individualinstitutionbasedonitsstrongriskmanagementpractices.Inthispaper,weusetheterms
higherorlowerrisk,assumingthatsuchsupervisoryrequirementsremainconstant.
3. BalanceSheetRatiosOverTimeinCanada

In this section, we document evolutions of balancesheet ratios over time and across different
categoriesofbanks.

3.1. Distributionsamongallbanks,BigSixandnonBigSixbanks
The distributions (median, 25th and 75th percentile) of the four ratios that indicate balancesheet
risksforthefinancialinstitutionsinoursampleareshowninFigures1and2.Overallmediantrends
in Figure 1 seem to suggest that the Canadian banking industry, as a whole, has become safer over
time. Moreover, widening dispersions with respect to these ratios suggest that degrees of
heterogeneity among banks have increased over the period. In Figure 2 we document some
differencesintheevolutionsofbalancesheetratiosbetweentheBigSixandnonBigSixbanks.
3.1.1. Leverageratio
Changes in the distribution of the leverage ratio for the Big Six and nonBig Six banks are shown in
Figure 2, panel a. The range for the Big Six is over the minimum and the maximum among the six
banks, whereas that of nonBig Six banks is from the 25th to the 75th percentile, excluding the Big
Six.Exceptforthelate1980sandtheearly1990s,theBigSixbankshaveahigherleverageratiothan
themajorityofnonBigSixbanks.
Furthermore, there is a clear diverging trend between the leverage ratios of these two groups of
banks since the mid1990s. In fact, leading up to the recent financial crisis, the ratios of the Big Six

31
This10percentthresholdwaschangedto5percentearlierin2012.
32
UnliketheNSFR,thisdefinitionofthefundingratiodoesnotdifferentiateamongthetermsoffundsortherisks
ofassets.
33
Nonpersonaldeposits(i.e.,acategoryintheregulatoryreportonbalancesheets)includemarketbased
funding,suchascommercialpaper,bankersacceptancesanddepositnotes.

11

bankshadbeenincreasing,whilethoseofnonBigSixbankshadbeendeclining.Theseobservations
areconsistentwiththeimplementationofaregulatorycaponleverage(i.e.,assettocapitalmultiple
(ACM) limits) by OSFI and their changes over the years, notably a placement of bankspecific ACM
limitssince2000onnonBigSixbanks.
34
OSFIconsidersarangeoffactors,suchasthestrengthofthe
parentbank(inthe caseofforeignbanks),assetdiversificationandappetiteforriskwhenassigning
individual leverage limits on banks.
35
For instance, due to their national branch network and wide
range of financial products (i.e., geographical and product diversifications), OSFI may have allowed
higher leverage limits for larger banks.

On the other hand, smaller institutions are typically

constrained to have lower limits, which may reflect an underlying risk in these banks operations
(e.g.,lessdiversificationofassets).
The gradual decrease in leverage among nonBig Six banks during the late 1990s could also be the
resultofconsolidation.Afterthe1992amendmentstotheBankAct,whichallowedcrossownership
between chartered banks and trust and loan companies, the Big Six acquired several trust and loan
companies. If these institutions were highly leveraged, their acquisition and removal from the non
BigSixsamplemayhavereducedthegroupsoverallleverage.

3.1.2. Capitalratio

PanelbinFigure2displaysthemovementsoftheTier1capitalratiosbetweentheBigSixandnon
Big Six banks. Most nonBig Six banks consistently have higher capital ratios than the Big Six, and
bothhaveadivergingtrendsincethelate1990s,althoughnotasstrongasthatintheleverageratio.
The observations regarding higher and widening ranges in capital ratios over time for nonBig Six
banksareinpartduetoOSFIsapproachofsettingbankspecificminimumtargets.Forinstance,the
assignment of bankspecific ACM limits since 2000 would indirectly impact a banks holding of
regulatorycapitalwithoutchangingtheweightedriskofitsassets.
Inaddition,theTier1 capitalratiosforbothsetsof bankshave beenincreasingsince1994.
36,37
This
stemsfromtwofactors:OSFIsminimumrequirementandachangeinbanksassetsmix.Ontheone

34
ACMistheregulatorydefinitionofleverageinCanada.Withtheintroductionoftheregulatoryleverageratioin
1982,OSFIimposedaformallimitonbanks.Thislimit,knownastheACMlimit,hassincechangedovertimeand,
in2000,becamespecifictoindividualinstitutions.Smallerinstitutionsaretypicallyallowedtohavelowerlimits
thantheirlargercounterparts.SeeAppendixAformoredetails.
35
SeeOSFIguidelinesoncapitaladequacyrequirementsat<http://www.osfi
bsif.gc.ca/osfi/index_e.aspx?DetailID=527>.
36
In2008,theBaselIIframeworkoncapitalrequirementswasimplemented,allowingOSFIapprovedinstitutions
toadopttheinternalratingsbased(IRB)approachtodeterminingriskweights.Incontrasttothestandardized
approach,theIRBapproachcanleadtolowerassessedriskweights.SinceonlytheBigSixbankshaveadoptedthis
approach,therecentdivergenceincapitalratiosmay,inpart,reflectthisdifferenceinriskassessmentpractices.In
addition,bankspecificlimitsonleveragewouldhavealsocontributedtoincreasingheterogeneityincapitalratios.
37
ThecapitalratiosfornonBigSixbankssince2007arealsohigher,despitethedifferentmethodusedtocalculate
theirriskweightscomparedtotheBigSixbanks.Exceptfortwomidtierbanks(INGBankofCanadaandHSBC
BankCanada),thenonBigSixbanksrelyonthestandardizedapproachtocalculatetheircapitalratios.This
approachprescribeshigherriskweightingchargesincomparisontotheinternalratingsbased(IRB)approachused

12

hand, OSFIs minimum requirements increased in 1999 from 4 per cent, the standard specified in
Basel I, to 7 per cent. Also, OSFI requires all financial institutions to establish higher internal capital
targets to cushion against unexpected losses and thus avoid breaching the minimum requirements.
Ontheotherhand,thebanksassetmixhadpusheddowntheaverageriskweightofbanksassets.
For instance, the relative share of corporate and business loans in the banking book has been
decliningsincethemid1990s,astheseloansaresubjecttoarelativelyhighriskweight.Atthesame
time,bankshaveincreasedtheirrelativeexposuretothecorporatesectorthroughtheirtradingbook
(i.e.,holdingofsecurities),sincetheaverageriskweightontheseassetsunderBaselIandIIislower
thantheriskweightoncorporateloans.Thisregulatoryarbitragebetweenthebankingbookandthe
tradingbookisonesubjectthatBaselIIIaddresses.
OnenoticeabledifferencefromtheobservationsoftheleverageratiosisthattherangeoftheTier1
capitalratiosamongtheBigSixismuchnarrowerthanthatofnonBigSixbanks,especiallysincethe
mid2000s.Sinceleverageratios,unlikeTier1capitalratios,donottakeintoaccountthedifference
in the riskiness of assets, the differences in the risk portfolio between the Big Six and nonBig Six
banks are likely the main cause. That is, the Big Six tend to have similar asset portfolios in terms of
riskweights,whereasnonBigSixbanksexhibitmoreheterogeneityamongthemselves.
Finally,incontrasttotheleverageratio,theliteratureoncapitalrequirementsandriskbehaviouris
not conclusive. Capitaladequacy policies seem to be putting conflicting pressures on risktaking
incentives.
38

3.1.3. Assetliquidityandfundingratios

Panels c and d in Figure 2 show the assetliquidity and funding ratios, respectively, for the Big Six
banksandnonBigSixbanksovertime.Thereisnoobviousdivergingtrendbetweenthetwogroups
ofbanksinassetliquidityratios,butthemediannonBigSixbankhasbeenholdingmoreliquidassets
than the median Big Six bank. As for the range between the 25th and 75th percentiles, the nonBig
Six bank distribution is much wider than that of the Big Six banks, implying more heterogeneity
amongthesmallerbanks.
ThefundingratiofortheBigSixhasbeenstableovertime.Moreover,similartotheotherratios,the
range between the maximum and minimum has been more stable and narrower over our sample
period relative to those of nonBig Six banks. On the other hand, the funding ratio for nonBig Six
bankshasbeendeclining,whiletherangebetweenthe25thand75thpercentileshasbeenwidening
since the early 1990s. The sharp decline in the funding ratio for nonBig Six banks in the late 1990s
canbeexplained,inpart,bytheintroductionofliquidityguidelinesbyOSFIin1995,
39
whichrequired

bytheBigSixbanks.AlsonotethattradingactivitiesatthemajorityofnonBigSixbanksareeithernonexistentor
donotmeetOSFIsthresholdforthecapitaladequacyrequirementsformarketrisk.
38
See,forinstance,Northcott(2004);Hellmann,MurdockandStiglitz(2000);Repullo(2003);KashyapandStein
(2004).
39
SeeOSFIB6guidelinesonliquidity,availableat<http://www.osfibsif.gc.ca/osfi/index_e.aspx?DetailID=527>.

13

institutions with high reliance on marketbased funding to have strict liquidity riskmanagement
practices.Amongotherthings,theguidelinesrequiredbankswithmorethan10percent(changedto
5 per cent in 2012) of marketbased funding to actively manage their shortterm funding within
internallimitssetbythebanksmanagement.
Moreover, the decline between 1999 and 2003 coincides with the Canada Mortgage and Housing
Corporations (CMHC) mortgage insurance rule changes and increased housing affordability. For
example, CMHC lowered the minimum down payment eligibility for their mortgage insurance to
5percentfromthepreviouslevelof25percent.Thesechangesmayhaveimpactedsmallerbanks
business models by increasing the share of mortgage loans for most nonBig Six bank subgroups
between2000and2011,from14percentto39percentforthemediumbanksandfrom11percent
to 27 per cent for the large banks (see Figure 3). Similarly, the share of wholesale funding for most
nonBig Six bank subgroups has declined, for example, from 55 per cent to 18 per cent for the
mediumbanksandfrom55percentto34percentforthelargebanks.Furthermore,theincreased
popularity of securitization following the introduction of the Canada Mortgage Bond program may
have allowed some of the nonBig Six banks to adopt an originate to distribute business model.
Sinceoriginatetodistributesecuritizationisanothertypeofmarketbasedfunding,thesebanksmay
haveshiftedoutofothertypesofmarketbasedfundingonbalancesheets.
Thissectioncomparestheleverage,capital,liquidityandfundingratiosofnonBigSixbankstothose
of the Big Six banks. Heterogeneity of these indicators within the banking system, measured by the
differences between the Big Six and other financial institutions, as well as the differences among
nonBig Six institutions, has generally increased since the mid1990s. This may be due, in part, to
greater discipline imposed by markets or regulations that have become increasingly bankspecific,
implyingamoreappropriatealignmentofthesebalancesheetratioswiththeunderlyingrisks.
OveralltrendssuggestthatnonBigSixinstitutionshavebecomemoreresilientovertime.Capitalhas
increased,whilebothleverageandfundingriskhavedecreased.FortheBig Sixbanks,capitalratios
increased moderately until 2008, when the trend became more positive. Their leverage ratios
declinedinthe1980s,followedbyanincreasingtrenduntil2008,whentherecentfinancialcrisishit
the Canadian economy. Assetliquidity and funding ratios for the Big Six banks are either stable or
display no longterm trend. Nevertheless, the Big Six hold more diversified portfolios such that
idiosyncraticshockstoaregionoraproductlinearemorelikelytobeevenedout.
40

We also identify wider dispersions of these ratios for the smaller banks relative to those for the Big
Six.Inthenextsection,weexploremoreofthisheterogeneityamongnonBigSixbanksbygrouping
themintosubcategories.

40
Regardingtheresultsreportedinthissection,wediscussvariousrobustnesschecksinAppendixE.

14

Figure1:IndicatorsofbalancesheetrisksatCanadianfinancialinstitutions(12monthmoving
average)
Note:Paneldincludesonlyinstitutionswithwholesalefunding.
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaLastobservation:August2011

15

Figure2:IndicatorsofbalancesheetrisksatCanadianfinancialinstitutionsBigSixvs.non
BigSix(12monthmovingaverage)

Note:Paneldincludesonlyinstitutionswithwholesalefunding.
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaLastobservation:August2011

3.2. BalancesheetratiosbyvarioustypewithinnonBigSixbanks
Table 2 shows the four measures of balancesheet risks according to bank size, charter type and
wholesalefundingbydecade.Thenumbersareobtainedbyaveragingthemonthlymedianforeach
groupovertime.
Weobservethatleverage ratiostendtobepositivelycorrelated with banksize.Overall, nonBigSix
financial institutions have higher capital ratios, among which large institutions, domestic banks and
low WSF banks have the highest leverage. Furthermore, all nonBig Six institutions show declining
trends in leverage, which is consistent with the evolution shown in panel a of Figure 2. The decline
appearstobethelargestforsmallbanksandnowholesalefundingbanks,movingfrom10.3overthe

16

198390 period to 1.8 after 2000 for small banks, and from 10.9 to 1.5 for no wholesale funding
banks. These declines follow the introduction of bankspecific regulatory limits on leverage. In
contrast,theBigSixbanksmaintainedrelativelyhigherleveragethantheirsmallerpeersthroughout
thesampleperiod.
Observations of capital ratios are consistent with those of leverage ratios. We observe that capital
ratios tend to be negatively correlated with size while noting that leverage has an inverse relation
with capital. Overall, nonBig Six financial institutions have higher capital ratios, among which small
institutions, trust and loan companies, and no wholesale funding banks have the highest capital
ratios and have shown large increases in capital over time, going from 23 per cent in the 1990s to
59 per cent in the 2000s, from 22 per cent to 30 per cent, and from 34 per cent to 57 per cent,
respectively. Thislikely contributed to theobservedspikesatthe75thpercentileofthedistribution
of capital during the 2000s, as shown in panel b of Figure 2. These observations point to increasing
heterogeneity in capital ratios across institutions in Canada;
41
however, this trend is not observed
everywhere(seesection4foracomparisonofCanadaandtheUnitedStates).

41
In2008,theBaselIIframeworkoncapitalrequirementswasimplemented,allowingOSFIapprovedinstitutions
toadopttheinternalratingsbased(IRB)approachtoassessingcreditrisk.Incontrasttothestandardized
approach,theIRBapproachcanleadtolowerassessedrisk.SinceonlytheBigSixbankshaveadoptedthis
approach,therecentdivergenceincapitalratiosmay,inpart,reflectthisdifferenceinriskassessmentpractices.In
addition,bankspecificlimitsonleveragewouldhavealsocontributedtoincreasingheterogeneityincapitalratios.

17

Table2:IndicatorsofbalancesheetrisksatCanadianfinancialinstitutions,bybanksizeandchartertype

BigSix
banks
NonBigSix

Large Medium Small

Foreign
subsidiary
Other
domestic
bank
Trustand
loan
company
b

High
wholesale
funding
Low
wholesale
funding
No
wholesale
funding
Leverageratios
19832011 16.1 14.1 11.1 6.0 10.7 13.5 6.2 10.9 12.0 3.0
19831990 17.3 18.2 15.4 10.3 15.0 16.7 15.7 14.6 10.9
19912000 14.7 13.3 10.2 6.9 10.0 14.6 9.8 10.0 11.9 2.6
20012011 16.6 11.7 8.8 1.8 8.0 9.9 4.5 8.3 10.1 1.5
Capitalratios
a
(%)
19942011 8.4 10.2 15.6 44.5 13.1 10.9 27.8 13.0 14.0 49.9
19942000 7.1 8.5 13.1 22.9 9.9 9.3 22.2 8.7 12.7 34.0
20012011 9.3 11.3 17.2 58.7 15.2 12.0 30.4 15.7 14.8 57.3
Assetliquidityratios(%)
19832011 15.0 16.5 16.9 31.9 19.8 11.3 22.7 17.9 17.0 42.5
19831990 16.0 16.2 25.4 26.0 23.0 9.7 23.3 20.7 34.6
19912000 15.9 18.8 14.8 20.5 18.7 12.6 11.8 15.4 17.2 52.2
20012011 13.4 14.6 12.6 47.0 18.5 11.3 27.8 16.3 14.0 37.6
Fundingratios(%)
19832011 45.8 53.8 47.3 29.1 58.5 18.4 0.2 69.5 31.4 0.0
19831990 46.9 70.6 75.1 66.1 72.5 31.2 80.0 61.0 0.0
19912000 44.3 65.5 63.7 30.3 68.9 17.3 0.4 79.5 33.5 0.0
20012011 46.4 30.3 11.1 0.2 38.3 9.7 0.0 52.2 7.4 0.0
a
Dataonregulatorycapitalratiodatefrom1994.
b
Dataontrustandloancompaniesdatefrom1996.
Note:Numbersrepresentanaverageofmonthlymediansineachperiod.
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanada

Assetliquidity ratios in panel c of Figure 2 display high dispersion among nonBig Six banks. Table 2
shows that during the entire data period of 19832011, the small institutions, trust and loan
companies, and no wholesale funding banks held high assetliquidity ratios, which partly drove the
observedheterogeneityinpanelcofFigure2.Theobservedhighratiosduringthe1990sinthefigure
appeartobemostlydrivenbynowholesalefundingbanks(52percent),whereasthoseinthe2000s
were driven by small institutions (47 per cent), trust and loan companies (28 per cent) and no
wholesalefundingbanks(38percent).Ontheoppositesideofthedistribution,thedomesticbanks
show the lowest assetliquidity ratios at 11.3 per cent over the 19832011 period, a lower number
evencomparedtotheBigSix(15percent).

18

Finally,regardingthefundingratio,smallinstitutions,domesticbanks,andtrustandloancompanies
display smaller funding ratios, whereas foreign subsidiaries, large institutions and, by default, high
wholesalefundingbanksdisplayhigherfundingratios,thelatterofwhichareevenhigherthanthose
oftheBigSix.Therelativelyhigh,continuoususeofthisfundingsourcebythelargeinstitutionsand
foreignsubsidiariesmaybeinfluencedbytheiraccesstoglobalfundingmarkets.Overall,theratiosof
almost all nonBig Six banks in Table 2 declined significantly in the late 1990s to lower levels than
those of the Big Six, as shown in panel d of Figure 2. As noted in section 3.1.3, the sharp decline in
thefundingratiofornonBigSixbanksinthelate1990scanbeexplained,inpart,bytheintroduction
ofliquidityguidelinesbyOSFIin1995.
42

3.3. Bankbalancesheets
The previous sections highlighted the degree of heterogeneity over important balancesheet ratios.
These ratios reflect the banks balancesheet composition in both asset and liability portfolios.
Hence, changes in balancesheet portfolios can help us understand more about these observed
heterogeneities.Thissectiondocumentstrendsand stylizedfactsaboutbanksassetsandliabilities,
firstbysizeandthenbyotherbankgroups(i.e.,chartertypeandWSF).
3.3.1. Bybalancesheetsize
Figure3showstheevolutionofthedifferentbalancesheetcomponentsforthefoursizegroups.For
each group, the numbers are calculated by taking the weighted portfolio of bank balance sheets in
each month and averaging them over time. The Big Six banks and the large institutions appear to
havesimilartrendsinoverallportfoliochanges.Bothmortgageandnonmortgageloansappeartobe
an important component for these groups since the mid2000s. Prior to then, nonmortgage loans
hadalargerweightovertotalloans.Slightdifferences,ifany,appearinmortgageloansandprivate
securities where nonBig Six large banks tend to hold more of the former and less of the latter
relative to the Big Six, especially toward the end of the data period. The medium and the small
institutionsbalancesheetcompositionshavesignificantlychangedduringthe200111period.There
appears to be a decline in the proportion of nonmortgage loans for the medium banks and both
mortgageandnonmortgageloansforthesmallbanks.
Figure 3 also shows the portfolio on the liability side of these banks. Contrary to assets, the Big Six
banksandlargeinstitutionsdidnothaveasimilarcompositionofliabilitiesuntil2000.Priortothat,
the large institutions relied more on wholesale funding than the Big Six banks. Following the year
2000, both had similar funding patterns, with retail and wholesale deposits being equally
important.
43
Among the medium and small institutions, the use of wholesale deposits has declined
since the early 2000s. For medium institutions, some of this decline was replaced by an increase in

42
SeeOSFIB6guidelinesonliquidityat<http://www.osfibsif.gc.ca/osfi/index_e.aspx?DetailID=527>.
43
Afewexceptionsappeartobetheshareofprivatesecuritiesontheassetsideandtheuseofreposonthe
liabilityside.WhiletheBigSixholdvisiblemoresharesofprivatesecuritiesandrepos,nonBigSixlargebanksdo
not.

19

retaildeposits.Forsmallbanks,theamountofretaildepositshasalsodeclinedsincethen;however,
ithasbeenreplacedbyahighershareofequity.
TheBigSixandthelargebanksassetmixappeartobewelldiversifiedandstableovertime,aswith
theirliabilitymix.Ontheotherhand,theassetandliabilitymixesformediumandsmallbankshave
changed over time (i.e., a decline in nonmortgage loans and an increase in mortgage loans),
especially since the 1990s, when banking regulation and mortgage insurance rule changes were
introduced.
44
This coincided with changes in the liability mix for these banks, via a decline in
wholesaledepositsandanincreaseinretaildeposits.Also,thelossofsmallbanksfromthesample,
owing to failures in the 1980s and 1990s, may have left only lessleveraged and bettercapitalized
institutionsinthesector.
45
Overall,itappearsthatpositivecorrelationsexistbetweenassetportfolios
andfundingportfolios,likelyreflectingtheirbusinessmodelchoicesandriskmanagement.
The balancesheet portfolio dynamics can shed light on the evolutions in balancesheet ratio
observationsfromtheprevioussections.Table2andFigure3tellusthatnonBigSixlargebanksare
similar to the Big Six in some balancesheet ratios, since both types display similar balancesheet
portfolios. For example, both types hold a low level of equity relative to their balancesheet size,
indicating similarly high leverage ratios in Table 2. As the bank size increases, the level of equity
relative to total assets decreases, implying that the balancesheet size and the leverage ratio are
positively correlated, as observed in Table 2. Over time, all banksize groups increase their equity
sharesrelativetothebalancesheetsize,leadingto areductioninleverageratios.Regardingcapital
ratios, a closer look at Figure 3 tells us that the holding of low riskweighted assets, such as cash,
mortgage loans and public securities, tends to decrease with balancesheet size. In addition, the
shareoftheselowriskassetsappearstohavekeptincreasingsincethemid1990sforallnonBigSix
size groups. Together with a higher fraction of equity, their capital ratios increased over time, as
showninTable2.
Thepositivecorrelationbetweenbanksizeandtherisksmeasuredbytheleverage/capitalratiosdo
not carry over directly to the assetliquidity and funding ratios. Panels c and d in Figure 2 already
showthatthereisasizablenumberofnonBigSixbanksthatholdmoreliquidassetsrelativetototal
assetsthantheBigSix,aswellasthoseholdingless.Inaddition,asobservedinprevioussections,the
holding patterns of marketbased funding among nonBig Six banks are quite diverse. This diversity
may not be directly reflected in bank size; instead, it may be a result of business model choices.
Indeed, several studies have shown that the source of funding is an essential element in banks
businessstrategiesandbalancesheetmanagementbehaviour.
46

44
ChangesineconomicrealityandinlegislationhavebothcontributedtotheevolutionofCanadianbanksasset
andliabilitymixoverthepastthreedecades(seeAppendixesAandBformoredetail).
45
SeetheCanadaDepositInsuranceCorporation,HistoryofMemberInstitutionFailures,availableat
<http://www.cdic.ca/e/insuredWhere/history_failures.html>.
46
See,forexample,AdrianandShin(2010);AllenandPaligorova(2011);Damar,MehandTerajima(2010,2012);
HuangandRatnovski(2011);He,KhangandKrishnamurthy(2010).

20

Figure 3: Balancesheet components of various financial institutions, by size, charter type and
wholesalefunding(asapercentageoftotalassets)

Note:Dataontrustandloancompaniesdatefrom1996.Percentagesaremonthlyaveragesacrossinstitutionsand
thenovertime.
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaLastobservation:August2011
3.3.2. Byotherbankgroups
Figure3alsoshowsthebalancesheetcompositionsofdifferenttypesofbanksinthisstudy.Among
charter types, foreign subsidiaries appear close to the Big Six on the asset side. However, on the
liabilityside,theyrelymoreonwholesaledepositsandlessonretaildepositsthantheBigSix.Other
domesticbanks,aswellastrustandloancompanies,tendtofocustheirassetsonmortgageloansby
relying more on retail deposits than the foreign subsidiary banks. In addition, as wholesale funding
use declines, the assets focus shifts from nonmortgage to mortgage loans. Also, less reliance on
wholesalefundingismadeupbyretaildepositsandequity.
These balancesheet composition changes may have been affected by changes in the regulatory
environment. For instance, the acquisition of the largest trust and loan companies by the Big Six
banks, following the legislative amendment of 1992, may have resulted in the trust and loan
company subgroup comprising only small and specialized institutions with riskier assets but more

21

capital.Inaddition,thegrowingpopularityofmortgageloansecuritizationinthelate1990sfollowing
theintroductionoftheCanadaMortgageBondprogramraisedthepercentageofmortgageloanson
bank balance sheets, especially among large and mediumsized financial institutions.
47
Finally, the
declineintheproportionofwholesaledepositsfornonBigSixbanksisobservedaroundthetimeof
theintroductionoftheliquidityguidelines.
These observations give further insights into the dynamics of balancesheet ratios. First, inverting
equitysharescanproxyleverageratios,andthusthehighertheequityshare,thelowertheleverage
ratio.Basedonthisproxy,weobservethatforeignsubsidiaries,otherdomesticbanks,andhighand
low wholesale funding banks tend to hold less equity relative to the rest and hence have a higher
leverageratio.
Similarly, since capital ratios reflect the riskiness of asset portfolios, we can elaborate on them by
identifying risky assets in Figure 3 and comparing their fractions relative to equity. Nonmortgage
loans and private securities contain higher risk than, for example, cash, mortgage loans and public
securities.Mediumsized,foreignsubsidiariesandhighwholesalefundingbanksholdtheseassetsfor
50percentormoreoftheirbalancesheets.Combinedwithlowequity,foreignsubsidiariesandhigh
wholesalefundingbanksexhibitlowTier1capitalratios.

Differencesinassetliquidityratioscanbeobservedbyadding cashandpublicsecuritiesasaproxy.
Except for nonBig Six domestic banks and the lowWSF banks, all other institutions hold more cash
than public securities. Also, nonBig Six domestic banks appear to hold less liquid assets than any
other charter type (including the Big Six banks). This may indicate that these domestic banks are
vulnerable to liquidity shocks. However, the need to hold less liquid assets by the domestic banks
maystemfromthefactthattheyholdhighersharesofresilientfundingsources(i.e.,retaildeposit)
andlessriskyassets(e.g.,mortgageloans)thantheotherchartertypes(includingtheBigSixbanks).

Finally, funding ratios are directly observable in Figure 3 by the shares of wholesale deposits and
repos combined. On average over the data period, mediumsized, foreign subsidiaries and high
wholesalefunding banks allhavethesemarketbasedfundingfractionshigherthan those oftheBig
Six. As we saw in Table 2, these ratios go down in the 2000s, which made them less subject to the
fundingmarketshocksduringthecrisis.

4. CanadaU.S.Comparison
Canadas financial system fared well in the recent financial crisis in comparison to the U.S. financial
system, whose banking sectors experienced failures, necessitating government funding guarantees
andpublicsectorcapitalinjections.TheresilienceoftheCanadianbankingsectorcouldpotentiallybe
attributed to several structural differences between the Canadian and U.S. financial systems. One

47
SeeAppendixesAandBformoredetailsonlegislationthatmighthaveimpactedtheevolutionofbankbalance
sheets.

22

important factor is the supervisory regulatory approach.

48
Federally chartered Canadian banks are
regulated by a single entity, whereas in the United States, bank regulation falls under the
responsibility of several authorities across both the federal and the state level. Another important
difference is that, in Canada, bank regulators apply a principlesbased supervisory approach, in
contrast to a rulesbased approach in the United States. A key advantage of a principlesbased
approachisthoughttobetheabilityofthesupervisortoenactprinciplestoadapttochangesinthe
bankoperatingenvironment.
In this section, we document the trends and stylized facts regarding the leverage and capital ratios
forlargeandsmallfinancialinstitutionsinCanadaandtheUnitedStates.ForCanada,wedefinethe
large institutions to be the Big Six banks and the small institutions to be nonBig Six banks with at
least$500millioninassets,inordertohaveaconsistentcomparisonbetweentheUnitedStatesand
Canada.FortheU.S.banks,wedefinethelargeBHCsasthelargest30BHCs,andthesmall BHCsas
theremainingbankswithatleast$500millioninassets.
49

4.1. Leverageratios
Figure4showstheevolutionoftheweightedaverageleverageratiosfortheBigSixandnonBigSix,
beforeandaftertherecentcrisis,asindicatedbytheredverticallineat2007Q4,andcomparesthose
ratios to the large and the small U.S. BHCs. Different patterns emerge between the Canadian banks
and the U.S. BHCs.
50
First, starting in the mid1990s, the leverage ratios for the Big Six have been
higherthanthosefornonBigSixbanks.Second,therehasbeenadivergingtrendbetweenthesetwo
groupsinCanada.NonBigSixbanksbecameincreasinglylessleveragedrelativetotheBigSixbanks,
especially leading up to the start of the crisis in 2007Q4. In contrast, during the same period, small
U.S.BHCsexhibitedconsistentlyhigher,althoughdeclining,leverageratiosthanlargeU.S.BHCs,with
nosignofreversioninthispattern.
Figure 5 shows the estimated probability density (i.e., kernel density estimations) of leverage ratios
at financial institutions in Canada and the United States. In 1988, the two countries had similar
distributions but the dynamics that followed appear different. In Canada, an increasing mode and
fatter right tail (i.e., the number of financial institutions with lower leverage ratios) have been
observed over time, while in the United States, the distribution has remained relatively unchanged
andiscentredarounditsmode.Itisalsoworthnotingthattheoverallaverageleverageratiosinboth
countriesdeclinedbetween1988and2010.

48
SeeRatnovskiandHuang(2009);Brean,KryzanowskiandRoberts(2011).
49
Refertofootnote15.
50
Differencesinaccountingstandardcanaffectthelevelofthemeasuredleverageratios.Forinstance,inthe
UnitedStates,nettingofonbalancesheetderivativesispermittedundertheU.S.generallyacceptedaccounting
principles(GAAP).Incontrast,thisisnotallowedunderCanadianGAAPandtheinternationalfinancialreporting
standards(IFRS).Assuch,thelevelofthemeasuredleverageratiosatU.S.banksisrelativelyunderstated
comparedtotheCanadianbanks.Furthermore,securitization(i.e.,movingonbalancesheetassetstooffbalance
sheet)inCanadawaslimitedbefore2000,whereasintheUnitedStatesitwasmorewidespread.Thismayhave
affectedthelevelofleverageatU.S.bankscomparedtotheCanadianbanks.

23

A possible explanation for the different patterns might be the results of regulatory approaches
betweenthetwocountries(seeBrean,KryzanowskiandRoberts2011).Since2000,Canadianbanks
arerequiredtomaintainanACMbelowanindividuallyauthorizedamount.
51
Thedivergingpatterns
of the Canadian leverage ratios are consistent with the timing of the implementation of this
regulation and the discussions that took place prior to the implementation in 2000, which would
havemadesomebankspreemptivelychangetheirleverageratios.Asnotedearlier,theincreasingly
fatterrighttailsforleverageinCanadahavebeendrivenprimarilybynonBigSixCanadianfinancial
institutions.
In contrast, minimum capital requirements in the United States have been uniformly applied across
financial institutions since 1985, following the enactment of the International Lending Supervision
Actin1983.Upuntil1990,allBHCshadtomaintainaprimarycapitalratioandatotalcapitalratioof
5.5percentand6percent,respectively.Thesecapitalratiosarecalculatedusingunweightedassets
forrisk,andareequivalenttothedefinitionofleverageratiosinthispaperwhentakingtheirinverse.
By 1990, the U.S. regulator sought to supplement the newly adopted Basel I riskweighted capital
ratioswithanunweightedcapitalratioof3percent(i.e.,aleverageratiolimitof33)
52
derivedfrom
the capital ratios prescribed above. Furthermore, the Federal Deposit Insurance Corporation
ImprovementAct(FDICIA),enactedin1991,requireda2percentagepointbuffer,effectivelyraising
theminimumrequirementfortheunweightedcapitalratioto5percent(i.e.,aleverageratiolimitof
20).
53,54
Similar to our findings, Lee and Stebunovs (2011) argue that the sharp decline in BHC
leverageratiosduringthesetwoperiods(1985and1990)isprimarilyduetoregulatorychanges.The
decline in BHC leverage ratios around the 1990s has been uniform across the BHCs, as shown in
Figures 4 and 5, mainly due to the uniform minimum requirement (as opposed to the individually
authorizedlimitsinCanada).

51
SeeAppendixAforadiscussionofCanadianleverageregulations.Also,theimplementationofindividual
leveragelimitsbasedonconsistentcriteriamaybefeasiblepartlybecauseCanadianbanksareregulatedbya
singleentity,butalsobecausetherearefewerbanksinthesystemcomparedtotheUnitedStates.Thelarge
numberofbanksandthedifferentjurisdictionalregulatorybodiesintheUnitedStateswouldmakeabank
specificsupervisoryapproachlessfeasible.Thismaybeonereasonforthenarrowrangeofleverageratiosinthe
UnitedStates.
52
TheU.S.regulationonleverageisspecifiedintermsofrequiredcapitalasapercentageofassets,whichisthe
inverseoftheACMdefinedinthispaper.
53
Formoredetails,seeLeeandStebunovs(2011).
54
TheFDICIAdefinesawellcapitalizedBHCasabankwithatleast5percentofunweightedcapitalratio,6per
centofTier1capitalratioand10percentoftotalcapitalratio.ItalsodefinesaBHCwith3to4percentof
leverage,6percentofTier1capitalratioand10percentoftotalcapitalratioasanadequatelycapitalizedbank.

24

Figure4:Leverageratiobyassetsize,Canadavs.UnitedStates(12monthmovingaverage)

Lastobservation:2010Q1
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaandtheFederalReserveBankofChicago

Figure5:Estimatedprobabilitydensityofleverageratios,Canadavs.UnitedStates

Lastobservation:2010Q1
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaandtheFederalReserveBankofChicago

4.2. Capitalratios
Figure 6 shows the evolution of Tier 1 capital ratios for the Big Six and nonBig Six banks, and
compares it to the large and small U.S. BHCs. Again, clear differences are observable between the
two countries. The capital ratios for nonBig Six banks in Canada had been trending upward leading
up to the crisis, while the Tier 1 ratio for the small BHCs in the United States had been declining.
Moreover, as shown in Figure 7, the distribution of capital ratios has been exhibiting increasingly
fatter right tails in Canada over time, while the distribution has remained relatively unchanged and
centred around its mode in the United States. As with the leverage ratios, this implies a higher

25

degree of heterogeneity in Canada than in the United States, especially in terms of the right tail of
the distribution. The increasing amounts of higher capital holdings and hence fatter right tails have
beendrivenprimarilybynonBigSixCanadianfinancialinstitutions.
Thedifferentpatternanddistributionofthecapitalratiosinthetwocountriesmayalsobearesultof
different approaches in bank regulation. In Canada, banks must maintain their capital ratios
comfortably above the minimum requirements as per the OSFI directive and without an explicit
threshold.Inotherwords,OSFImayrequireriskybankstosethighercapitaltargetsonadiscretional
basis. For instance, OSFI may require specific banks with geographical and singlename
concentration, which includes the majority of nonBig Six banks, to set higher internal capital
targets.
55
Incontrast,intheUnitedStates,theFDICIAexplicitlyestablishes,forallbanksuniformly,a
threshold above the minimum requirements for regulatory ratios, and sets out mandatory and
optionalenforcementactionsincasethethresholdsarebreached.
56

Figures 6 and 7 also show that both the Canadian and U.S. banks experienced a sharp increase in
their capital ratios following the financial crisis. To assess the drivers behind this upward trend, we
analyze the two main components of the capital ratio: Tier 1 capital and riskweighted assets. In
Figures8and9,weshowtheyearoveryeargrowthofthesetwocomponents.
Figure 8 compares the Tier 1 capital ratio components of the Big Six Canadian banks and large U.S.
BHCs.Notethatfollowingthefinancialcrisis,theBigSixbanksachievedahighercapitalratiobyboth
reducingtheirriskweightedassetsandincreasingtheirTier1capital.Thereductioninriskweighted
assets for the Big Six reflects the increasing share of lowrisk assets, such as secured loans and
insuredresidentialmortgages,aswellasthetransitiontoBaselII.Ontheotherhand,theincreasein
Tier 1 capital for the Big Six Canadian banks is attributable to both solid internal capital generation
and to OSFI changing the regulatory limit on noncommon Tier 1 capital components (preferred
shares,hybridsandinnovativeinstruments)inTier1capital.
57
AsforthelargeU.S.BHCs,thecapital
ratiosincreasedonthebackofstrongTier1capitalgrowth,mainlyduetointernalcapitalretentions
and external capital injections by the U.S. public authorities, and the riskweighted assets kept
growingaswell.
Figure9comparestheTier1capitalratiocomponentsofnonBigSixCanadianbanksandsmallU.S.
BHCs, showing a similar trend for the smaller banks. On the one hand, the nonBig Six bank Tier 1
capital ratio mainly improved on decelerating growth in riskweighted assets (e.g., a higher
proportion of insured residential mortgages which carry zero risk weights) combined with strong
growth in Tier 1 capital due to internal capital generation and the regulatory change in the limit on
noncommon Tier 1 capital. On the other hand, the small U.S. BHC capital ratios received a boost

55
SeeInternalCapitalAdequacyAssessmentProcess(ICAAP),OSFI,October2010.
56
Thethresholdissetat2percentabovetheminimumrequiredTier1capitalandtotalratiosof4percentand
8percent,respectively.Theseminimumrequirementsmaychangeaccordingtothenewbankingcapitalguideline
proposedbytheBoardofGovernorsoftheFederalReserveSystemon7June2012,availableat
<http://www.federalreserve.gov/newsevents/press/bcreg/20120607a.htm>.FormoredetailsabouttheFDICIA
enactedin1991,see<http://thomas.loc.gov/cgibin/query/z?c102:S.543.ENR:>.
57
Itincreasedfrom25percentto40percentofTier1.

26

from public sector capital injections. Therefore, for both the large and small banks, the postcrisis
improvement of capital ratios in Canada and the United States depicts a very different picture of
balancesheet management. Namely, Canadian banks reduced the proportion of risky assets or
loweredtheirgrowth,whiletheirU.S.counterpartsdidnotorcouldnot.

Figure6:Capitalratiobyassetsize,Canadavs.UnitedStates(12monthmovingaverage)

Lastobservation:2010Q1
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaandtheFederalReserveBankofChicago

Figure7:Estimatedprobabilitydensityofcapitalratios,Canadavs.UnitedStates

Lastobservation:2010Q1
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaandtheFederalReserveBankofChicago

27

Figure8:Breakdownofcapitalratios,largebanks(yearoveryeargrowthrate)

Lastobservation:2010Q1
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaandtheFederalReserveBankofChicago

Figure9:Breakdownofcapitalratios,smallbanks(yearoveryeargrowthrate)

Lastobservation:2010Q1
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaandtheFederalReserveBankofChicago

5. Conclusion/policyimplications
This paper documents balancesheet ratios of Canadian financial institutions. Overall, various
measures of risk have decreased over the past three decades for most nonBig Six institutions and
have remained relatively unchanged for the Big Six banks. We find that smaller institutions,
particularly trust and loan companies, generally have lower leverage and higher capital ratios than
othertypesofbanks,includingtheBig Sixbanks.Theyalsohavelargerholdingsofliquidassetsand
facelowerfundingrisk comparedwith otherfinancialinstitutions.Theobservedoveralldeclineand
increased heterogeneity in risk, measured by divergent trends in the leverage, capital and asset

28

liquidity ratios, followed certain regulatory changes: specifically, the introduction of liquidity
guidelines on funding in 1995 (which preceded a sharp decline in, and more dispersion of funding
ratios among, nonBig Six institutions) and the implementation of bankspecific leverage
requirementsin2000(whichprecededadivergenceinleverageratiosbetweentheBigSixandnon
BigSixinstitutions).Thissuggeststhatregulatorychangeshadsignificantandheterogeneousimpacts
onthemanagementofbalancesheetsbyfinancialinstitutions,resultingintheincreasedresilienceof
thebankingsystem.Whilemarketdisciplinemayhavealsoplayedarole,moreresearchisneededto
identifychangesinthedegreeofmarketdisciplineintheCanadianbankingsector.
The CanadaU.S. comparison shows that small U.S. banks were more vulnerable than their larger
banks in terms of leverage ratios, and also shows increasing vulnerability leading up to the crisis in
riskweighted capital. Observations of Canadian banks do not show similar vulnerabilities among
smallbankspriortothecrisisperiod.
TheresilienceoftheCanadianfinancialsystemcouldbeattributedtotheconservatismandprudent
approachofitsregulatorybodies.Overthepastcoupleofdecades,Canadianbankswereresilientto
several financial stresses that, for the most part, originated outside Canadas borders.
58
More
recently, at the onset of the 2007 financial crisis, while many international foreign banks faced
difficultiesandrequiredpubliccapitalinjectionsanddebtguarantees,theCanadianfinancialsystem
didnotrequireanypublicassistanceorexperienceanybankfailures.Ithasbeenarguedthatthiswas
dueinlargeparttothetighterregulatoryratiossetbytheOfficeoftheSuperintendentofFinancial
Institutions (OSFI), which exceeded international minimums. Potentially more important is OSFIs
regulatory approach based on individual financial institutions. A part of the observed heterogeneity
inbalancesheetratiosamongCanadianbanksislikelyattributabletothis.
However,inthispaper,wefocusonlyontherisksideoffinancialregulations.Thereislikelyatrade
offbetweenthebenefitsofregulationsforfinancialstabilityandproductivitylossesinbankingsector
activities. These potential productivity losses could accumulate over a long horizon, since these
regulations are effective even during normal times when the financial sector would not pose a
systemic risk. As important future research topics, these tradeoffs need to be properly assessed to
striketherightbalancebetweenthebenefitsandthecostsofregulations.

58
Forinstance:theMexicancrisisin1994,theAsiancrisisin199798,andtheLongTermCapitalManagement
crisisin1998.

29

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31

Appendixes
A. EvolutionoftheCanadianFinancialSystem
59

The Canadian financial system has been shaped by several legislative and regulatory changes.
Most notably, periodic revision of the Bank Act has led to a number of important legislative
amendments that shaped the financial institutions that we know today. We begin first by
highlighting some important regulatory changes that affected the financial system as a whole,
andfollowwithimportantregulatorychangesrelatedtoourregulatoryratios.

A.1. Legislativeamendments

Achronologicallistofsomeimportantlegislativeamendmentsisbrieflydescribedhere.

1954amendments:Charteredbankswereallowedtomakemortgageloansinsuredby
the National Housing Association and to make personal loans secured by chattel
mortgagesonpersonalproperties,suchasautomobilesandappliances.
1967 amendments: Chartered banks were allowed to make conventional mortgage
loans(i.e.,uninsured).Atthesametime,the6percentceilingontheinterestrateon
bank loans was eliminated. Also, a 10 per cent ownership limit of Canadian bank
shareswasintroduced.
1980 amendments: The Bank Act was revised and had significant regulatory changes.
Whentheamendmentsbecameeffectiveon1November1981,charteredbankswere
permitted to broaden their activity by having operations in leasing and factoring, and
by providing venture capital and other services. Also, banks were permitted to raise
new equity through ways previously restricted. For instance, the amendments
removedtherestrictionofhavingonlyoneclassofshares,andallowedbankstoissue
equitytootherswhowerenotexistingshareholders.Furthermore,foreignbankswere
permittedtoentertheCanadianmarketthroughsubsidiariesonly.
1987 amendments: Chartered banks were further permitted to expand their
operations by allowing them to own and invest in securities dealers. As a
consequence, by the mid1990s, no single large and independent Canadian securities
dealersexisted.
1992 amendments: With the revision of the Bank Act, further deregulation of the
financial industry was introduced. Barriers between the chartered banks, trust and
loancompanies,andinsurancecompanieswereeliminated.Charteredbanksandtrust
companies were allowed to enter the insurance business; however, restrictions on
network insurance products through their branches were imposed. Moreover,
chartered banks were now allowed to own trust companies, which led to a wave of
acquisitionsthatreducedthenumberofindependenttrustandloancompanies.

59
ThissectiondrawsheavilyonFreedman(1998).Foramoreindepthdiscussion,seeDaniel,Freedmanand
Goodlet(199293);FreedmanandGoodlet(1998);FreedmanandEngert(2003);Armstrong(1997).

32

1995 amendments: Restrictions on the size of all foreign bank subsidiaries were
removed.Thiswasaresultoftwoprioramendments,wherethesizerestrictionswere
removed for the U.S. foreign bank subsidiaries in 1989, and for Mexican foreign bank
subsidiariesin1994.
1998amendments:Trustandloanreportingformswerecombinedwiththechartered
banks reporting returns. As a consequence, only monthly data on trust and loan
companiesfrom1996exist.
1999 amendments: Foreign banks branches were allowed in Canada; however,
restrictions were imposed on their business models, where they were limited to
raising only wholesale deposits, with very few retail deposits permitted. In addition,
foreign branches needed to maintain a minimum capital equivalent deposit amount
withadomesticfinancialinstitution.
2002 amendments: Chartered banks were allowed to own finance companies.
However,investmentinnonfinancialbusinesseswasstillrestricted.

A.2. Regulatoryrequirements

In addition to satisfying legislative requirements, federally regulated deposittaking

institutionshavetosatisfyregulatoryrequirementsimposedbyOSFI.Thefollowingisalist
ofimportantchangesrelatedtoourthreeratios.

A.2.1. Leveragerequirements

Withtheintroductionoftheregulatoryleverageratio,aformallimitwasimposedbyOSFI.
This limit is known as the assettocapital multiple (ACM) limit. Based on Bordeleau,
Crawford and Graham (2009), the ACM limit evolution can be divided into three distinct
periods:
1982: A formal ACM limit of 30 was imposed only on large banks. The actual limit
wasindeedlower.
1991: The formal ACM limit of 30 was reduced to 20. This limit was applied
uniformlyacrossallDTIs.
2000: The ACM limit of 20 was maintained; however, banks that satisfied certain
sets of criteria were temporarily allowed a limit of 23. Furthermore, supervisors
could use their discretionary powers to impose lower actual limits. For instance,
smallandnewlyfoundedfinancialinstitutionshaveACMlimitsmuchlowerthan20.
2010:TheBaselCommitteeonBankingSupervision(BCBS)issuedthesocalledBasel
III requirements. It introduced a pillarII leverage ratio requirement, which should
migrate to pillarI by 2018. The BCBS is still in the process of calibrating the
minimumstandardsforthisratio.

33

A.2.2. Capitalrequirements

Officially,minimumrequirementsoncapitalratioswerefirstintroducedwiththeadoption
of the Basel I accord. The minimum requirement limits and the components of the ratios
haveevolvedovertime.Here,wefocusonlyonTier 1ratiocomponentswhichareTier 1
capitalandriskweightedcapital:

1988:TheBaselIaccordwassignedandrequiredimplementationbyallbanks,with
significantinternationalbusinessintheG10bytheendof1992.
1994: Canadian banks started reporting the Basel Capital Adequacy Returns to
supervisoryauthorities.TheminimumrequirementsweresetbyBaselat4percent
and 8 per cent for the Tier 1 capital ratio and the total capital ratio, respectively.
Tier 1 capital included mainly equity and retained earnings. Riskweighted capital
focusedprimarilyoncreditriskandwascalculatedusingthestandardizedapproach.
1996: The Basel I framework was amended to account for market risk due to
increasedbankactivitiesintradingbooks,usingthestandardizedapproach.
1999:OSFIofficiallyraisedtheminimumrequirementto7percentand10percent
fortheTier1capitalandtotalcapitalratios,respectively.
2004: The Basel II accord was released, with its framework to be implemented by
2008. The new framework introduced operational risk in addition to market and
credit risk. The methodology for calculating market risk remained the same
standardizedapproach.However,theframeworkallowedbankstousetheirinternal
models to calculate the weighting for credit and operational risk exposures. It
shouldbenotedthatbanksmustobtainapprovalfromregulatoryauthoritiesbefore
using their own methodologies. Also, Tier 1 capital components were adjusted;
however, the equity and retained earnings remained its major components, with a
minimumof75percentcommonequity(corecapital)requirementinTier1capital.
2008: The Basel II framework was implemented in Canada. However, only the six
topbankshaveadoptedtheinternalratingsbased(IRB)approach.
2010:TheBaselCommitteeonBankingSupervision(BCBS)issuedthesocalledBasel
III requirements,
60
which refined the level and quality of the capital requirements.
By the end of the transition period (end2019), internationally active financial
institutions would have to comply with a 4.5 per cent minimum common equity
ratio plus a 2.5 per cent minimum capital conversion buffer; a minimum of 6 per
centand8percentTier1capitalandtotalcapital,respectively.

A.2.3. Liquidityrequirements

Untilrecently,andunliketheothertworegulatorymeasures,liquidityregulationtookthe
form of guidelines and directives to be applied at the discretion of the banks. The first
guideline was introduced by OSFI in December 1995. However, OSFI is in the process of

60
SeeBCBS(2010a).

34

reviewing this guideline in light of the new BCBS requirements. Indeed, with the
introduction of Basel III requirements, banks will have to report two regulatory liquidity
ratios, known as the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio
(NSFR).However,theBCBSisstillintheprocessofcalibratingtheminimumstandardsfor
thisratio,whichareexpectedtobeintroducedin2015fortheLCR,and2018oftheNSFR.

B. OverviewoftheCanadianFinancialSystem

B.1. Historicalevolutionofthebankinglandscape
In the early and mid1900s, the Canadian financial system was characterized by five distinct, yet
complementary, financial institutions: chartered banks, credit unions and caisses populaires, trust
and loan companies, life insurance companies, and security dealers.
61
This was the result of federal
and provincial regulatory barriers that prohibited crossownership and, to a certain degree,
separatedbusinessactivitiesbetweentheseinstitutions.
Forinstance,charteredbanks,

whicharefederallyincorporatedandsupervised,weremainlyinvolved
in making commercial loans, whereas trust and loan companies, which operated under federal or
provincialcharters,
62
specializedinresidentialmortgagelendingandfiduciarybusiness.
63

Gradually, over the years, periodic changes in legislation have reduced the traditional barriers
betweentheseinstitutionsandpermittedthemtoentereachothersbusinesslines.Whilethe1967
legislative amendments removed restrictions on chartered banks involvement in residential
mortgage lending, the legislative amendments of the 1980s allowed the banks to directly compete
withtrustandloancompaniesbypermittingthemtoownmortgagecompanies.
64
However,itwasnt
until1992thatthedistinctionbetweenthedifferentinstitutions almostcompletelydisappeared,by
eliminating the prohibition on crossownership.
65,66
Over the following two decades, banks have
emerged as the largest pillar of the Canadian financial system, with the six largest domestic bank
conglomeratesdominatingthebankingsystem.

61
There are, of course, other types of institutions; e.g., cooperative credit movements, pension funds, venture
capital companies, and financial market infrastructures such as clearing and settlement systems. However, this
paper focuseson federally incorporated deposittaking institutions (banks, bank holding companiesand federally
regulatedtrustandloancompanies).
62
Trustandloancompaniescanbeincorporatedundereitherfederalorprovinciallegislation;however,alltrust
andloaninstitutionsaresubjecttoprovinciallicensingagreements.
63
Asfortheothertwotypesofinstitutions,lifeinsurancecompaniescanbeincorporatedthroughfederalor
provincialcharters,whilesecuritiesdealersareincorporatedunderprovinciallegislation.
64
Also,duringthisperiod,trustandloancompaniesbegantoaggressivelycompetewithbanksforconsumerand
commerciallending.
65
Althoughsomerestrictionsstillprevail.Forexample,charteredbankscanmarkettheirinsuranceproductsonly
throughindependentbranches(distinctfromtheirretailbankingbranches).Also,creditunionsandcaisses
populairesarestillprovinciallyregulated.
66
FormoredetailsontheevolutionoftheCanadianfinancialsystem,seeFreedman(1998);Freedmanand
Goodlet(1998);FreedmanandEngert(2003);Armstrong(1997).

35

These Big Six banks,

67
which hold roughly 90 per cent of all Canadian bank assets, offer financial
servicestoawiderangeofsectors,andoperateonanationwidebasisthroughtheirbranchnetwork.
Their activities are organized into three broad business segments: retail banking, which offers loan
productstohouseholdsandsmall/mediumsizedbusinesses;capitalmarketsactivities,whichinclude
security dealers, investment banking and credit products to large corporations; and wealth
managementactivities,whichincluderetailbrokerageandmutualfundproducts.Ontheotherhand,
most of the smaller financial institutions have a more traditional model of banking, which mainly
consists of raising deposits, providing loans to a few economic agents, and operating in specific
regions.
B.2. Historicalevolutionoftheoverallbalancesheet
Changes in economic reality and in legislation have both contributed to the evolution of Canadian
banksassetandliabilitymixoverthepastthreedecades.Noticeably,therelativesharesofmortgage
loans and private securities have trended up, while the relative share of nonmortgage loans has
trendeddown.
On the asset side, the share of mortgage lending, which includes residential and nonresidential
mortgages,butexcludesoffbalancesheetsecuritization,
68
hasbeencontinuouslygrowingsincethe
1980s (Figure B1).
69
This trend has been mainly driven by residential mortgage lending. During the
1980s and early 1990s, residential mortgage growth was in part facilitated by several legislative
amendments of the Bank Act, which allowed chartered banks to directly compete with other
financialinstitutionsforresidentialmortgagefinancing.Thetrendinthe1990swasalsosupportedby
favourable demographics. The BabyBoomer generation was starting to form families and buying
their first homes.
70
Modifications to the mortgage insurance rules by the Canada Mortgage and
HousingCorporation(CMHC)intheearly2000salsoaidedthegrowthtrendforresidentialmortgage
lending.Forinstance,theminimumdownpaymenteligibilitycriterionwasloweredfrom25percent
to5percentin1999,andpriceceilinglimitswereremovedin2003.Thedeclinein2009isattributed
totheintroductionoftheInsuredMortgagePurchaseProgram,throughwhichCMHCboughtroughly
$75 billion of the banks insured mortgage portfolios on behalf of the government. In 2010, the
growthtrendpickedupagain,stemmingfromrobusteconomicconditionsinCanada.
In contrast to mortgage loans, the share of nonmortgage loans, which includes business loans and
personalloans,hasbeendecliningsincetheearly1980s.AsshowninFigureB1,thedecliningshare
ofnonmortgageloansinthe1980swasinpartduetoincreasedcompetitionfromdifferentfinancial

67
Thesebanksare:BankofMontreal,BankofNovaScotia,CanadianImperialBankofCommerce,NationalBankof
Canada,RoyalBankofCanadaandTorontoDominionBank.
68
Securitizationsareexcludedsincetheyarenotincludedintheleverageratiocalculationpriortoimplementation
oftheIFRSin2011,andsincetheeffectoncapitalratiosisnegligible(immaterialriskweighting).Itisworthnoting
thatbefore2007,securitizationwaslimitedinCanada(around4percentin1997to17percentin2007oftheir
residentialmortgages).Formoredetails,seeArmstrong(1997);Allen,HortasuandKastl(2011).
69
FiguresB2andB3displaybalancesheetsizedynamicsforassetsandliabilities,respectively,bybanksizegroups.
Inaddition,TableB1showsaverageassetandliabilityportfoliosovertheentiresampleperiodforallbankgroups.
70
SeeArmstrong(1997)foramoredetaileddiscussion.

36

institutions.Forinstance,lifeinsurancecompaniesweredirectlycompetingforbusinessloans,while
credit unions and caisses populaires were competing for personal loans. Additionally, as corporate
borrowersincreasinglyreliedoncapitalmarketsfortheirfinancingneedsinthe1990sthroughbonds
and equity issuances, the decline in the share of nonmortgage loans began to accelerate. At the
same time, banks relative holdings of private securities had risen, indicating continued exposure to
corporate sector risk, albeit through different instruments. On the other hand, holdings of public
securitiesremainedstable.Theshareofpublicsecuritiesremainedrelativelysmall,despitethesmall
uptickduringthemid1990s,inpartduetotherapidlygrowingsecuritieslendingandrepomarkets
inwhichbankswereincreasinglyparticipatingthroughtheirdealersubsidiaries.
71

On the liability side, deposits remain the dominant source of funding. Both retail and wholesale
deposits represent more than half of total liabilities. However, their relative shares have been
decliningsincethemid1990s,asbanksincreasedtheirparticipationintherepomarkets.Therelative
shareofotherliabilitiesalsoincreasedduringthisperiod,mainlyduetoderivativerelateditemsheld
bythebanks.Thisincreaseisalsoreflectedbythederivatesheldontheassetsside.
72

71
SeeMorrow(19941995).
72
Canadianaccountingrulesrequirereportingofderivativesonagrossbasis,incontrasttothenetbasisinthe
UnitedStates,forinstance.

37

FigureB1:BalancesheetcomponentsofCanadianfinancialinstitutions(asapercentageof
totalassets)

Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaLastobservation:August2011

38

FigureB2:AssetcomponentsofCanadianfinancialinstitutionsbalancesheets,bysizein
billionsofdollars(12monthmovingaverage)

Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaLastobservation:August2011

39

FigureB3:LiabilitycomponentsofCanadianfinancialinstitutionsbalancesheets,bysizein
billionsofdollars(12monthmovingaverage)

Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaLastobservation:August2011

40

TableB1:AveragebalancesheetcompositionofCanadianbanksbytypeinpercent,(19832011)

BigSix
banks
NonBigSix

Large Medium Small

Foreign
subsidiary
Other
domestic
bank
Trustand
loan
company
a

High
wholesale
funding
Low
wholesale
funding
No
wholesale
funding
Assets

Cash 7.9 9.6 16.5 21.5 11.4 4.9 17.8 14.7 7.3 15.9
Mortgageloans 18.7 19.8 18.2 20.3 12.8 42.0 56.9 8.3 29.6 33.0
Publicsecurities 6.8 9.0 4.2 5.3 9.0 8.4 4.2 7.0 10.2 10.6
Nonmortgage
loans
43.0 44.8 47.1 37.7 47.5 37.1 12.4 52.4 38.3 31.2
Privatesecurities 11.9 5.0 5.7 5.2 5.5 3.9 4.3 5.3 5.3 4.1
Otherassets 11.7 11.9 8.3 10.0 13.7 3.7 4.4 12.2 9.3 5.1
Liabilities

Retaildeposits 32.6 27.6 28.2 30.6 19.1 57.4 64.0 10.2 43.9 42.7
Wholesale
deposits
40.8 46.1 48.5 38.6 52.9 23.7 17.9 65.5 30.9 0.0
Repos 4.3 2.0 0.2 0.0 2.2 1.0 0.0 2.5 1.4 0.0
Bankers
acceptances
3.9 6.0 4.2 1.8 7.0 0.5 0.4 6.0 5.0 0.1
Otherliabilities 13.7 12.5 8.0 7.1 12.2 12.2 7.2 9.1 12.9 25.9
Equity 4.7 5.8 10.9 21.8 6.6 5.2 10.5 6.8 6.0 31.2
a
Trustandloandatastartfrom1996.
Source:OfficeoftheSuperintendentofFinancialInstitutions
Note:Numbersarecalculatedbyfirstaggregatingeachbalancesheetitembygroupsforeachmonthandtakingthesimpleaverageovertime.

41

C. ReportingRequirementsandReturnsforDTIs

42

D. ActiveFinancialInstitutions,ByBankSizeandCharterType,inAugust2011
NonBigSixbanks

Foreignsubsidiary Otherdomesticbank Trustandloancompany

Large

[L]AMEXBankofCanada
[H]BankofTokyoMitsubishiUJF(Canada)
[H]BNPParibas(Canada)
[L]CitibankCanada
[H]HSBCBankCanada
[L]ICICIBankCanada
[L]INGBankofCanada
[H]MBNACanadaBank
[N]BridgewaterBank
[N]CanadianTireBank
[H]CanadianWesternBank
[L]LaurentianBankofCanada
[H]ManulifeBankofCanada
[N]AGFTrustCompany
[L]EquitableTrustCompany(The)
[L]HomeTrustCompany
[N]MCANMortgageCorporation
[N]PeoplesTrustCompany
[H]RBCDexiaInvestorServicesTrust
[L]ResMorTrustCompany
Medium

[H]BankofChina
[H]IndustrialandCommercialBankofChina(Canada)
[H]KoreaExchangeBankofCanada
[L]MegaInternationalCommercialBank(Canada)
[H]ShinhanBankCanada
[H]SocitGnrale(Canada)
[L]StateBankofIndia(Canada)
[H]SumitomoMitsuiBankingCorporationofCanada
[H]UBSBank(Canada)
[L]BankWest
[H]FirstNationsBankofCanada
[L]GeneralBankofCanada
[N]HomEquityBank
[L]Pacific&WesternBankofCanada
[N]President'sChoiceFinancialServices
[L]CommunityTrustCompany
[H]EffortTrustCompany(The)
[H]LeagueSavingsandMortgageCompany
[L]M.R.S.TrustCompany
[N]PeaceHillsTrustCompany
Small
[L]CTCBankofCanada
[H]HabibCanadianBank
[N]CitizensBankofCanada
[H]AlternaBank
[N]DirectCashBank
[H]JamesonBank
[N]BNYTrustCompanyofCanada
[N]CaledonTrustCompany
[N]ComputershareTrustCompanyofCanada
[N]ConcentraTrust
[L]EquityFinancialTrustCompany
[N]FiduciaryTrustCanada
[L]FirstDataLoanCompany,Canada
[N]IndustrialAllianceTrustInc.
[N]InvestorsGroupTrustCo.Ltd.
[N]LegacyPrivateTrust
[N]OakTrust
[N]StandardLifeTrustCompany
[N]StateStreetTrustCompanyCanada
[L]ValiantTrustCompany
BigSixbanks
BankofMontreal
BankofNovaScotia(The)
CanadianImperialBankofCommerce
NationalBankofCanada
RoyalBankofCanada
TorontoDominionBank(The)
Note:Highwholesalefundingfinancialinstitutionsareindicatedwith[H],lowwholesalefundingwith[L]andnowholesalefundingwith[N].

43

E. RobustnessChecks
This appendix investigates whether the main findings in the paper are robust to changes in the
calculation methods and sample selections. The first check that we conduct is an analysis of the
averagesoftheratiosinsteadofthemediansoftheratiosusedinthispaper.Theresultsofthistest
showsimilartrendsasthemediansoftheratiosdespiteslightdifferencesinlevels.Weprefertouse
themedian,sinceitprovidesabettermeasureforthecentraltendencybyeliminatingthebiasfrom
outliers.
The second check that we conduct relates to the disaggregation of the Big Six banks, instead of
grouping them together. The results reveal that the Big Six banks have fairly similar balancesheet
compositions, implying similarity in their resilience to different types of shocks. Therefore, analyses
inthispaperhaveonlyfocusedontheBigSixasagroup.
The next two checks that we conduct pertain to the entry, exit and acquisition dynamics and their
potentialimpactontheregulatoryratios,specificallytheonesthatexhibitedsignificantchanges(i.e.,
leverage and funding ratios). The third check analyzes the measured leverage ratios calculated by
only including the active financial institutions throughout the data period. The results still reveal a
divergent trend for the leverage ratios between the Big Six and the other institutions, albeit to a
lesserdegree.ThisresultsuggeststhattheacquisitionsofnonBigSixinstitutionsbytheBigSixbanks
partlycontributed totheobserveddivergence.Thetrustandloan companies,togetherwithseveral
Canadianinvestmentdealers(notincludedinthedataset)thatwereacquiredbytheBigSixbanksin
the late 1980s (e.g., Dominion Securities by the Royal Bank of Canada and Nesbitt Thomson by the
Bank of Montreal), did not seem to have significantly increased the leverage of their parent
institutions.
Thefourthcheckcomparesthefundingratioswithandwithoutincludingcertainacquisitions,entries
andexits.Theresultsrevealthatthe declineinthefundingratio(Figure2, paneld)isreinforced by
theinclusionoftrustandloancompanydatain1996,which,onaverage,exhibitlowfundingratios.
Inaddition,dynamicsregardingmergers,exitsandcharterchangesofforeignsubsidiaries(e.g.,from
aforeignsubsidiarytoaforeignbranch)
73
appeartohaveplayedsomeroleinthedeclineoffunding
ratios around the year 2000. Regardless of these factors, a decline in funding ratios is observed
aroundthetimeoftheintroductionoftheliquidityguidelines,asshowninFigureE.Potentialeffects
oftheliquidityguidelinesareseenespeciallyforthelowfundingratios(25thpercentile),whichhad
declinedpriorto1995andstabilizedsincethattime.
The final check relates to the repurchase agreements securities (i.e., repos) in the funding ratio.
Some contend that the repos should not have been included in the calculation of the wholesale
fundingratio,sincetheCanadianrepomarketstructureisdifferent,andisperceivedasmorestable
and resilient than in the United States. For instance, the repo transactions in Canada are largely
bilateral and are mostly secured by securities backed by the Government of Canada. However,

73
Therewere38suchforeignsubsidiaries,ofwhich11changedtheirchartertoaforeignbank,11mergedorwere
acquiredbyanotherfinancialinstitutionand16ceasedoperation.

44

despite being perceived as resilient, the repo market in Canada was not entirely shielded from
marketturbulence.Attheonsetoftherecentfinancialcrisis,spreadsinCanadaincreasedinlinewith
the spreads in other major economies, although not as much as in some advanced economies that
havebeenhardhitbythecrisis.
74
Finally,byexcludingthereposecuritiesfromthewholesalefunding
ratio,weobtainsimilarresultswithonlyslightdifferencesinlevels.
Overall, these checks have confirmed the robustness of, and have increased our confidence in, our
results.
FigureE:FundingratiofortheBigSixandnonBigSixbanks(monthlydata)

a
Excludetrustandloancompaniesandforeignsubsidiariesthatmerged,exitedorchangedtheirchartertype.
Source:OfficeoftheSuperintendentofFinancialInstitutionsCanadaLastobservation:August2011

74
Forinstance,thespreadsbetweentheinterbankofferedratesandovernightindexedswapsmovedfrom8basis
pointsin2007tomorethan100basispointsattheheightoftherecentfinancialcrisisin2009.