The effects of the Canadian Bank Acts of 1967 and 1980 on competition in the financial sector : a welfare loss approach
Date
1988
Authors
Malatest, Robert A.
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Abstract
The following study evaluated the effectiveness of Canadian legislation, embodied in the revisions to the Bank Act, in curbing the market power wielded by the five largest Canadian Banks. If the legislation was as effective as it was proclaimed to be, then one would expect the magnitude of the "welfare loss" to diminish with each revision.
An analysis of the Canadian banking sector using the standard Structure-Conduct-Performance model suggests that Canadian banking markets are characterized by excessive concentration and considerable market power. However, as the expressed intent of Canadian bank legislation (the 1967 and 1980 Bank Act revisions) was to enhance "effective" competition in Canadian financial markets, it is possible to quantify the effectiveness of such legislation by using welfare loss techniques.
In order to accurately determine the monopoly profits ( and hence, subsequently, the welfare loss) associated with Canadian chartered banks, bank profits were compared to profits earned by Canadian trust and loan corporations. This comparison entailed the application of a standardized accounting system to eliminate accounting differences which could alter or distort the actual profitability of the financial institution(s).
The application of this standardized methodology allowed for a cross sectoral comparison of financial institution profitability. Differences between the profit rates of the five largest chartered banks and trust and loan corporations reveal considerable disparity in profitability, particularly after the revisions of the Bank Act in 1967 and 1980. Prior to 1967, average bank profitability was slightly lower than the profitability of trust and loan companies. However, with the advent of the 19 6 7 Bank Act, Canadian chartered bank profits exceeded those of trust and loan companies by a considerable margin. Likewise, welfare loss estimates indicate a substantial increase following the 1967 Bank Act revision. While the welfare loss declined marginally after the passage of the 1980 Bank Act revision, it is unclear whether the decline represents an increase in domestic bank competition or rather, a deterioration in the profitability associated with the overseas operations of the major chartered banks.
Al though the Bank Act revisions were to be a "blueprint for competition", detailed analysis of the legislation indicates that there was no major amendment that would have substantially altered the underlying structure of the Canadian banking system and so increased competition in the banking sector. While there may be several reasons that could explain this "bias" among policy makers, the major reason appears to be the power exerted by various "pressure groups". In particular this applies to the Bank of Canada, which had no interest in promoting freer entry, given the Bank's preference for "covert" policy tools such as moral suasion; and the Chartered Banks, which did not want to compromise their joint monopoly position.
Since the passage of the 1980 Bank Act, there has been considerable debate pertaining to the potential for competition in the Canadian banking sector. Although federal proposals contained in the Green Paper would have significantly increased competition through the establishment of Schedule C banks, the subsequent collapse of two Canadian chartered banks and the rash of failures among Canadian trust & loan companies has resulted in the government withdrawing such legislation in preferencing instead to maintain the "stability" of the financial sector. Given the government's past record in introducing "effective and equitable competition", it is unlikely that the projected 1990 revisions to the Bank Act will contain legislation that will substantially alter the oligopolistic structure of the Canadian chartered banking system.