Browse Profiles > Canada > Core Principles for Effective Banking Supervision
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Canada

Core Principles for Effective Banking Supervision

Summary
In its 2008 Financial System Stability Assessment (FSSA) Update, the International Monetary Fund (IMF) commended Canada's "highly effective and nearly unified" regulatory and supervisory framework. The banking system is regulated by a tripartite structure comprised of the Office of the Superintendent of Financial Institutions (OSFI), the Canada Deposit Insurance Corporation (CDIC), and the Department of Finance (DoF). The OSFI is the only agency responsible for supervising banks, whereas the CDIC and the DoF are in charge of developing the policy and legislative framework for the financial sector. In 2000 the IMF published a Report on the Observance of Standards and Codes for Canada in which it assessed Canada's observance of the Basel Core Principles (BCPs) for Effective Banking Supervision and concluded that full compliance with all BCPs would be achieved following the implementation of the proposals contained in the government's 1999 Policy Paper on Reforming Canada's Financial Services Sector. According to the 2008 FSSA, these changes were subsequently made. The legal framework for banking supervision in Canada is mainly comprised of the 1991 Bank Act, which was last amended in 2007.

    General Overview

    The International Monetary Fund (IMF) conducted a Financial Sector Assessment Program (FSAP) in October 1999 of Canada's observance of the Basel Core Principles (BCPs) for Effective Banking Supervision, and reported its findings in its 2000 Report on the Observance of Standards and Codes (ROSC). The IMF report concluded that there was "virtual full compliance" with the BCPs. Shortcomings were identified with regard to internal controls and corrective action. According to the IMF's 2000 ROSC, full compliance would be achieved following the implementation of the proposals contained in the government's 1999 Policy Paper "Reforming Canada's Financial Services Sector: A Framework for the Future," which provided an outline of the coordinated intervention processes applied by the Office of the Superintendent of Financial Institutions (OSFI), and the Canada Deposit Insurance Corporation (CDIC). The proposals give additional powers to the supervisory authority - the OSFI - to deal with increased risks in the banking sector, including the right to remove directors and senior officers from office in certain circumstances, such as in instances of misconduct, and additional powers to deal with related party transactions of financial institutions.
    Weaknesses highlighted in the 2000 ROSC have since been addressed, according to the IMF's 2008 report titled "Canada: Financial System Stability Assessment - Update" (hereafter referred to as the 2008 FSSA Update) which is based on a 2007 FSAP review. The 2008 FSSA Update concludes that Canada now fully observes all BCPs. The Basel Committee on Banking Supervision revised its BCPs and Methodology in 2006. The IMF's 2008 FSSA mentions four of the new 2006 BCPs, notably liquidity risk, operational risk, interest rate risk and supervisory techniques, and finds that the OSFI is compliant with all four. The report further concludes that the supervisory framework is "risk-focused and reliance-based" (p. 30). However, the focus of this report is primarily on Canada's compliance with 1997 BCPs and the Basel Committee's 1999 methodology.
    According to the IMF's 2008 FSSA Update, "Canada has established a highly effective and nearly unified regulatory and supervisory framework" (p. 27). The 2000 ROSC stated that the banking system is regulated by a tripartite structure comprised of the OSFI, the CDIC, and the Department of Finance (DoF). The OSFI is the only agency responsible for supervising banks, whereas the CDIC and the DoF are in charge of developing the policy and legislative framework for the financial sector. The responsibilities and objectives of the OSFI and the CDIC are provided under the 1985 OSFI Act and the 1985 CDIC Act respectively. The OSFI also supervises trust and loan companies, insurance companies, cooperative credit associations, and pension plans. The legal framework for banking supervision is mainly comprised of the 1991 Bank Act, which provides a comprehensive legislative framework for banking, and is reviewed every five years. In 2006, the government of Canada published its "Financial Institutions Legislation Review." The legislative and regulatory proposals comprised enhancing consumer protection, improving disclosure to consumers, increasing legislative and regulatory efficiency, and adapting the regulatory framework to new developments in the markets. The government was expected to draft legislation to implement the policy proposals. On April 20, 2007, according to the Institute of International Bankers' (IIB) 2007 Global Survey, the Bank Act was amended through Bill C-37 to increase legislative efficiency, improve the regulatory framework, and enhance consumer protection.
    According to the IMF's 2008 FSSA Update, Canadian banks account for about 60 percent of total financial system assets, with the five largest banks holding more than 85 percent of total bank assets. While the participation of foreign banks has been increasing, it remains under 10 percent of total bank assets. Basel II came into effect in Canada in November 2007. The 2008 FSSA Update reports that, unlike in Europe, Canada "will have a single phase rather than two phases, and the large banks opting for internal ratings will use only the advanced internal ratings-based approach. The foundation internal ratings-based approach is not an option. Other banks will adopt the standardized approach" (p. 31).


    The Principles

    1. (1) Clear responsibilities and objectives for each supervisory agency.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle. The banking system is regulated by a tripartite structure comprised of the OSFI, the CDIC, and the DoF. The OSFI is the only agency responsible for supervising banks, whereas the CDIC and the DoF are in charge of developing the policy and legislative framework for the financial sector. The responsibilities and objectives of the OSFI and the CDIC are provided under the 1985 OSFI Act and the 1985 CDIC Act respectively.

    1.(2) Operational independence and adequate resources.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. While the legislative framework guarantees the operational independence of each agency, the Minister of Finance maintains "some formal powers to overrule OSFI on chartering and some banking policy issues." In its 2008 FSSA Update, based on the 2007 FSAP review of the 2006 BCPs, the IMF states that the OSFI is characterized by "a well-balanced and fully articulated organization, robust processes, well elaborated documentation, sound and suitable methodologies, up-to date tools in line with the international best practices, adequate and competent staffing, and sufficient legal powers effectively used where appropriate" (p. 35).

    1.(3) A suitable legal framework for authorization and ongoing supervision.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle. The legal framework for banking supervision is mainly comprised of the 1991 Bank Act, which provides a comprehensive legislative framework for banking, and is reviewed every five years. In 2006, the government of Canada launched a "Financial Institutions Legislation Review." The legislative and regulatory proposals comprised enhancing consumer protection, improving disclosure to consumers, increasing legislative and regulatory efficiency, and adapting the regulatory framework to new developments in the markets. The government was expected to draft legislation to implement the policy proposals. On April 20, 2007, as noted in the IIB's 2007 Global Survey, the Bank Act was amended through Bill C-37 to increase legislative efficiency, improve the regulatory framework, and enhance consumer protection.

    1.(4) A suitable legal framework to address compliance with laws as well as safety and soundness concerns.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. The 1991 Bank Act gives legal powers to the OSFI "to address compliance with laws and with safety and soundness of banks."

    1.(5) Legal protection for supervisors.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle.

    1.(6) Arrangement for sharing of information between supervisors and protection of confidentiality of shared information.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. The IMF report expressed doubts, however, regarding the effectiveness of ongoing exchange of information, coordination and responsibilities between the OSFI, the CDIC, and the provincial securities supervision authorities.

    2. Clearly defined permissible activities for banks and control of the use of the word 'bank'.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle. The IMF report notes that "the use of the term bank is restricted and the permissible activities of banks and the permissible investment powers are clearly defined by the Bank Act of 1991." Moreover, only licensed and supervised institutions are authorized to take "proper bank deposits" from the public.

    3. Criteria for structure, directors, operating plan, controls, financial condition and capital base.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. Furthermore, an effective supervisory framework is in place to govern the licensing process. The IMF report notes that while there is some uncertainty regarding the involvement of the DoF in licensing, in practice, the Minister of Finance does not override the OSFI's recommendations.

    4. Authority to review and reject transfer of ownership.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle. Furthermore, an effective supervisory framework is in place to govern ownership control.

    5. Authority to review major acquisitions and investments.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. Furthermore, an effective supervisory framework is in place to govern acquisitions and investments. The IMF report notes that the supervisors have "the authority to establish criteria for reviewing major acquisitions or investments by a bank and for ensuring that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision."

    6. Minimum capital adequacy requirements (meet Basle Capital Accord for internationally active banks).

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle. Per the same report, Canadian banks are required to comply with the minimum capital adequacy requirements. Basel II came into effect in Canada in November 2007. The 2008 Update notes that, unlike in Europe, Canada "will have a single phase rather than two phases, and the large banks opting for internal ratings will use only the advanced internal ratings-based approach. The foundation internal ratings-based approach is not an option. Other banks will adopt the standardized approach" (p. 31).

    7. A method exists for the evaluation of procedures related to loans, investments and portfolio management.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC.

    8. Policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle.

    9. Prudential limits and management information system on concentration of exposure.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. The IMF report noted that the OSFI required "credit limits to single or connected borrowers of 25 percent of regulatory capital." Information systems were also in place to identify the concentration of exposure.

    10. Arm's length rule and monitoring for connected lending.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle. The IMF report noted that while most related party transactions are not subject to approval by the Board of Directors, "the Conduct Review Committee of the board is required to review the bank's practices and procedures to ensure that such transactions are proper individually and in the aggregate."

    11. Policies and procedures for country risk and transfer risk.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC.

    12. Measuring and monitoring market risk. Limit and/or specific capital charge on market risk exposure.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle. The OSFI requires that the banks' Value-at-Risk models "accurately measure, monitor and adequately control market risks."

    13. Comprehensive risk management processes.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. The IMF report notes that the OSFI has established "a risk-based methodology to evaluate an institution's risk profile, financial condition, risk management processes and compliance with applicable laws and regulations." According to the IMF's 2008 FSSA Update, based on the 2007 FSAP review of the 2006 BCPs, operational risk analysis, interest rate management, and liquidity risk review are an integral part of the OSFI's supervisory framework. The OSFI has issued Guidelines on Interest Risk Management and Liquidity Risk, and all banks are required to comply with the Basel Committee's document on Sound Practices for the Management and Supervision of Operational Risk. Moreover, the OSFI monitors the involvement of the board and senior management in the banks' asset and liability management committees. The 2008 IMF report welcomes the OSFI's plan to make its interest rate risk assessments "more forward-looking and quantitative" (p. 35).

    14. Adequate internal controls.

    In its 2000 ROSC, the IMF rates Canada as "broadly compliant" with this principle due to the supervisor's lack of authority "to remove Board members, or to require changes in the composition of Board or Management." The OSFI requires "that banks have internal controls in place that are adequate for the nature and scale of their business." The OSFI further advises that internal control policies and procedures "be approved by the Board of Directors, and their effectiveness assessed by an independent internal audit/inspection function, on an annual basis." The CDIC's Standards Assessment and Reporting Program (SARP) also includes an Internal Control Standard to promote prudential management of banks' operations. According to the ROSC, full compliance was expected following implementation of the government's proposals contained in the 1999 Policy Paper "Reforming Canada's Financial Services Sector, A Framework for the Future." In its 2008 FSSA Update, the IMF notes that the weaknesses observed in the 2000 ROSC in regards to this principle were remedied by the authorities and Canada now fully complies with this principle.

    15. Strict "know-your-customer" rules and high ethical and professional standards.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. The OSFI "expects banks to have codes of conduct that, among other matters, deal with ethical behavior towards customers." The CDIC's SARP includes an Internal Control Standard, which requires banks to have a comprehensive code of conduct. In July 2005, according to the IIB's 2007 Global Survey, the DoF published a Consultation Paper ("Enhancing Canada's Anti-Money Laundering and Anti-Terrorist Financing Regime") with specific proposals to improve the anti-money laundering (AML) and combating the financing of terrorism (CFT) regime in Canada. The IIB report notes that the banking industry has been very active in the consultation process following the release of the Consultation Paper. In December 2006, per the same report, Bill C-25 was enacted, amending the 2000 Proceeds of Crime (Money Laundering) and Terrorist Financing Act, to comply with the Financial Action Task Force (FATF) new methodology. Canada's financial intelligence unit - the Financial Transactions and Reports Analysis Centre of Canada - was created under the 2000 AML/CFT law. The IIB survey notes that Bill C-25 will have to be complemented by new regulation to be fully effective.

    Despite the above positive outlook, a 2008 FATF mutual evaluation on Canada's AML/CFT framework reveals that Canada's "the preventive system is generally insufficient to meet the FATF Recommendations" (p. 6). The financial system, among other shortcomings, suffers from a weak customer due diligence (CDD) process, and the FATF report assigns a "non-compliant" rating for Canada in terms of its CDD measures for financial measures. However, the report assigns largely compliant ratings for Canada's measures relating to record keeping, suspicious transactions reporting, and internal controls. In spite of the FATF's less than favorable assessment, the IMF in its 2008 FSSA Update deems Canada to fully comply with all BCPs.

    16. Effective supervisory system consisting of on-site and off-site supervision.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle. In its 2008 FSSA Update, based on the 2007 FSAP review which focuses on the new 2006 BCPs, the IMF states that "on-site, offsite, and oversight work are efficiently blended, with good communication within the organization" (p. 35). The OSFI monitors larger banks on a quarterly basis through off-site reporting, benchmarking, review of internal audit reports, and other techniques. With regards to smaller banks, the OSFI relies more on these institutions' own reports. The IMF report notes that there is a need for additional resources for cross-checking of the submissions provided by financial institutions, including in on-site inspections.

    17. Regular contact with bank management and understanding of bank's operations.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. The IMF report noted, however, that banks were "not required by law to give notification of any substantive changes in activities or of any adverse developments."

    18. Analytical reports and statistical returns on solo and consolidated basis.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle.

    19. Independent validation of supervisory information through on-site examination or external auditors.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. The IMF report notes however that there is "no guideline to assess the quality of work done by external auditors for supervisory purposes."

    20. Ability to supervise on a consolidated basis.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle. The IMF report notes that consolidated supervision is an essential element of banking supervision in Canada, and that it is carried out through a combination of on-and-off-site supervision. In this context, the OSFI meets regularly with key officers and management of banks on a regular basis, and relies on external auditors. Per the same report, regulatory filings are prepared on a consolidated basis.

    21. Consistent accounting policies and practices that provide a true and fair view of the financial condition of the bank.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. The IMF report notes that while the 1991 Bank Act requires banks to prepare their annual statements in accordance with Canadian Generally Accepted Accounting Principles (GAAP), banks are not required to directly apply international accounting and auditing standards. According to the February 2008 update available from the Deloitte & Touche IAS Plus website, as of 2011 the Canadian Accounting Standards Board will require the use of International Financial Reporting Standards (IFRSs), replacing the Canadian GAAP, for publicly accountable enterprises, including listed companies and other profit-oriented enterprises. Per the same report, private companies, and not-for-profit organizations will have the permission, but will not be required to adopt IFRSs in 2011.

    22. Adequate supervisory measures to ensure timely corrective action.

    In its 2000 ROSC, the IMF rates Canada as "broadly compliant" with this principle due to the supervisor's lack of authority "to bar an individual from banking once the person has been hired." The OSFI has extensive powers to safeguard the soundness of the banking system, and its mandate and related supervisory powers are focused on early intervention. The proposals contained in the government's 1999 Policy Paper aim to empower the OSFI "to impose civil monetary penalties for violations of legislation or written agreements with banks and other federal financial institutions." According to the IMF's 2000 ROSC, full compliance was expected to be achieved following the implementation of the proposals contained in the 1999 Policy Paper. In its 2008 FSSA Update, the IMF notes that the weaknesses observed in the 2000 ROSC in regard to this principle were remedied by the authorities and Canada now fully complies with this principle.

    23. Banking supervisors must practice global consolidated supervision over their internationally-active banking organizations.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. The IMF report notes that the supervisory framework applies "equally to all significant activities of the bank regardless of whether that activity takes place in a foreign branch, joint venture, or subsidiary."

    24. International exchange of information with other supervisors.

    According to the 2000 IMF ROSC, Canada is "fully compliant" with this principle. The IMF report notes that the OSFI has concluded Memoranda of Understanding with banking supervisors in the US and UK, which represent 65-70% of domestic banks' international exposures, as well as Hong Kong.

    25. Supervision of local operation of foreign banks and information sharing with home country supervisors.

    Canada is "fully compliant" with this principle, as stated in the IMF's 2000 ROSC. The IMF report notes that the supervisory framework of the OSFI applies "to all federally regulated institutions, including subsidiaries of foreign banks."

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    Sources of Assessment

    International Monetary Fund, "Canada: Report on the Observance of Standards and Codes - Banking Supervision," June 2000. Available from International Monetary Fund website. Accessed on April 7, 2008. (IMF 2000)

    International Monetary Fund, "Canada: Financial System Stability Assessment - Update," Country Report No. 08/59, Washington, D.C.: IMF, February 2008. Available from International Monetary Fund website. Accessed on April 7, 2008. (IMF 2008)

    Relevant Organizations

    Accounting Standards Board - Conseil des Normes Comptables (AcSB)

    Bank of Canada - Banque du Canada (BoC)

    Canada Deposit Insurance Corporation - Société d'Assurance-Dépôts du Canada (CDIC)

    Department of Finance - Ministère des Finances (DoF)

    Financial Transactions and Reports Analysis Centre of Canada - Centre d'Analyse des Opérations et Déclarations Financières du Canada (FINTRAC)

    Office of the Superintendent of Financial Institutions - Bureau du Surintendant des Institutions Financières Canada (OSFI)



    Relevant Legislation/Regulation

    Bank Act, 1991 - Loi sur les Banques, 1991

    Act to Amend the Law Governing Financial Institutions and to Provide for Related and Consequential Matters (Bill C-37), 2007 - Loi Modifiant la Législation Régissant les Institutions Financières et Comportant des Mesures Connexes et Corrélatives (Projet de Loi C-37), 2007

    Bank of Canada Act, 1985 - Loi sur la Banque du Canada, 1985

    Office of the Superintendent of Financial Institutions Act, 1985 - Loi sur le Bureau du Surintendant des Institutions Financières, 1985

    Canadian Deposit Insurance Corporation Act, 1985 - Loi sur la Société d'Assurance-Dépôts du Canada, 1985

    Proceeds of Crime (Money Laundering) and Terrorist Financing Act, 2000 - Loi sur le Recyclage des Produits de la Criminalité et le Financement des Activités Terroristes, 2000

    Act to Amend the Proceeds of Crime (Money Laundering) and Terrorist Financing Act and the Income Tax Act and to make a consequential amendment to another Act (Bill C-25), 2006 - Loi Modifiant la Loi sur le Recyclage des Produits de la Criminalité et le Financement des Activités Terroristes, la Loi de l'Impôt sur le Revenu et une autre loi en consequence (Projet de Loi C-25), 2006



    Supplementary Sources

    Deloitte & Touche Tohmatsu IAS Plus website. Accessed on April 7, 2008. (Deloitte IAS Plus website)

    Department of Finance, "Reforming Canada's Financial Services Sector, A Framework for the Future," June 1999. Available from Department of Finance website. Accessed on April 7, 2008. (DoF 1999)

    Department of Finance, "Enhancing Canada's Anti-Money Laundering and Anti-Terrorist Financing Regime: Consultation Paper," DoF, June 2005. Available from Department of Finance website. Accessed on April 7, 2008. (DoF 2005)

    Department of Finance, "2006 Financial Institutions Legislation Review: Proposals for an Effective and Efficient Financial Services Framework," DoF, June 2006. Available from Department of Finance website. Accessed on April 7, 2008. (DoF 2006)

    Financial Action Task Force, "Third Mutual Evaluation on Anti-Money Laundering and Combating the Financing of Terrorism," Paris, France: FATF/OECD, February, 2008. Available from Financial Action Task Force website. Accessed on February 29, 2008. (FATF 2008)

    Institute of International Bankers, "2007 Global Survey: Regulatory and Market Developments - Banking, Securities and Insurance," October 2007. Available from Institute of International Bankers website. Accessed on April 7, 2008. (IIB 2007)

    Office of the Superintendent of Financial Institutions, "Annual Report 2006-2007," OSFI, 2007. Available from Office of the Superintendent of Financial Institutions website. Accessed on April 10, 2008. (OSFI 2007)

    U.S. Department of Commerce, "2008 Doing Business in Canada: A Country Commercial Guide for U.S. Companies," U.S. & Foreign Commercial Service and U.S. Department of State, March 2008. Available from U.S. Department of Commerce website. Accessed on April 7, 2008. (U.S. DoC 2008)

    U.S. Department of State, Bureau for International Narcotics and Law Enforcement Affairs, "International Narcotics Control Strategy Report 2008," March 2008. Available from U.S. Department of State website. Accessed on April 7, 2008. (U.S. DoS 2008)
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