CHAPTER 19: Other Depository Institutions

FOCUS OF THE CHAPTER

Near banks are depository institutions which offer services similar to the chartered
banks, but which cannot legally be called banks. This chapter provides a discussion of
three main types of near banks, namely, trust companies, mortgage loan companies,
and credit unions, and other smaller depository institutions.
This chapter deals with non-deposit-taking financial institutions, which are not as
dominant as deposit-taking institutions, but, nevertheless, are an important part of
Canadas financial system. They offer specialized services which deposit-taking
institutions are not authorized to offer (due to regulations). These institutions include
leasing and consumer finance companies, investment dealers, government financial
institutions, insurance companies, mutual funds, and pension funds.

Learning Objectives:

List some other depository institutions besides chartered banks and describe the key
aspects of their operations
Explain the role of trust and mortgage loan companies in Canada and their
importance in the financial system today
Explain the role of credit unions in Canada and their importance in the financial
system today
Understand some of the key features of the remaining types of deposit-taking
institutions
Describe the roles of nondeposit-taking institutions and how they fit into the overall
financial system
Identify the key activities of financial and leasing corporations
Explain the key activities of investment dealers
Obtain a general overview of government financial institutions
Get a general understanding of the insurance industry
Discuss the environment in which investment and pension funds operate and the
various type of institutions and instruments that they provide

Outline the essentials of the pension fund industry, both private and public

SECTION SUMMARIES
The Size of the Near Bank Sector

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During the 1980s other depository institutions (traditionally referred to as near banks)
began to take away market share from the chartered banks. But since the passage of the
1991 Bank Act, the size of the near-bank sector has shrunk. Prior to 1991, near banks
were a respectable presence in the finance industry. But since then, chartered banks have
begun buying up trust companies and controlling most of the sectors assets.

Trust and Mortgage Loan Companies

Trust companies are depository institutions that may also offer services as corporate
trustees. They have two distinct roles: 1) an intermediation function (channelling
deposits and making loans, primarily in the form of mortgages); and 2) a fiduciary
function (providing and administering Estates, Trusts, and Agency [ETA] assets).
A mortgage loan company accepts deposits and makes mortgage loans, thus
providing intermediation services. Trust companies and mortgage loan companies are
treated under one heading because both are major players in the mortgage market, and
because both are regulated by the federal and provincial governments.
The History of Trust Companies: The first trust company was formed in 1843. A number
of these companies were established in the second half of the twentieth century. These
trust companies were established because chartered banks werent permitted to act as
trustees.
In the beginning trust companies were authorized to accept deposits but not to issue
cheques. In the 1920s, they became true financial intermediaries.
While their role as depository institutions has grown, the estate, trust, and agency
(ETA) function is their primary function, which includes sponsoring mutual funds, acting
as trustee for corporate securities, serving as agents for real estate agencies, managing
investments, and making commercial loans. Its becoming more difficult to distinguish
trust companies from chartered banks, especially since most are wholly owned
subsidiaries of chartered banks.
The History of Mortgage Loan Companies: Mortgage loan companies (MLCs) existed
before trust companies, and were established because banks were not allowed to offer
residential mortgages. After 1874, MLCs were allowed to issue debentures for funding,
which significantly expanded their activities. Today there are three types of MLCs:
1) Deposit-taking mortgage companies operate under the federal Loan
Companies Act or similar provincial legislation. Assets are from deposits and debt
instruments. Liabilities come from mortgage investments.
2) Mortgage Investment Companies (MICs) diversify investors portfolios
through mortgages, bonds, and equities. These companies can raise funds by selling
stocks and bonds with a term of less than five years. There are also MLCs under
provincial jurisdiction similar to federally regulated ones but which raise funds mainly by
issuing guaranteed investment certificates.
3) Real Estate Investment Trusts (REITs) finance mortgages by issuing shares.
Shareholders are reimbursed through annual dividends.

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Assets and Liabilities: The principal assets of MLCs and trust companies are mortgages.
Term deposits called Guaranteed Investment Certificates (GICs) form the majority of
their liabilities (see Figure 20.1 in the text).

Credit Unions and Caisses Populaires

Credit unions are non-profit, deposit-taking institutions whose shareholders are local
depositors and borrowers. They were established to meet the needs of small investors and
savers, and are sometimes referred to as the peoples banks. Caisses populaires
(Quebec-operated credit unions) are Canadas best known cooperative banks. The first
caisses populaires were formed in 1900 and subsequently spread throughout the province.
By the 1920s they were united, forming regional associations.
Credit unions began in New Brunswick, Ontario, and Manitoba, and then spread
to the Maritimes and Prairies.
Regional unions or centrals were created to act as lenders of last resort to credit
unions within a region and to facilitate cheque clearing. The centrals offer support, but do
not exert central control. Today, there are federally regulated provincial central credit
unions which are similar to centrals but provincial in scope. Their activities include
accepting deposits, making loans, and acting as agents for their region.
Assets and Liabilities: Cash loans to members and mortgages form the bulk of credit
unions assets. The remaining assets come from cash and demand deposits. Shareholders
equity forms a small fraction of liability, while savings and term deposits form the largest
portion of liabilities. In other words, deposits are the principal source of funding.

Other Deposit-Taking Institutions

Public need has given rise to other types of depository institutions besides commercialtype banks, such as trust companies, MLCs, and credit unions. Another type of near bank
is the savings bank, whose core business is holding savings of individuals in the form of
time deposits and making loans to households. Except for the Quebec savings banks and
provincial government savings offices, most savings banks have become provincially
regulated.
Provincial governments have also offered banking services, mostly in deposittaking and lending capacities, in rural areas. Notable provincially operated institutions are
the Province of Ontario Savings Offices and the Alberta Treasury Branches.

Other financial institutions

A description of other financial institutions follows.

Financial and Leasing Corporations

These firms in the finance company segment of the financial industry create debts, with
the funds used for purchasing specific goods and services. Credit is secured by
mortgages, current or anticipated income or sales, and the sale of debentures.
Four Types of Institutions: Four major categories of institutions are included in this
section of the financial industry:
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1) Acceptance Companies make loans to consumers through retailers. For example, a

car dealer would take a contract after selling a car, and sell the contract to an acceptance
company for its face value plus a discount factor. The acceptance company is then
responsible for collecting the payments from consumers. Many of these companies are
wholly owned subsidiaries of the manufacturers of various products. They may also
finance inventories.
2) Consumer Loan Companies make cash advances to individuals. Their market share
in the personal loans market has shrunk due to competition from banks and near banks.
3) Financial Leasing Corporations lease assets such as equipment or furniture to firms,
on two kinds of leases: full-out financing leases, lasting for the anticipated life of the
asset; and operating leases, lasting for a specified term.
4) Business financing institutions serve as an alternative to banks in commercial lending
activities. They may also engage in other activities such as financing inventories, exports,
and specific types of construction, and providing funds for working capital, factoring, and
bridge financing. Merchant banks, until 1980, were classified under this category.
Merchant banks buy new financial instruments (directly from the issuing firm) and sell
them in smaller amounts to investors. They also advise companies on mergers and
acquisitions. Merchant banks are now considered Schedule II banks.
Assets and Liabilities: Significant portfolio changes have occurred since 1985. Sales
finance and consumer loan companies have clearly focused on leasing. Their proportion
of business credit has decreased from 60.5% in 1985 to 53.9% in 1999. In reaction to low
and stable interest rates, their long-term liabilities have increased from 24.6% in 1985 to
44.1% in 1999.

Investment Dealers
Investment dealers underwrite securities; that is, they purchase newly issued debts from
corporations or governments and resell them in the secondary market. A select few, called
primary market dealers, have privileged access to credit and are designated to purchase
federal government securities. After 1989 most investment dealers became wholly owned
subsidiaries of banks. Others are subsidiaries of large foreign firms. They are provincially
regulated by securities commissions (e.g., the Ontario Security Commission). Unlike
dealers, brokers act as agents for investors. They are members of the Investment Dealers
Association (IDA).

Government Financial Institutions

The federal and provincial governments provide credit to the private sector through
Crown corporations. Government financial involvement provides for regional economic
development and expansion, and equalizes opportunities across provinces and regions.
Examples of such Crown corporations are: Canada Mortgage and Housing Corporation
(CMHC), which provides housing opportunities to low-income families; the Federal
Business Development Bank, which provides loans to firms which are unable to get
financing because they are new high-risk ventures; the Export Development Corporation
(EDC), which provides financing to foreign concerns for the purchase of Canadian
exports; and the Farm Credit Corporation, which provides financing to assist the
agricultural sector (e.g., long-term credit to finance the purchase of farm machinery).
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Insurance Companies
Insurance is a contract to pay premiums to an insurance company to provide financial
compensation if a specified, negative event should occur. In effect, an insurance company
pools the risk of many policyholders. In Canada, there are approximately 360 insurance
companies.
Kinds of Issuers: Insurance companies may be owned by shareholders (joint stock
companies) or by policyholders (mutual companies). Most (about 95%) are
incorporated and federally regulated. A few are provincially regulated. In 1999, the
federal government passed legislation allowing for demutualization, which permits
mutual companies to convert to joint-stock companies.
There are three types of insurance company in Canada: life; property and
casualty; and accident and sickness. Life insurance companies must maintain segregated
funds; i.e., a portion of their business invested in mutual funds and kept separate from the
rest of the companys activities.
Insurance companies are not allowed to take deposits or make loans. However,
they have found ways to offer similar services. They may not participate in the Canada
Deposit Insurance Corporation (CIDC). They have set up their own contingency fund
against defaults on policies under the Canadian Life and Health Compensation
Corporation (Compcorp). Because they are regulated, no insurance company in Canada
failed between 1875 and 1990, unlike those in the United States.
The incursion of foreign insurance companies, mainly from Europe, was a trend
in the 1990s. Foreign insurance companies are regulated separately by the federal
government.
Types of Insurance Contracts: Broadly, there are three types of insurance contract:
1) Term insurance contracts cover risk for a set period. The dollar amount of coverage
and the duration are specified in the contract. Premiums are collected from policyholders
and claims are paid when events occur.
2) Permanent insurance combines life insurance with savings; i.e., if a policyholder
does not die by a specified age, he/she will receive a lump-sum payment.
3) An annuity provides a stream of payments, usually paid out upon retirement to an
individual or beneficiaries. The best-known annuity is the Registered Retirement Income
Fund (RRIF).

Investment Funds and Companies

Investment funds (i.e., mutual funds) and mutual companies pool funds and diversify
risk in order to serve the typical individual investor. They purchase securities from other
firms, and participants (individual investors) own shares (units) whose value is
proportional to the total value of the pool of funds.
Investment and mutual funds can be set up by anyone. Some are established by
trust companies or banks, others exist as separate companies.
Kinds of Investment Funds: Investment Funds can be categorized in two ways: closedend funds have a fixed number of shares that are issued and sold; and open-end funds
have no restrictions on the number of shares issued and traded. Mutual funds are also
classified by the type of investments they make. A few are unspecialized, some
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concentrate on particular sectors of the economy, and many, called equity funds, invest
principally in common shares.
Mutual funds are popular because they offer diversity to an investors portfolio,
thus reducing risk. With some no-load funds, investors do not have to pay upfront
brokerage fees, which adds to their appeal.

Pension Funds
Pension funds are devices designed to accumulate assets for retirement. Both employers
and employees can contribute to the funds and receive tax breaks for doing so.
Private Pension Plans: These plans are established by private employees or unions, and
are provincially regulated. A plan may be contributory or non-contributory (the employer
may or may not match the employees contribution); voluntary or compulsory (the
employee may or may not be required to join the plan); and trusteed or insured (managed
by a trust or by an insurance company). Private pension plans are registered with the
federal government so that income tax can be deferred.
Private pension plans differ on the basis of how benefits are earned. In a definedbenefit plan, policyholders are guaranteed a specific benefit upon retirement. In a
defined-contribution plan (also called money-purchase plan) benefits are not determined,
but vary according to the amount of accumulated contributions and the return on the
fund's investment.
Public Pension Plans: Public pension plans are government-operated. The largest of
these plans are the Canada Pension Plan (CPP) and Quebec Pension Plan (QPP).
Membership in these funds is mandatory. Contributions are a fixed percentage of
earnings and are matched by the government.
An aging labour force has resulted in benefits exceeding the value of accumulated
contributions. The government has had to change the contribution level, and has
authorized the CPP to invest in securities and equities to prevent the CPP fund from being
extinguished. The CPP is managed by an investment board and the QPP is managed by a
similar board in Quebec. Canada has a variety of public pension plans in addition to CPP
and QPP.
Registered Retirement Savings Plans (RRSPs): RRSPs are a special, tax-sheltered trust
account to which people can contribute a certain amount of their income to accumulate
savings towards retirement. When an individual is between ages 65 and 69, he or she
must close out the account by buying annuities or RRIFs, and tax is due only on the
benefits as they are paid out. Many Canadians have RRSPs in addition to their pension
plan in order to take advantage of the tax break. RRSPs are offered by banks, trust
companies, life insurance companies, brokers, and mutual funds.

MULTIPLE-CHOICE QUESTIONS
1. Depository institutions other than chartered banks have traditionally been referred to as
a) commercial banks.
b) savings banks.
c) investment dealers.
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d) near banks.
2. Which of the following is not correct about trust companies?
a) They do not specialize in mortgage loans.
b) They function as financial intermediaries by channelling deposits and making loans.
c) They administer assets they do not own.
d) They provide services as corporate trustees.
3. Trust companies are regulated provincially in
a) in all provinces.
b) in Quebec, Ontario and the Atlantic provinces.
c) in Quebec, Ontario, British Columbia and Alberta.
d) in British Columbia, Alberta and the Atlantic provinces.
4. Mortgage loan companies were founded
a) after trust companies were founded.
b) because the chartered banks charged very high interest rates on mortgage loans.
c) to break the monopoly of chartered banks in mortgage loans.
d) because the chartered banks were prevented from offering residential mortgages.
5. Which of the following accounts for the largest share of the assets of trust and
mortgage loan companies?
a) term deposits
b) long-term bonds
c) short-term instruments
d) mortgages
6. Which of the following is not true about credit unions?
a) They are federally regulated institutions.
b) They are non-profit organizations.
c) They are cooperative organizations.
d) They provide lending at a local level.
7. Caisses populaires
a) operate nationwide in Canada.
b) operate only in the province of Quebec.
c) operate only in French-speaking communities across Canada.
d) operate only in Quebec and parts of New Brunswick.
8. Which of the following institutions were created mainly as a lender of last resort to
credit unions?
a) regional unions or centrals
b) caisses populaires
c) trust companies
d) mortgage loan companies

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9. At present, the deposit liabilities of local credit unions account for

a) more than 80% of liabilities.
b) less than 80% of liabilities.
c) about 50% of liabilities.
d) about 25% of liabilities.
10. Alberta Treasury Branches are
a) a good example of caisses populaires outside Quebec.
b) a good example of a federally regulated credit union.
c) a good example of provincial government savings offices.
d) cannot be considered financial institutions.
11. Firms in the finance company segment of the financial system engage in
a) the provision of commercial loans to private corporations.
b) underwriting securities.
c) providing loans indirectly through Crown corporations.
d) creating debt, with the funds being used for purchasing specific goods and services.
12. The market share of the consumer loan companies has become concentrated in
a) low-income customers.
b) large corporations.
c) low-risk, high-income customers.
d) small businesses.
13. The selling or discounting of accounts receivable to a specialist who undertakes to
collect the amount owing is called
a) factoring.
b) hedging.
c) bridge financing.
d) compounding.
14. The merchant banks are also known as
a) trust companies.
b) chartered banks.
c) acceptance companies.
d) investment banks.
15. Which of the following accounts for the largest share of the assets of sales finance
and consumer loan companies?
a) term deposits
b) mortgage loans
c) business credit
d) household credit
16. Which of the following is the primary function of investment dealers?
a) bridge financing
b) leasing equipment and consumer goods
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c) underwriting securities
d) factoring
17. Which of the following statements is true of the Export Development Corporation
(EDC) and the Canada Mortgage and Housing Corporation (CMHC)?
a) EDC and CMHC are two private, for-profit corporations.
b) EDC and CMHC are two government financial institutions.
c) EDC and CMHC are two public investment funds.
d) EDC and CMHC are two merchant banks.
18. What does demutualization mean?
a) forming an insurance company owned by its insurance policyholders
b) merging a trust company with an insurance company
c) withdrawing funds from a mutual fund
d) converting a mutual company into a joint-stock company
19. Investments which have a fixed number of shares that cannot be redeemed on demand
are known as
a) open-end funds.
b) closed-end funds.
c) load funds.
d) no-load funds.
20. Under which of the following pension plans is the plan holder guaranteed a specific
benefit?
a) defined-contribution plans
b) defined-benefit plans
c) contributory plans
d) trusteed plans

PROBLEMS
1. Write a brief introduction to near banks.
2. Trust companies have two broad functions. What are they? Describe each briefly.
3. What are the main differences between chartered banks and credit unions?
4. What are the four types of non-depository financial institutions that operate in the
finance company segment of the Canadian financial system? Indicate their main
services of specialization.
5. Briefly state what is meant by the demutualization of an insurance company.
6. What are mutual funds? Why are they popular?

ANSWER SECTION
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Answers to multiple-choice questions:

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.

d
a
c
d
d
a
b
a
a
c
d
a
a
d
d
c
b
d
b
b

(see page 372)

(see page 373)
(see page 373)
(see page 374)
(see page 375)
(see pages 375-376)
(see page 376)
(see page 376)
(see page 377)
(see page 379)
(see page 380)
(see page 380)
(see page 381)
(see page 381)
(see page 380)
(see page 381)
(see page 382)
(see page 383)
(see page 386)
(see pages 387-388)

Answers to problems:
1. Near banks are a group of deposit-taking financial institutions which are not chartered
as banks but provide many of the same services as the chartered banks. These
institutions are regulated by both federal and provincial laws. The institutions in this
category include trust companies, mortgage loan companies, credit unions, caisses
populaires, and government savings offices.
2. The two functions of trust companies are: 1) the intermediary function, and 2) the
fiduciary function. The intermediation function is performed by accepting a variety of
deposits, both chequable and non-chequable, and by making loans, primarily in the
form of mortgage loans. Under the fiduciary function, the trust companies provide
estates, trusts, and agencies (ETA) business, which includes sponsoring various types
of mutual funds, acting as trustee for various corporate bonds and stocks, serving as
agents for real estate agencies, and acting as investment managers.
3. The main differences between the chartered banks and credit unions are: a) the
chartered banks are federally regulated, while credit unions are provincially regulated
institutions; b) the chartered banks are privately owned institutions, while credit
unions are cooperative institutions; c) the chartered banks are profit-making (or forprofit), while the credit unions are non-profit organizations; and d) the chartered
banks accept deposits from and issue loans to the general public, while credit unions
accept deposits from and issue loans to their members.
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4. The four types of non-deposit taking financial institutions that operate in the finance
company segment are stated below along with their main services of specialization.
1) Acceptance companies make loans to consumers through retailers. They may also
finance inventories.
2) Consumer loan companies make cash advances to individuals.
3) Financial leasing corporations lease assets such as equipment or furniture to firms.
4) Business financing institutions serve as an alternative to banks in commercial
lending activities. They may also engage in other activities such as financing
inventories, exports, specific types of construction, providing funds for working
capitals, factoring, and bridge financing.
5. Demutualization is a process by which insurance companies owned by policyholders
(mutual companies) convert to insurance companies owned by shareholders (jointstock companies). Demutualization enables insurance companies to raise capital by the
sale of shares to non-policyholders.
6. Mutual funds (also called investment funds) are pools of funds from various sources
which are invested in a variety of assets. They can be classified in many ways, as
closed-end funds and open-end funds, and as money market funds, equity funds, bond
funds, and mortgage funds. They are popular because they enable investors to
diversify their portfolios to a greater extent and thereby substantially reduce and share
risk. Investors also believe that by investing in mutual funds, they will receive expert
advice on investment that they could not obtain otherwise.

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