Banks play an important role in how governments maintain their financial security. This is why laws governing banks often require the input of multiple departments. The classification of banks determines what regulations apply to their day-to-day operations. Common classifications include Shcedule I banks, Schedule II banks, and so on.
In this article, we’ll talk about how and why these classifications matter. Not just for depositors but also for all persons transacting with banks – including the Canadian government.
What is a Schedule I Bank?
Schedule I banks is the classification used for domestic banks. These domestic banks operate only in Canada and are not affiliated with any other bank across borders. This includes not being a subsidiary of a foreign bank.
Another qualification is that they must take deposits from customers. Currently, there are 36 domestic banks regulated under the Bank Act. Some of the six largest financial institutions in Canada belong to this classification. Here’s an overview about Canada’s top banks:
What is the difference between Schedule I, II, and III banks?
Bank schedules essentially categorize banks depending on their ownership. As explained, Schedule I banks are domestic, which means that they are incorporated in Canada with zero connection with foreign banks.
So how are they different from Schedule II and Schedule III banks? Here’s a look:
Schedule I |
Schedule III |
|
---|---|---|
These banks are domestic with no affiliations with any foreign bank |
They are subsidiaries of foreign banks and authorized to operate in Canada |
These are foreign institutions allowed to operate in Canada with certain limitations |
Must be Canadian-owned and controlled |
Since they are subsidiaries, they can be owned by non-residents |
Owners may be non-residents |
Must take deposits from depositors |
Must take deposits from depositors |
|
Regulated by the Bank Act |
Regulated by the Bank Act |
Not incorporated by the Bank Act |
Examples: Royal Bank of Canada, Canadian Imperial Bank of Commerce, Equitable Bank |
Examples: Amex Bank of Canada, ICICI Bank of Canada, SBI Canada Bank |
Examples: Bank of China Limited, Wells Fargo Bank National Association, First Commercial Bank |
From here, the primary difference between schedule I, II, and III banks is ownership. However, the law regulating the bank is also different for schedule III banks. Note that schedules are just one of the many classifications of banks. They can be further categorized based on equity size, applicable laws, and so on.
If you’re wondering about cross-border financial institutions instead of domestic, you can look through Lexpert’s cross-border page for lawyers that specialize in international financial concerns.
Recent changes in bank ownership structure
As mentioned, banks may be further categorized based on the precise measure of ownership. Previously, banks followed the “widely held” rule, which means no single person may own more than 10 percent of any class shares of a schedule I bank. This changed in 2001 through Bill C-8.
Under Bill C-8, banks are categorized based on their assets. From there, a precise measure of ownership is prescribed. This tends to override the “schedule” classification but is still widely used today. Here’s a look:
If banks have an equity of less than $1 billion, called small banks |
No restrictions |
---|---|
If banks have an equity of more than $1 billion but less than $5 billion, called mid-sized banks |
There must be a public float of at least 35 percent of voting shares |
If banks have an equity of more than $5 billion, called large banks |
No single person must have more than 20 percent of the voting shares or for non-voting shares, not more than 30 percent |
For those wondering – yes, the restriction applies to corporations or organizations too. This means that even corporations who decide to purchase bank stocks cannot acquire more than the limited amount imposed by the law. This guarantees that no single person or group of persons has significant control over Schedule I of banks.
Operational capacity of Schedule I banks
Schedule I banks typically offer full service. That is, they can offer a wide range of financial services such as deposit-taking, investment, and lending. In contrast, Schedule II banks have a targeted service while Schedule III ones are focused on wholesale banking services.
The services offered by a bank are further limited by their own articles of incorporation or by-laws. The equity of the bank could also limit the activities it can engage in. Fortunately, directors or shareholders of banks have the power to change internal policies to help the operational activities of the organization.
Governing laws in Schedule I banks
Since banks categorized as Schedule I are incorporated through the Bank Act, all of their activities are regulated under this law. Schedule I financial institutions also play a critical role in Canada because they are fully domestic banks. This means that additional laws and regulations come into play for their operation. This includes:
-
Bank Act, which deals with the economic and financial welfare of Canada through banks. Implementing agencies include the Office of the Superintendent of Financial Institutions (OSFI)
-
Canada Business Corporations Act (CBCA), which governs the incorporation of businesses in the country
-
Canada Deposit Insurance Corporation Act (CDIC)
-
Canadian Payments Act (CPA)
Of course, that’s just a small snapshot of the laws that banks must follow. The regulations for schedule I financial institutions constantly develop in response to the changing economic climate.
This is not counting possible provincial or territorial laws imposed by certain jurisdictions like British Columbia. For these reasons, banking lawyers are often required to harmonize different laws and ensure that compliance measures are up to date.
Risk management and compliance regulations
Multiple government agencies play a role in imposing compliance requirements and risk management regulations on banks. Other than those mentioned above, the most salient aspects of bank compliance are through the following:
-
The Proceeds of Crime (Money Laundering) and Terrorist Financing Act administered through the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC). This requires banks to report suspicious transactions
-
For risk management, banks comply with OSFI, which requires routine reports to assess the health of financial institutions. OSFI is responsible for setting standards in how banks operate, such as imposing interests or debt-to-income ratios
-
Data breach notification laws require banks to be stringent with the personal information of their clients and report data breaches as soon as possible
Liabilities in case of violation
A very high degree of diligence is required from banks in their day-to-day operations. This is expected because of their critical role in maintaining the financial health of the country. This goes double for Schedule I banks since they are wholly domestic with domestic shareholders.
A high degree of diligence means that any violations come with high penalties. In case of violations, banks may be liable for millions. For example, FINTRAC imposed monetary penalties on the Exchange Bank of Canada amounting to $2,457,750 for violations of the Proceeds of Crime (Money Laundering) and Terrorist Financing Act.
OSFI can also impose a per diem penalty in case of erroneous or late financial reports filed by the bank. This excludes the reputational damage that can happen to banks because of these violations. For this reason, Schedule I banks typically have a team dedicated towards making sure all regulations are followed strictly.
Best practices of Schedule I banks
Considering the high price of violations, banks should commit practices that ensure all pertinent laws and regulations are followed. Best practices that help meet these goals include:
Corporate governance
Everything starts with strong corporate governance. This is the role of bank directors who create policies and guidelines that the bank must follow. To create these policies, however, directors must know exactly what is going on in the bank and outside it. This means staying up to date with reports, laws, and any developments impacting the bank.
Directors have a duty of care that holds them responsible for blatant violations of the law. In most cases though, directors have a team of advisors that help them streamline information. For example, a team of accountants or banking lawyers are available to help communicate the gist of information before decisions are made.
Transparent reporting
Reporting in banks covers external reports and internal reports. This means reporting to directors, shareholders, investors, the government, and other stakeholders. For example, banks are required to publish their financial statements which let depositors and shareholders know about the financial health of the bank.
Transparent reporting of forms ensures that stakeholders make informed decisions when entering transactions with the bank. Otherwise, the bank may be accused of keeping important information secret, especially if they are required to disclose that data.
Crisis preparedness and risk management
Banks can’t be expected to run perfectly 100 percent of the time. Problems can happen, and banks should have backup plans to ensure it doesn’t affect operations. Some risk management measures are required by law such as membership in the CDIC to insure the money of depositors. Banks are also required to have “reserves” in case of fluctuations.
Some risk management features are left at the discretion of the bank. For example, data breach notification laws give banks the discretion to choose the people who will be responsible for personal data. They are also left to create their own policies if those policies follow the primary principles of the law.
Here’s a great explainer about risk management in businesses:
Investing on cybersecurity
Cybersecurity is an evolving aspect of bank security. It covers not just the privacy of personal information but also ensuring that any leaks are reported immediately. As most transactions go online, banks have the burden of ensuring that the movement of money and information is done lawfully in good faith.
In some cases, cybersecurity concerns overlap with money laundering and terrorist financing concerns. In all transactions, banks are mandated to know their client and ensure that suspicious transactions are marked and reported. Investing in excellent security measures and people is typically critical for banks.
Dedicated teams
Having dedicated teams for specific jobs is perhaps one of the best practices banks can have. A team that’s focused on limited goals helps ensure that they’re following even the smallest guideline required by the bank. Certain laws also require the creation of specific offices, such as data breach notification laws.
The separation of powers within a bank also helps prevent connivance or conspiracies within the organization. It also ensures that the right people are responsible in case of breaches.
Transaction with Schedule I banks
Ultimately, Schedule I banks are just like any other corporation but with the added burden of public interest. As domestic banks, they are prone to more regulatory measures because of the wide breadth of their services. It’s therefore not surprising that most banks have a team of lawyers who guide the bank through complex legal issues.
The multiple layers of complexity in banks usually means there’s a need for lawyers who specialize in this branch of law. If you’re interested in getting expert help in banking law, our list of best ranked banking and financial institution lawyers should get you started in finding out more!