Commercial Banking in the U.S. Versus Canada
For many companies, one of the most important business relationships is with the commercial bank that provides them with credit and non-credit services. Just as business environments vary from country to country, so does the nature of the banking relationship-sometimes in very significant ways.
While banking in the U.S. and Canada are alike in many ways, there are also critical differences between banking laws, regulations, and practices. The purpose of this article is to articulate these differences and evaluate their impact on business transactions in the U.S. vis-à-vis Canada. The article also provides a critical overview of the sometimes confusing U.S. banking system for those unfamiliar with it.
Although the primary purpose of a commercial banking relationship is for credit services, that is, to borrow funds, it is only half of the picture. Businesses also require a wide range of non-credit services from their commercial banking relationships. Most important is the daily cash management functions related to collection and disbursement of funds for the company. On the collection side, incoming payments (checks, electronic payments, and credit cards) must be processed and value transferred to the business. On the disbursement side, payments must be made to suppliers, employees, tax authorities, investors, and others in a timely and cost-efficient manner.
While the traditional method of invoicing and payment in the U.S. (especially in the business-to-business or B2B world) has been a mail-and-check-based system, this is rapidly changing as more and more companies embrace the benefits of electronic billing and payment. A comparison of the U.S. and Canadian Banking environment highlights the benefits of Canada’s electronic-based transactions and reveals other banking nuances that are encountered by companies doing business in the U.S. versus Canada.
The U.S. Banking Environment: 7 Key Factors You Need to Know
The U.S. banking environment is very unique when compared to systems in Canada and most other countries. Some of the factors which make the U.S. banking environment unique are:
- Large number of depository financial institutions;
- Lack of nationwide branching;
- Significant usage of checks and mail-based payments;
- Restrictions on corporate checking accounts;
- Unbundled pricing of banking services;
- Arms-length relationships between banks and customers; and
- Involvement of a central bank (the Federal Reserve) in the processing of payments.
An important factor is the sheer number of depository financial institutions in the U.S. Recent reports from the Federal Deposit Insurance Corporation (FDIC) state that there are 7,350 commercial banks, 1,265 thrift institutions (formerly known as savings and loans or mutual savings banks), and over 8,000 credit unions. While credit unions primarily serve the consumer market, both commercial banks and thrifts are active participants in serving the business community.
Another key distinction of the U.S. banking market is the lack of full nationwide branching for commercial banks. It has only been about 10 years since banks were allowed to expand across state lines and even today there are no banks that have a presence in all 50 states. The few banks with an extensive network of branch locations, notably Bank of America, Chase, and Wachovia, still have gaps in their coverage in certain regions. This has a significant impact on large retailers which must collect and deposit funds on a nationwide basis from their many store locations. This factor, along with U.S. Federal Reserve restrictions on bank lending practices, generally results in many U.S. companies of any size having several, or in some cases tens or even hundreds of, banking relationships.
As mentioned above, the primary mechanism for commercial invoicing and payment in the U.S. is still a mail-and-check-based system. In 2005 there were approximately 33 billion checks cleared in the U.S. for total value of $37.7 trillion, representing about 70 percent of non-card-based transactions. A table with the breakout of transactions by volume and amount is provided below.
|Types of Transactions||Number (billions)||% of Total Non-Card||$ Value (billions)||% of Total Non-Card|
|Checks||33,070||71.8 %||$37,729,100||4.0 %|
|ACH||12,796||27.8 %||$28,544,700||3.1 %|
|Wire||204||0.4 %||$868,417,300||92.9 %|
Though the use of electronic billing and payment is increasing at a rapid pace in the consumer sector, the business-to-business market has been slow to implement these changes. One of the key change impediments is the sending and receiving of remittance information with the payment, i.e. the payor needs to let the receiver know exactly what they are paying for. In a B2B environment, this is complicated by the fact that most companies are paying multiple invoices, with adjustments on each of the invoices, with a single check. This makes the application of the payment-posting to and closing out of the accounts receivables-a difficult task for the receiving company.
In the U.S. the nature and depth of the relationship between customer and bank is impacted by both regulations and business practice. For example, it is still against current Federal Reserve regulations for banks to pay interest on corporate checking accounts or for banks to offer accounts denominated in currencies other than the dollar (known as foreign currency accounts). This means that U.S. customers that need to hold foreign currency balances must hold them outside of the United States.
There are also limits on how much a bank can lend to any one customer, resulting in a more “arms length” relationship between U.S. banks and their customers than in other countries. Another unique practice is that many U.S. banks follow an “unbundled” pricing relationship with their corporate customers. This is where each and every service or transaction is billed to the customer and reported in sometimes excruciating detail in an Account Analysis Statement. This statement becomes an extremely useful tool for both the customer and the bank as it clearly outlines the services and value that the bank provided to the customer as well as the value to the bank of the balances the customer has deposited.
The last key factor in the U.S. banking environment is the role played by the Federal Reserve in the management of the payment system. In other countries most central banks “outsource” the operation and the management of the payment systems (both paper and electronic) to the banks operating in that country. Sometimes, as in the United Kingdom, a small group of banks are designated as clearing banks that run the payment and clearing system. Other countries, such as Canada and much of the Euro-zone, have an association of some type usually run by the member banks that operate and manage different payment systems. In the U.S., the Federal Reserve clears the majority of checks, owns and operates the major wire transfer system (FedWire), and acts as the operator for most of the ACH (Automated Clearing House) system.
Due to the large number of banks and other depository institutions in the U.S., the process of clearing checks can be somewhat cumbersome. Even though it is highly automated, it still generally takes one to three business days to “clear” a check for a commercial customer. The process involves the bank where the check is first deposited sending the check through the clearing system back to the bank where the check was written. If there are funds available to pay the check, then value is sent to the depositing bank. As mentioned above, a large number of these checks are cleared by the Federal Reserve.
In an effort to increase the efficiency and effectiveness of the U.S. check clearing system, there have been some key developments in recent years, including:
- Increasing efforts to convert checks to electronic payments (check conversion);
- Development of standards for the creation and exchange of check images; and
- Prevention techniques to reduce the high level of check fraud.
Based on the discussion above, commercial banking in the U.S. is different from virtually every other country in the world. It is no wonder that many foreign companies entering U.S. markets are bewildered by its banking regulations and practices.
The Canadian Banking Environment
In contrast to the U.S., the Canadian banking environment is much simpler and easier to understand. There are a small number of large banks that branch across the entire country and a company will typically have only one primary banking relationship, rather than the many we observe here in the U.S.
In Canada, the depository institutions or banks are divided into three categories: Schedule I, II, or III. Schedule I banks are Canadian-owned and are authorized to accept deposits and carry on a range of activities. There are currently 22 Schedule I banks in Canada, but they are dominated by the six largest with combined total assets of $1.8 trillion (USD). A table of the largest Canadian versus U.S. banks is provided below.
(6 largest – 2006)
(6 largest – 2006)
|Royal Bank of Canada||478||Citibank||1,883|
|Toronto Dominion (TD)||350||Bank of America||1,460|
|Bank of Montreal||279||Wachovia||707|
|National Bank of Canada||100||Washington Mutual||347|
|Total Assets||1,816||Total Assets||6,230|
|Total Bank Assets – All Banks||2,052||Total Bank Assets – All Banks and Thrifts||12,261|
|% of Assets Held by Top 6 Banks||88.5 %||% of Assets Held by Top 6 Banks||50.8 %|
|Canadian GDP||1,161||U.S. GDP||13,153|
|Ratio of Assets to GDP||1.56||Ratio of Assets to GDP||0.47|
Though the largest Canadian banks are smaller than their U.S. counterparts on an absolute basis, it is important to point out that the Canadian economy is only about 10 percent that of the U.S. If we examine the size of the banks in the U.S. and Canada relative to each country’s GDP, we can see that the six largest Canadian banks are about three times larger than the six largest banks in the U.S. The six largest Canadian banks also represent about 90 percent of total bank assets versus only 51 percent for the U.S. banks.
The other types of banking institutions in Canada include 25-plus Schedule II banks, which are subsidiaries of foreign banks authorized to accept deposits and provide a ranges of services, and about 20 Schedule III banks that are branches of foreign banks with limitations on their activities.
The uses of the different payment methods are also significantly different in Canada than in the U. S. While the check is still the primary business-to-business payment mechanism in the U.S., Canadian companies have moved much more quickly to electronic payments.
In Canada, as well as most countries other than the U.S., the typical commercial bank account pays interest on positive balances, while charging interest on negative balances (overdraft banking). Canadian banking customers also have the ability to open accounts in currencies other than the Canadian dollar, which are known as foreign currency accounts.
One practice where Canadian and U.S. banks are similar is in the “unbundling” of banking services. As Canadian bankers have dealt with more and more U.S. corporate customers, they too have begun to offer detailed billing for services provided. An area of difference, however, is in the relationship between banks and their customers. As mentioned earlier, there are fairly strict lending limits imposed on U.S. banks, especially those with national charters, to reduce the exposure the bank has to any one customer. This often results in multi-bank credit agreements for large U.S. companies. In Canada the rules are more flexible (based on “prudent lending practices”) and the relatively larger size of the banks-compared to both the average Canadian company and overall economy-mean that many corporate customers do not need to follow the same multi-bank borrowing practices as their U.S. counterparts.
Finally, the last area of key differences is how the central bank in Canada (the Bank of Canada) involves itself in the day-to-day activities of the chartered banks. While the roles of supervision and “lender of last resort” are similar to those of the Federal Reserve, the Bank of Canada does not participate in the operation of the payments system.
Automated Clearing Settlement System (ACSS) and the Large Value Transfer System (LVTS)
While the typical business-to-business check takes from one to three days to clear in the U.S., checks in Canada (or cheques as they are known) are essentially same-day items. The processing of the payments (both checks and electronic) is handled by the banks themselves or through bank associations, such as the Canadian Payments Association (CPA). The CPA runs both the Automated Clearing Settlement System (ACSS) and the Large Value Transfer System (LVTS).
The ACSS is designed to clear both paper and electronic items and in recent years, the trend has definitely been towards electronic. According to ACSS statistics, in 2006, almost 79 percent of payment items were electronic, up from only 13 percent in 1990. Over this same period, paper items declined from 86 percent down to just 21 percent. However, Canadian companies do still tend to use cheques for large B2B payments, as the bulk of larger transactions-those over $50,000 (CAD)-are still paper-based.
The LVTS is similar to the FedWire in the U.S. and provides real-time finality of payment and guaranteed settlement. The average value of an LVTS transaction is $8.5 million (CAD) and all transaction over $25 million (CAD) are required to use the system. The LVTS was implemented in 1999, and in 2006 over $41.7 trillion (CAD), 89 percent of all value flowing through payments systems in Canada, was settled through the system.
As has been the case in the U.S., Canadian banks have implemented programs related to the creation and exchange of check images as well as the use of prevention techniques to reduce the incidence of check fraud. However, since there is already high use of electronic payments in Canada and all checks essentially clear the same day, there has not been a need to implement check conversion initiatives.
Canadian banks are becoming more active participants in the U.S. markets as many of their customers either expand their businesses into the U.S. or as opportunities to enter the U.S. banking market present themselves. When Canadian banks operate in the U.S. under a U.S. charter they must abide by all the laws and regulations governing financial institutions in the U.S.
While Canada may seem very similar to the U.S., there are significant differences between the banking systems in the two countries. The U.S. system is unique in the world, especially with respect to the sheer number of financial institutions and its high use of checks, but Canada seems to follow the more general developed-country model. In addition, U.S. companies tend to have multiple bank relationships for both credit and non-credit services, while Canadian companies typically have only one, primary commercial bank relationship. Finally, in the U.S. the Federal Reserve plays a key role in operating and managing the key payment systems, but in Canada this role is handled by an association of banks. The information presented in this article provides business managers with the “roadmap” they need to understand key commercial banking and treasury management practices in both the U.S. and Canadian markets. A summary table of some of the key differences between the two banking environments is provided below.
|Key Area||United States||Canada|
|Number of Banks||Over 8,500||Approx. 70|
|Nationwide Branching||Effectively Limited to Regions||Full Nationwide|
|Interest Paid on Corporate Checking Accounts||NO||YES|
|Foreign Currency Accounts||NO||YES|
|Number of Bank Relationships per Company||Many||One|
|Check Usage||Very High||Medium|
|Check Clearing Times||1-3 Days||Same Day|
|Check Conversion Initiatives||YES||NO – Not Needed|
|Government Operation of Clearing System||Very High||Low|
|“Unbundling of Banking Services”||YES||YES|
 U.S. Federal Deposit Insurance Corporation. Statistics at a Glance As of June 2007, http://www.fdic.gov/bank/statistical/stats/2007jun/industry.html. (Note: these numbers refer to the number of banking charters, large banks with many branches such as Bank of America or Chase only count as one charter.)
 U.S. National Credit Union Administration. 2006 Year-End Statistics for Federally Insured Credit Unions, http://www.ncua.gov/ReportsAndPlans/statistics/YearEnd2006.pdf. (no longer accessible).
 U.S. Federal Reserve regulations generally restrict national banks from lending more than 15 percent of their capital base to any one corporate customer. The result is that many companies obtain their short-term credit arrangements through a group of banks rather than a single bank.
 Committee on Payment and Settlement Systems of the Group of Ten Countries. Statistics on Payment and Settlement Systems in Selected Countries – Figures for 2005, Bank for International Settlements, CPSS Publications No. 78, (2007/03).
 The Account Analysis Statement is essentially a detailed commercial invoice outlining all of the services and pricing for those services provided by the bank. For example, banks will bill for each check cleared, deposit made, transaction processed, etc.
 FedWire is what is known as an RTGS or Real Time Gross Settlement System. This system is used to transfer large amounts on a same-day (virtually real-time) basis. The ACH system is designed for high volumes of low-value payments (direct deposit of payroll, benefit transfers, direct debits for insurance payments, etc.).
 There are several new standards recently introduced by the U.S. National Automated Clearing House Association (NACHA) in conjunction with the U.S. Federal Reserve that allow retailers, utilities, credit card companies, etc., to convert a check into an ACH transaction, thus reducing the number of checks and speeding up the value transfer.
 Federal legislation known as Check 21 (Check Clearing for 21st Century Act: www.federalreserve.gov/paymentsystems/truncation (no longer accessible)) governs the format and use of check images for clearing purposes rather than the check itself. The primary objective is to reduce the volume of paper and speed the clearing process.
 Most large commercial banks in the U.S. offer services that will match a list of checks issued to those that are presented for payment. These services, known as positive pay or match pay, can significantly reduce the amount of check fraud to the customer.
 T. Baker-Self, B. Ghavimi, G. Paoli. “The Top 1,000 World Banks 2006,” The Banker, (2006/7); International Monetary Fund, IMF World Economic Outlook and EconStats, http://econstats.com/weo/V019.htm; U.S. Federal Deposit Insurance Corporation, Statistics at a Glance As of June 2007. Office of the Superintendent of Financial Institutions Canada. Striking a Balance – OSFI Annual Report 2005-2006, http://dsp-psd.pwgsc.gc.ca/Collection/IN-2006E.pdf.
About the Author(s)
D.J. Masson, PHD, CTP, Cert ICM, is an associate professor of finance at the Graziadio School of Business and Management at Pepperdine University. Dr. Masson is a frequent conference speaker on a variety of financial, treasury management, and electronic commerce topics, and is the author of numerous articles and such financial textbooks as Treasurer's Handbook of Financial Management, Essentials of Cash Management, and Essentials of Treasury Management. He holds an MBA and PhD in Finance from Indiana University and professional certifications in cash/treasury management from both U.S. and U.K. treasury associations.