The Impact of the North American Free Trade Agreement on Commercial Banking

By Libby, Barbara | Journal of Economic Issues, June 1994 | Go to article overview

The Impact of the North American Free Trade Agreement on Commercial Banking


Libby, Barbara, Journal of Economic Issues


This paper examines the effect of the North American Free Trade Agreement (NAFTA) on commercial banking by comparing the banking systems of the United States, Canada, and Mexico and the consequences of the NAFTA treaty on these systems. It will also compare the provisions of NAFTA dealing with commercial banking to provisions of the existing U.S.-Canada Free Trade Agreement in this area.

The United States banking industry is diverse and fragmented with side-by-side federal and state chartering and supervision. Two important pieces of legislation that distinguish U.S. banks from those in Canada and Mexico are the McFadden Act, which prohibits interstate branching, and the Glass-Steagall Act of 1933, which separates commercial from investment banking. At the present time, there is a relaxation in the enforcement of provisions of these acts by various regulatory agencies but not outright repeal.

Aside from its regulatory functions, the main duties of the Federal Reserve System (FED) are the control of monetary policy and maintenance of the nationwide check collection system. The FED uses changes in reserve requirements, changes in discount rates, and, most importantly, open market operations in order to implement monetary policy.

While not under total control of the Federal Reserve, the Federal Funds market and rate play an important role in U.S. monetary policy. The Federal Reserve uses this rate as a target and an indicator in its open market operations.

Foreign banks in the United States. The International Banking Act (IBA) of 1978 brought the domestic agencies, branches, and commercial lending affiliates of foreign-owned banks under federal supervision and regulation. Foreign banks also have to obey branching prohibitions similar to those of the McFadden Act and have essentially the same privileges and restrictions as do U.S. banks.

The Canadian Commercial Banking System is characterized by a few very large banks and a number of smaller ones. Nationwide branching is permitted, and the federal government has almost complete regulatory control of the commercial banking system. The shares of Schedule A banks (the largest domestic banks) are widely held-no investor can own more than 10 percent, and no group of nonresident investors can own more than 25 percent of the shares. Since 1987, banks have been allowed to underwrite and distribute corporate securities, underwrite and distribute debt issues of Canadian government and Crown corporations, and invest their surplus funds in government and corporate securities.

The Office of the Superintendent of Financial Institutions is responsible for supervising the soundness of all federally chartered financial institutions. Because commercial banking regulation is a federal responsibility in Canada, there are fewer regulatory authorities, regulatory coordination is easier to achieve, and banks cannot change their regulatory environment by changing their charters.

The Bank of Canada uses open market operations to influence short-term interest rates and exchange rates [Joyce 1989]. Transfers of government deposits between the Bank of Canada and the chartered banks have become the most important method of changing the reserve position of the chartered banks. The concentrated nature of the banking system means that this method of reserve control can be used rather easily.

The bank rate (the interest rate for advances to banks) is a market-determined penalty rate. At the present time, it is allowed to float at one-quarter of 1 percent above treasury bill rate.

In June 1992, four new pieces of legislation governing financial institutions were implemented. Commercial banks will now be allowed to enter the trust and insurance business and own a substantial investment in an expanded list of businesses. These acts also immediately eliminated secondary reserves and initiated the phasing out of primary reserves over a two-year period. …

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