One of the unique and unusual features of the Canadian bank regulatory system is that it regulates financial entities based on what they are, rather than what they do. As a result, you can have two entities carrying out the same line of business, one of which is highly regulated and one which has little regulation. The difference is due to the nature of the entities.

If the entity carrying out a financial services activity is Canadian, it is subject to bank-like regulation which includes capital ratios, concentration ratios, anti-money laundering and anti-terrorist financing requirements and governance requirements. Conversely, apart from some exceptions regarding foreign banks (detailed below), an entity that is not a Canadian bank is not subject to regulation.

The fundamental question is how to differentiate a bank from a non-bank, and the answer is surprisingly simple: an entity that is incorporated under the Bank Act is a bank and an entity that is not incorporated under the act is not. There is no functional test, just an incorporation test.

Prohibitions on banks

This distinction is important with respect to two significant financial activities: operating lease financing and uninsured high loan-to-value mortgages.

Canadian banks are prohibited from carrying out an operating lease business. An operating lease is a lease where the collateral at the end of the lease term has a residual value greater than 25% of its cost of acquisition, or which imposes on the lessor owner-like responsibilities such as maintenance, repairs and insurance.

Canadian banks are also prohibited from carrying out a high loan-to-value mortgage business. Generally, unless mortgage insurance is in place, a Canadian bank cannot lend on the security of a residential property an amount greater than 80% of the value of the property.

As a result of these two prohibitions, Canadian banks have been unable to provide competitive operating leases or uninsured high loan-to-value mortgage lending.

Level playing field principle

Canadian bank regulation has a level playing field principle to the effect that, if a Canadian bank is prohibited from carrying out certain activities in Canada, foreign banks are also prohibited from carrying out those same activities in Canada.

As a result of the level playing field principle, a foreign bank that carries out business in Canada is also prohibited from carrying out an operating lease business and an uninsured high loan-to-value mortgage business.

The level playing field principle also applies to foreign bank groups that carry out business in Canada. Generally, a group will be considered to be a 'foreign bank group' if more than 35% of its consolidated assets or 35% of its consolidated revenues relate to, or are derived from, entities that are real banks.

As a result of this 35% rule, financial entities that have banks in their families, but whose consolidated assets and revenues do not exceed the 35% threshold, can carry out business in Canada without regard to the level playing field principle.

GE Capital

GE Capital is one foreign financial institution that has amassed in Canada significant portfolios of what would be impermissible assets for banks. GE Capital has made a substantial contribution to providing competitive financing in Canada through lines of business that cannot be carried out by banks.

As has been widely reported, GE Capital has decided to divest itself of most of its financial assets and businesses. In Canada, both Canadian and foreign banks are acquiring some of these assets and businesses. However, the difficult legal issue for the banks is finding a way to purchase and maintain the assets and businesses which, although were permissible assets and businesses for a non-bank entity like GE Capital, are impermissible assets and businesses for bank entities.

Each potential acquisition by banks faces the same question – given the level playing field principle, how can a bank acquire these impermissible assets and businesses?

New policy objective

Fortunately, a policy objective has come to the aid of the banks. Given the prominence which GE Capital had with these impermissible assets and businesses, the federal government appreciates that there would be a significant lack of competition in the Canadian market to replace the operating lease financing and uninsured high loan-to-value mortgage financing previously obtained from GE Capital. As a result, although it is unlikely that there will be any permanent and unconditional consents from the Department of Finance that will allow banks to maintain the impermissible assets and businesses for an indefinite period of time, there appears to be a willingness to allow banks to acquire and hold the assets and businesses for a limited period of time. During this limited period, the banks can hopefully restructure the assets so that they are permissible, allowing them to continue to carry out similar lines of business to those which were carried out by GE Capital. Certainly, Canadians need to have a continuation of this kind of financing.

For further information on this topic please contact John W Teolis at Norton Rose Fulbright Canada by telephone (+1 416 216 4000) or email ( The Norton Rose Fulbright Canada website can be accessed at

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