Some content in this column has been edited for accuracy.
Within Canada there are banks and credit unions. Canadian banks are regulated in three categories, Schedule I, Schedule II and Schedule III banks. All of these banks are federally regulated by the Bank Act, which outlines operating rules for the banks to follow.
Schedule I chartered banks are Canadian-owned banks and are best known as the big-6 banks: Bank of Nova Scotia, Royal Bank, Bank of Montreal, Toronto Dominion Bank, Canadian Imperial Bank of Commerce and National Bank.
Schedule II banks are incorporated and operate in Canada as federally regulated foreign subsidiaries. An example of a Schedule II bank is BNP Parabis (Canada), which is a French retail banking company.
Schedule III banks include branches of foreign banks that are federally regulated and are allowed to do business within Canada under the Bank Act. The likes of Bank of New York Mellon and Barclay’s Bank would fall under the Schedule III bank umbrella.
Credit unions are financial institutions similar to banks, except they are co-operative member-owned financial institutions. They share their profits with members in accordance with the credit union principles. Any excess in revenues over costs are used to increase retained earnings, fund operational improvements, etc., or are returned to members in the form of patronage dividends.
Credit unions historically have not had national operations like the Schedule I, II and III banks have. Instead, credit unions would often serve people from a particular area (such as Island Savings, a division of First West Credit Union), or of a specific business group (such as the Vancouver Firefighters Credit Union).
As a result of this, they are subject to different regulations. Each province is responsible for regulating their credit unions. Credit unions in British Columbia must follow the provincial Financial Institutions Act (1996) and the Credit Union Incorporation Act (1996).
In addition to provincial credit unions, there are regional credit union centrals and federal credit unions. Federal credit unions (i.e. credit unions) operate federally as co-operative banks under the Bank Act. Regional credit union centrals are organizations, which provide central financial facility and, in some jurisdictions, trade association support to their member credit unions. Regional credit union centrals operate under provincial credit union legislation.
The Canadian Credit Union Association (CCUA) is the national credit union trade association that provides services to Canada’s credit unions, caisses populaires (outside of Quebec), and regional central organizations, and is incorporated under the Canada Cooperatives Act. CCUA’s predecessor, the Credit Union Central of Canada (CUCC), incorporated under the Cooperative Credit Associations Act (CCAA). Central credit unions ceased to be governed by the Cooperative Credit Associations Act in 2017 upon the repeal of Part XVI of that Act.
Canadian Deposit Insurance Corporation
Banks offer their patrons deposit insurance through the Canadian Deposit Insurance Corporation (CDIC). Under CDIC, eligible deposits up to $100,000, per depositor, in each member institution are insured. If a member institution were to fail, the depositors would be reimbursed for any insured amounts.
Since 1967, CDIC has provided protection to depositors in a total of 43 member institution failures. None of these failures have been the big banks, but instead have been smaller financial institutions. Insurable deposits include savings and chequing accounts and Guaranteed Investment Certificates (GICs) with terms of less than five years, as long as they are payable in Canadian dollars. They do not include securities investments such as stocks, bonds, t-bills or mutual funds.
As well, it is possible for more than $100,000 to be eligible for CDIC insurance, so long as the deposits are held in multiple types of eligible accounts such as: accounts held in one name, accounts held jointly in more than one name, trust accounts, Registered Retirement Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs) or a mortgage tax account.
To illustrate, let’s assume Mrs. Smith has $20,000 in cash in her chequing account, and has $110,000 invested in a two-year GIC in her RRSP. If the institution Mrs. Smith deals with went under, she would receive a total of $120,000 from CDIC ($20,000 cash in her chequing account and $100,000 from the two-year GIC in her RRSP).
CDIC insurance for GICs
In addition to deposits, CDIC insures the principal, plus interest, on most GICs up to $100,000. If we buy GICs for clients, we always ensure that the amount per issuer is no greater than $100,000. That way, if ever an issuer were to default, our clients would receive the full insured amount of $100,000.
Credit Union Deposit Insurance Corporation
Credit unions in British Columbia offer their members deposit insurance through the Credit Union Deposit Insurance Corporation (CUDIC).
Prior to 2008, CUDIC provided a similar level of insurance to CDIC where up to $100,000 of eligible deposits were covered. This changed, however, on October 22, 2008, when the headlines read that there was to be unlimited deposit insurance for deposits held at credit unions.
The Financial Institutions Act of 1996 was amended to reflect this, and since October 22, 2008, credit union members are eligible to receive insurance for the full amount of their eligible deposits in the event a BC credit union were to fail.
Credit unions going federal
Members of Coast Capital Savings Federal Credit Union (“Coast Capital”, formerly, Coast Capital Savings Credit Union) voted in 2016 to become a federally regulated Schedule I bank. Nearly 80 per cent of its voting members voted in favour of this change.
Effective November 1, 2018, Coast Capital became the second credit union in Canada to become federally regulated. The first credit union to make the switch, UNI Financial Cooperation, did so on July 1, 2016.
When Coast Capital became federally regulated, their members’ CUDIC coverage transitioned to CDIC. Now, all member’s deposits and accounts are insured in accordance with CDIC.
As mentioned above, CUDIC offers 100 per cent coverage on eligible deposits, compared to CDIC, which offers $100,000, per depositor, per account, on eligible deposits.
If your investments are structured correctly, this change may have no impact on your investments. However, if your investments are not structured correctly, this could result in unnecessary risk exposure. It is for this reason we urge investors at credit unions to be extra cautious.
There could be a switch to federal regulation for your particular credit union, and it’s never off the table for 100 per cent CUDIC insurance to be revoked and revert back to pre-2008 insurance limits which were in-line with CDIC.
As of November 1, 2018, Coast Capital became a federal credit union. From the day Coast Capital’s voting results were announced on December 14, 2016, to the day the transition period ended on April 30, 2019, it was less than two and a half years.
The impact of the change from provincial to federal regulation as it relates to deposit insurance is important. CUDIC’s deposit insurance coverage ends on the date of continuance of the credit union to the federal regime and the credit union becomes a member of CDIC (November 1, 2018).
CDIC’s deposit insurance coverage applies from the date of continuance (November 1, 2018). Under CDIC’s transitional coverage, CDIC’s insurance coverage on a pre-existing term deposit/GIC would be the same as CUDIC’s deposit insurance coverage, until the term deposit matures or is cashed out.
To illustrate, we will look at Mrs. Smith who is holding a five-year, $1 million GIC. Under provincial insurance coverage (CUDIC), the full $1 million, plus accrued interest, would be insured.
If Mrs. Smith purchased this GIC on October 31, 2018, she would receive the full CUDIC insurance until its maturity. However, if Mrs. Smith purchased this GIC on November 1, 2018, Mrs. Smith would be covered under federal coverage (CDIC) and only $100,000 of her term deposit would be insured, leaving $900,000 plus accrued interest uninsured until maturity in five years time.
Some retirees perceive GICs to be the least risky investment. We disagree with this. Factoring in inflation and taxes, we feel the loss of purchasing power and negative rate of return is a greater risk to one’s retirement savings. It is for this reason that we do not recommend GIC investments to our clients.
To illustrate, current one-year GIC rates range from 0.25 per cent (AA rated – least risky) to 0.96 per cent (BBBL rated – riskier). We have run the numbers, and even with the best one-year GIC rate available today, it is impossible for investors to receive a positive rate of return, on an after-tax and inflation adjusted basis.
One of the first rules of investing is diversification in order to reduce risk. Many people think of this just being applicable to equities, but this should apply to fixed-income as well. For our clients who choose to invest in GICs, we ensure their GICs never exceed $100,000 per issuer. We have dozens of GIC issuers to choose from. For our clients who are wishing to put a significant amount of their funds in GICs, we ensure that they have as much CDIC coverage as possible. To make sure our clients are fully protected, we never have more than $100,000 with a single GIC issuer.
Using the illustration above, if a client had $1 million and they want to have full CDIC coverage, we would purchase 10 different GIC issues of $100,000 each to ensure complete coverage. The investor would hold 10 different GICs and receive 100 per cent coverage on their original principal invested. There is no impact on the return, but there is significant less risk exposure as the investment is 100 per cent insured.
Although the risk of default is minimal, there have been 43 member institution failures in 53 years, so this risk is not zero. Why choose to open yourself up to unnecessary risk? We feel that it is prudent to minimize risks by diversifying, especially when there is no impact to the bottom line.
In contrast, if you invest $1 million with a credit union, you may be inclined to invest the full balance of $1 million in the GIC with the highest rate, since 100 per cent of that balance is insured through CUDIC. However, now that not all credit unions in British Columbia have 100 per cent CUDIC insurance, we recommend investors be careful when reinvesting and to make sure their GICs and term deposits are not automatically reinvested.
CUDIC’s deposit insurance coverage ends on the date of continuance of the credit union to the federal regime and the credit union becomes a member of CDIC. Deposits that existed prior to the date of federal continuance are covered under CDIC’s transitional deposit insurance coverage. During the transition period, CDIC provides the same coverage provided under provincial law on pre-existing deposits. CDIC’s transitional coverage for pre-existing demand deposits ends after 180 days from the date of continuance and for term deposits, ends when the term deposit matures or is cashed out.
If the credit union you’re dealing with today is provincially regulated and changes to federally regulated in the future (similar to Coast Capital), our concern is you may lose your deposit insurance. Be sure that you are not taking unnecessary risks with the drop in coverage and be fully aware of the risk impact of such a change.
With rates as low as they are, GIC investors may feel they need to invest all their money in the highest rate they can. We urge investors against doing this. Do not focus solely on the rate, and when making investment decisions consider other factors like also securing the highest possible deposit insurance coverage.
Our preference for most clients is for them to avoid GICs because of the low rate of return. Despite this, we do have clients who have large trust accounts, conservative clients, or individuals who have power of attorney over their parents’ accounts and have a fiduciary duty to them. Some of these clients request that we purchase GICs. In these instances, we ensure they have full CDIC coverage to minimize their risk.
As we have mentioned in past articles, with interest rates being so low, some institutions have created structured GICs, such as linked notes. We recommend proceeding with caution when investing in these products – always read the fine print! Before investing in GICs, first consult with your Portfolio Manager to ensure you receive the maximum deposit insurance coverage on your investments.
Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138. greenardgroup.com.