Low angle view of Skyscrapers in downtown Toronto during the day

The advent of open banking, growing use of fintechs and modernization of the payments system could increase competition in the highly concentrated Canadian banking industry — and this doesn’t necessarily have to come at the expense of financial stability, Morningstar DBRS said in a report Tuesday.

According to the report, the high degree of concentration in the Canadian banking system — the Big Six banks currently account for about 95% of total bank assets — contributes to financial system stability.

For one, it underpins the willingness “of the Canadian federal government to provide extraordinary support … because of these banks’ systemic importance to the Canadian economy,” the report said.

The concentrated sector also facilitates supervision by a single federal banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), it noted.

At the same time, bank concentration, “also somewhat creates barriers to entry and hampers competition, which can result in a slow pace of innovation,” the report said.

While a lack of competition contributes to stability by not requiring the banks to take excessive risks to drive profits, it also translates into higher fees and less choice for banking consumers, the report noted.

“For example, it appears that Canadian customers tend to pay somewhat higher bank account fees as well as interest rates on loans, while receiving lower interest on deposits. As a result, the Big Six benefit from lower funding costs, higher yielding loans, and bolstered fee income, all of which supports their stronger profitability compared with most peers globally,” it said.

The report argued that competition could be enhanced through initiatives such as open banking, increased fintech penetration and modernization of the payments system without weakening regulation and stability.

For instance, open banking — which allows consumers to share their banking data with other firms — could enable innovation and make it easier to switch banks, the report said.

Similarly, the development of fintechs could enable the development of a wider range of more tailored products and services, it suggested.

“Payments system modernization supporting real-time and more data-rich payments is among other initiatives that could help promote competition by creating more options for instant money transfers and making this financial infrastructure freely accessible to smaller financial services and fintech companies,” the report said.

These developments would likely come with increased risks including data privacy, cybersecurity and fraud risks, the report acknowledged.

“In our view, comprehensive risk management and technical frameworks supported by prudential regulatory and supervisory oversight will be instrumental to mitigate such risks,” it said.

In particular, a number of fintechs are pursuing banking licences, which would subject them to “stringent supervision with greater regulatory scrutiny and compliance requirements,” the report noted.