FINA Committee Meeting

37th PARLIAMENT, 2nd SESSION

Standing Committee on Finance

EVIDENCE

CONTENTS

Tuesday, February 4, 2003

Á

1105

The Chair (Mrs. Sue Barnes (London West, Lib.))

Dr. Douglas Peters (Economist, As Individual)

Á

1110

Dr. Arthur Donner (Economist and Consultant, As Individual)

Á

1115

The Chair

Prof. Jean Roy (Full Professor of Finance, University of Montreal, As Individual)

Á

1120

Á

1125

Á

1130

The Chair

Mr. Joseph Oliver (President and Chief Executive Officer, Investment Dealers Association of Canada)

Á

1135

Á

1140

The Chair

Mr. Richard Harris (Prince George—Bulkley Valley, Canadian Alliance)

Á

1145

Dr. Douglas Peters

Á

1150

The Chair

Mr. Richard Harris

The Chair

Mr. Pierre Paquette (Joliette, BQ)

Mr. Joseph Oliver

Mr. Pierre Paquette

Mr. Joseph Oliver

Mr. Pierre Paquette

Mr. Joseph Oliver

Mr. Pierre Paquette

The Chair

Prof. Jean Roy

Á

1155

Mr. Pierre Paquette

Dr. Douglas Peters

Â

1200

The Chair

Ms. Maria Minna (Beaches—East York, Lib.)

Dr. Douglas Peters

Ms. Maria Minna

The Chair

Dr. Arthur Donner

Â

1205

The Chair

Mr. Joseph Oliver

The Chair

Mr. Bryon Wilfert (Oak Ridges, Lib.)

Dr. Douglas Peters

Â

1210

Mr. Bryon Wilfert

Dr. Douglas Peters

Mr. Bryon Wilfert

Dr. Douglas Peters

The Chair

Mr. Bryon Wilfert

Dr. Douglas Peters

The Chair

Mr. Lorne Nystrom (Regina—Qu'Appelle, NDP)

Â

1215

Dr. Douglas Peters

Mr. Lorne Nystrom

Dr. Douglas Peters

Â

1220

Mr. Lorne Nystrom

Dr. Douglas Peters

Mr. Lorne Nystrom

The Chair

Mr. Roy Cullen (Etobicoke North, Lib.)

Dr. Douglas Peters

Â

1225

Mr. Roy Cullen

Prof. Jean Roy

Â

1230

Mr. Roy Cullen

Prof. Jean Roy

The Chair

Mr. Nick Discepola (Vaudreuil—Soulanges, Lib.)

The Chair

Prof. Jean Roy

Â

1235

Mr. Nick Discepola

Prof. Jean Roy

Mr. Nick Discepola

Prof. Jean Roy

Mr. Nick Discepola

Dr. Douglas Peters

Mr. Nick Discepola

Dr. Douglas Peters

Â

1240

Mr. Nick Discepola

Dr. Douglas Peters

The Chair

Mr. Richard Harris (Prince George—Bulkley Valley, Canadian Alliance)

Mr. Joseph Oliver

Â

1245

Mr. Richard Harris

The Chair

Mr. Joseph Oliver

The Chair

Mr. Roy Cullen

Dr. Douglas Peters

Mr. Roy Cullen

Dr. Douglas Peters

Â

1250

The Chair

Prof. Jean Roy

The Chair

Mr. Pierre Paquette

Prof. Jean Roy

Â

1255

Mr. Pierre Paquette

Prof. Jean Roy

The Chair

Mr. Nick Discepola

Prof. Jean Roy

Mr. Nick Discepola

Prof. Jean Roy

Mr. Nick Discepola

The Chair

---

CANADA

Standing Committee on Finance

---

NUMBER 037

l

2nd SESSION

l

37th PARLIAMENT

---

EVIDENCE

Tuesday, February 4, 2003

[Recorded by Electronic Apparatus]

Á  (1105)  

[English]

    The Chair (Mrs. Sue Barnes (London West, Lib.)): Good morning, everyone. Bienvenue à tous.

    We will continue with our hearings pursuant to Standing Order 108.(2), the study on the public interest implications of large bank mergers.

    Our four witnesses for this session are Dr. Douglas Peters, who is an economist, and Dr. Arthur Donner, who is an economist and consultant. The two of them are doing the one presentation together. We have Professor Jean Roy, who is full professor of finance at the University of Montreal, and from the Investment Dealers Association of Canada, Joseph Oliver, president and chief executive officer. With him we have Jon Cockerline.

    Welcome to all of you who will be assisting with the presentation of Mr. Oliver.

    I think the best way to commence will be to go in order of the presentations on the agenda.

    I presume, Dr. Peters, you'll be going first.

    Dr. Douglas Peters (Economist, As Individual): Thank you, Madam Chair, and good morning, ladies and gentlemen.

    Our brief was presented to this committee in the hope that you will take a broad view of major bank mergers. The authors of this brief are experienced economists in the field of public policy and finance and have written on the bank merger question as it relates to Canadian public policy and the public interest.

    We have serious concerns that allowing major banks in Canada to merge would have detrimental effects on the interests of bank customers and staff and shareholders. Major mergers among the Canadian banks would result in problems in the Canadian capital markets and could make it difficult for Canadian corporations and governments to finance in Canada. Without an adequate and competitive capital market managing the Canadian currency, money supply would become a serious difficulty.

    The questions your committee should ask are the following:

    Would the merger of Canada's major banks, lower the costs of banking services to individual Canadians?

    Would the merger of Canada's major banks improve the level and quality of service that Canadians receive from their banks?

    Would the merger of Canada's banks increase the choices of Canadians in their banking services?

    Would the merger of the banks improve the availability of credit and lower the cost of credit to small and medium-sized businesses in Canada?

    Would the merger of Canada's major banks lower the cost of credit to Canada's large businesses?

    Would the merger of Canada's major banks increase the profitability of Canadian banks from their international operations?

    Lastly, would the merger of Canada's major banks improve the Canadian economy by increasing employment and economic growth?

    The answer to all these questions, we feel, is no. Indeed, in almost all cases, the exact opposite would result.

    Bank mergers are about raising prices and reducing service to the public and concentrating economic power in the hands of the few. They may also be about the glorification of chief executives and the early cashing-in of stock options. We feel none of these outcomes are in the public interest of the average Canadian, and Canadians have consistently voiced their disapproval of the suggested mergers of major Canadian banks.

    In a paper we wrote in 1998, we stated, and I quote:

To be in favour of the two behemoth bank model it is necessary to show that the benefits of being of behemoth size in international markets are so large as to outweigh the negative effects on the Canadian public of job losses, branch closures, reduced service and lessened competition.

    Now, it's interesting that the banks have offered no evidence that this proposition is in any sense true. Indeed, it would appear that all the evidence is to the contrary.

    A major Federal Reserve study of bank mergers and consolidations concluded that the historical evidence suggests no lasting improvements on efficiency, profitability, or stockholder wealth from bank mergers.

    Those comments are of particular interest, as they refute all of the main arguments in favour of major bank mergers.

    In Canada we have just witnessed the largest bank merger in Canadian banking history--the Toronto-Dominion Bank and Canada Trust. What was the result? Well, the result was what the studies would have predicted: increased prices for services, reduced service to the public. And the merged TD and Canada Trust is the worst performing bank of the big five.

    I'd like to turn it over to my colleague, Dr. Donner.

Á  (1110)  

    Dr. Arthur Donner (Economist and Consultant, As Individual): Thank you very much, Madam Chair.

    Recognizing that time is tight, I'd like to first of all start off by emphasizing four propositions. The first proposition is that there will be unwelcome capital market concentration as an outcome of major bank mergers, down to two or three large banks. The second proposition is that concentrating the system down to two or three large banks would have implications for monetary policy, the management of interest rates, and the Canadian dollar. The third proposition is that without an adequate and competitive capital market, Canadian corporations would have difficulty with bond borrowing in Canada and would likely turn to the United States for borrowing. The fourth proposition is that the increased U.S. dollarizaton of the Canadian economy is a logical consequence of major bank mergers.

    I will quickly comment on all of those issues.

    We believe that major bank mergers will worsen the concentration in the auction process for government bonds and treasury bills. Provincial security regulators would have to be concerned with the market power of a combined major bank merger. With no national securities commission, it would be difficult for the individual provincial securities agencies to effectively supervise these giants in a relatively small Canadian market. In addition, the underwriting of securities will be placed in a very small number of hands, with two or three bank-owned firms the dominants. The potential for conflict of interest questions to arise would also increase as a number of bank-owned investment firms would be lending to, investing in, and underwriting the securities of most large Canadian firms. The likelihood seems high of there being much less ease of access to capital for Canadian firms.

    The Bank of Canada and the Department of Finance should be concerned with the concentration of power in the government securities market and the effectiveness of the bidding process for treasury bills and Canada bonds.

    A number of misguided Canadians may welcome increased dollarization, but we do not. Allowing the bank mergers to go ahead will make a case for dollarization seem all that stronger. Recent events have provided even more reason for our concerns. The number of major dealers in the wholesale trading of bonds has shrunk from about seventeen a few years ago to the present number of seven. A number of major U.S. firms have tried unsuccessfully to operate in the Canadian investment market. These include Goldman Saks, Lehman Brothers, and Salomon Smith Barney. All appear to have found the Canadian market unprofitable. If Canada were to lose two or more players to major bank mergers, there would no longer be an effective competitive capital market in the bond market.

    If the equity and bond markets in Canada become too concentrated because of the mergers of major banks, the temptation for Canadian firms to finance in U.S. capital markets will grow. If Canada's capital markets become less relevant because of the bank mergers, then the political pressure for dollarization--that is, the complete abandoning of the Canadian dollar and the elimination of a separate Canadian monetary policy--will gather momentum.

    Adopting U.S. currency as legal tender would have profound negative implications for the Canadian economy and for Canadian sovereignty.

    In sum, the number of major Canadian banks must not be reduced through mergers. The consequences of such mergers and a more concentrated banking and investment system would have detrimental effects on Canada's capital markets and eventually Canada's sovereignty.

Á  (1115)  

    The Chair: Thank you.

    We'll now go to Professor Roy.

[Translation]

    Prof. Jean Roy (Full Professor of Finance, University of Montreal, As Individual): Note to Publications: Affiliation should be M. Jean Roy (témoigne à titre personnel) Thank you, Madam Chair.

    I'm very honoured to have the opportunity to express my opinion on this very important question. I'm going to read my brief, though without reading the introduction, which merely provides context. This brief will provide statistical information and personal views that are intended to help advance the debate.

    The question of the merger of Canada's major banks may be asked in the following terms: "Would the potential benefits of greater international expansion associated with one or more bank mergers outweigh the possible costs of the impact of those mergers on the domestic market?"

    We therefore propose to consider in turn the questions of the international position of Canada's banks, the national impact of potential mergers and, lastly, the appropriate mode of government intervention with regard to that impact.

[English]

    On the international position of Canada's banks, in June of every year the economic magazine Euromoney publishes a section entitled “Bank Atlas”, where it presents a ranking of the world's 250 largest banks based on shareholders' equity, which is the best measurement of a bank's size. The June 2002 ranking, which is presented in table 1, shows the 51 largest banks at the end of 2002.

    In our view, the group of the 50 largest banks is really the dominant group of the major international banks. We increased the size of the group to 51 because Scotia Bank ranked 51st. That made our analysis slightly more conservative. This group also roughly coincides with the group of banks that have equity of more than $10 billion U.S. Canada thus has two banks in that group: the Royal Bank in 41st position, and the Scotia Bank in 51st position.

    We then grouped the banks by country of origin, as presented in table 2, and added the equity of the banks of each country to obtain a measurement of country representation in the group of the 51 largest banks. We then measured the size of each country's economy based on gross domestic product, as provided by the World Bank's August 2002 statistics for the comparable year 2001.

    As a result, it is possible to relate the participation of one country in the group of the 51 largest banks to the size of its economy. Table 3 is the most important table of the several I have at the end of my paper. It shows various ratios calculated for this purpose. As may be seen, Canada's GDP represents 2.81% of the aggregate GDP of the 14 countries participating in the group of the 51 largest banks. The aggregate equity of the two Canadian banks in the group represents only 1.77% of the total equity of those banks.

    Similarly, it may be seen that the average equity of the major banks of a given country for that group of 14 equals 4.87% of the GDP of the country in question, on average, whereas the ratio is only 3.07% for Canada.

    These statistics clearly show that Canada is under-represented in the group of the 51 largest banks, based on the size of its economy. This is a highly significant conclusion, since it shows that Canada lags behind the other countries and indicates, to a certain degree, its expansion potential.

    It can also be noted that the average size of the banks in the groups of the 51 largest banks is roughly $22.9 billion U.S., whereas the average size of the two Canadian banks in the group is only $10.4 billion, approximately half that average figure. That reveals the small relative size of those two banks.

    Over the weekend my research assistant provided me with slightly more data. I have another table that's not in the paper, and I would like to comment on what we got from these supplementary data.

    We took a sample of 11 large banks--Citigroup, HSBC, Bank of America, Deutsche Bank, UBS, Parisbas, Barclay's, Credit Suisse, Société Générale, ING, and Santander. We got the total revenues for these institutions and the number of employees and computed the revenue per employee. On average, it's $280,000 U.S. per employee. If we compute the same figure for Canadian banks we get $149,000 per employee. That shows our Canadian banks are also lagging in productivity per employee compared to these leaders.

    Another figure for these large international banks is the proportion of their revenue that is generated locally compared to what they are generating abroad. On average, for these institutions it's 50% in the home country and 50% outside the home country. If we look at our Canadian banks we see they generate 68% of their revenues in Canada and 32% outside Canada. That again shows they are not as international as the leaders.

Á  (1120)  

[Translation]

    In Table 4, we present an analysis of what we call a catch-up scenario, under which Canada is assigned a weight corresponding to the size of its economy, that is to say 2.81% of the total figure for the 14 reference countries.

    This objective would require consent for the merger of the two smallest of the five major Canadian banks. In that case, Canada would have a weighting of 2.96% in the group of 51.

    Lastly, Table 5 shows the results of an aggressive international expansion strategy to merge the existing five major banks into three. In that case, Canada would have equity of US$43.5 billion in the group, which would give it international size almost as great as that of Spain, which has equity of $48.7 billion in this group, or that of Holland which has $48 billion equity. The GDP of these countries is significantly lower than that of Canada. Canada's GDP is US$667 billion, whereas that of Spain is $577 billion and Holland's is $374 billion.

    Table 5 also shows that the aggregate equity of the three Canadian banks after the merger would represent 6.43% of Canadian GDP. As may be seen, this statistic would not be out of the ordinary on the international scale, since it would rank Canada in eighth place. Comparable figures for this ratio are 21% for Switzerland, 13% for the Netherlands, 12% for the United Kingdom and 8.44% for Spain. In a way, these numbers show that the aggressive international expansion strategy considered here would be entirely reasonable relative to those of the high intensity banking countries.

    Now that we have identified Canada's potential for participating in the activity of the largest international banks, the question that arises is: Can the Canadian banks carry out the mergers contemplated?

    Every merger obviously entails a risk, and the report of the Senate Committee on Banking, Trade and Commerce aptly emphasizes the need to assess such risks before proceeding with any merger. Furthermore, in my view, the Canadian banks' history of integrating new organizations, through the acquisition of brokerage firms, trust companies, insurance companies or foreign subsidiaries, shows that, in the vast majority of cases, the integration process was successfully completed. Consequently, on this basis, I am highly optimistic about the prospects for success of potential Canadian bank mergers.

    To what extent would greater size enable the Canadian banks to accelerate their international growth? Personally, like Mr. Godsoe of Scotia Bank, I do not believe that the phenomenon of economies of scale is very significant; what is important is the greater equity base, which makes it possible to conduct more major financing transactions and eventually to proceed with larger foreign acquisitions. These two factors lead me to believe that bank mergers would be a significant way to accelerate the international growth of the Canadian banks.

    It is also clear in my view that greater international presence for the Canadian banks would be beneficial for a number of stakeholders: employees, suppliers, major clients and the Canadian government itself, which would enjoy even greater prestige with international financial organizations, in particular the Bank for International Settlements.

    Now let's talk about the potential impact of bank mergers on the domestic market. What impact would bank mergers have on access to financial services for vulnerable clienteles and on SME financings? In fact, this impact is very hard to assess if the complexity of the situation is fully considered. It should be noted that, under Bill C-8, a number of measures protecting access to financial services and the closure of branches are already in place.

    Furthermore, should the largest banks abandon certain lines of business, there would clearly be a reaction by their competitors, which would view such action as a business opportunity. Life insurers, foreign banks and the cooperative movement are increasingly significant presences in the Canadian market and will undoubtedly limit the negative effects of greater concentration in the banking sector. The cooperative movement in particular has previously demonstrated its willingness and ability to serve certain market segments. Accordingly, it would not be out of the question that the situation of certain clienteles would be improved by the growth of suppliers of financial services more adapted to their needs.

Á  (1125)  

    In short, bank mergers could afford the opportunity for a certain degree of reorganization of Canada's financial institutions in which each institution could exploit its comparative advantage, thus making the entire system more efficient.

    Ultimately, we want to emphasize that the reaction of competitors to every change in strategy adopted by the merged banks makes it very difficult to assess the net impact.

[English]

    Government intervention to protect the public interest: in economic theory, government intervention is warranted whenever the actions of an economic agent create externalities--that is to say, positive or negative effects for third parties. This justifies the government in penalizing or regulating polluters, or subsidizing job creation. Corrective government measures presuppose that damage caused or benefits created can be estimated.

    In the case of bank mergers, it is clear, in our view, that it is very difficult to estimate the impacts before the fact. In these circumstances, should the government refrain from intervening? As noted above, any strategic change by the banks will likely cause a reaction among competitors. Furthermore, market restructuring may take time, and it is appropriate to protect vulnerable clientele in the short term following any major structural change.

    How to go about this? In our opinion, in view of the difficulty involved in assessing impacts, the best approach would be to ask the banks to make commitments on public interest issues. To this end, we think the document produced by the Royal Bank and the Bank of Montreal as part of their merger plan was a highly pragmatic approach to solving the question of public impact.

    In this sense, we believe the present component of the process for reviewing mergers by major institutions should be preserved, with a view to maintaining a certain degree of pressure on banks to make reasonable commitments to minimize the potentially negative short-term effects of their merger plans.

    In addition, we should forgo attempts to assess impacts in view of the difficulty involved in doing so, and instead view this stage of the process as an opportunity to determine whether the banks offer sufficient guarantees on public interest issues. We believe this change would reduce the burden of banks interested in mergers.

    Furthermore, as ordered, the expressions “reasonable commitments” or “sufficient guarantees” remain ambiguous and should be further clarified by the government. The government could potentially state a position that any transaction acceptable to the Office of the Superintendent of Financial Institutions and the Competition Bureau could be conducted, provided reasonable commitments were made on public interest questions.

Á  (1130)  

[Translation]

    In conclusion, our analysis of the international statistics shows that Canada does not occupy a position commensurate with the size of its economy in the group of the world's large banks. In our view, Canada's banks are capable of successfully completing mergers and that would undoubtedly accelerate their international expansion, which would be beneficial for the country in a number of respects.

    Furthermore, the impact of such mergers on the international market is hard to assess in view of the complex dynamic of reactions by competitors.In the circumstances, the government is still responsible for monitoring the negative impact that such transactions could have on vulnerable clienteles in the short term.

    We therefore believe that the Public Interest Impact Assessment component must be retained with a view to requiring reasonable commitments by merger candidates to protect the public interest.

    We believe that this approach, which is consistent with the legitimate growth strategies of the major Canadian banks and would provide acceptable safeguards for the interests of vulnerable clienteles, should lead to a restructuring of the Canadian financial sector that is beneficial for all concerned.

[English]

    The Chair: Thank you very much for your presentation.

    We'll now go to the presentation from the Investment Dealers Association of Canada. Mr. Oliver.

    Mr. Joseph Oliver (President and Chief Executive Officer, Investment Dealers Association of Canada): Good morning, ladies and gentlemen, Madam Chair. Thank you for the opportunity to address the House of Commons committee on bank mergers.

    The banking industry worldwide is going through a period of large-scale consolidation. One result of this consolidation is that Canada's banks, once among the top tier globally, have slipped to second-tier status in recent years. This is significant because size matters in international banking, particularly with regard to winning and retaining the most sought-after global corporate and government clients. Moreover, global reach is frequently essential for our banks to be able to service their Canadian clients, who are becoming increasingly global themselves.

    That said, a number of broadly based concerns about mergers must be addressed, including solvency of the system, access to regional banking services, and local employment.

    The purpose of my presentation today is not to reach a conclusion about the overall advisability of Canadian bank mergers. Rather, it is to focus on a specific but significant issue related to bank mergers: their potential impact on the competitiveness and efficiency of our capital markets, especially for users and providers of capital.

    Canadian capital markets are concentrated in the hands of six bank-owned security dealers. They control 60% of the new-issue market, 60% of the wealth management market, and about 75% of the fixed income and secondary equity trading markets. These six investment dealers represent 59% of the total dealer capital and 54% of employment in the securities industry.

    The banks' share of the new issue and wealth management markets is considerable. In securities trading, few will deny that the bank-owned dealers dominate this business. Market share is a key consideration in examining market concentration and market power, but mergers could unleash a dynamic that would encourage competition. Over time, that process would reduce the market share of banks and lower concentration in the industry. By looking at each of these businesses in turn, we can form our conclusions about the potential impact of bank mergers on Canadian capital markets.

    Investment banking includes mergers and acquisitions and underwriting or new issues, which entails raising capital for corporations and governments. At the large-cap end of the client base, the market is competitive and global. In 2001, for example, the top 20 dealers accounted for 95% of the merger and acquisition business by dollar volume and about 72% of the number of deals. The bank-owned dealers accounted for one-third of the business, and foreign and non-bank-owned firms the remaining two-thirds.

    Similarly, in big-ticket equity underwriting, the top 20 Canadian and foreign dealers serviced about two-thirds of the deals in 2001, which represented 98% of the market value. While the big six represented 78% of this dollar market share, the remainder was accounted for by a number of mid-tier Canadian dealers and some foreign dealers. Therefore, even in the event of one or two bank mergers, clients would continue to have a large number of capable domestic and foreign firms to choose from in making up their syndicates.

    Many large-cap Canadian companies are also listed on U.S. exchanges and have ready access to competitively priced equity capital in that market. Moving down in size, virtually all of the small new corporate-issue financings under $10 million are serviced by mid-sized independent dealers. Banks and bank-owned firms represent a small share of the activity in the venture capital market. So any bank mergers should have virtually no negative impact on the small debt and equity issues.

    Arguably, the merger of banks would set in train a dynamic that would spur the growth of mid-tier independent firms, with added competition and new players to meet the financing needs of small and medium-sized businesses.

Á  (1135)  

    As a result, it is our opinion that if one or two bank mergers occur among the big six, the overall percentage of M and A and new equity issues handled by the big Canadian bank-owned dealers in Canada will not increase, and may in fact decline if business flows to non-bank competing firms.

    Typically, merged firms are unable to retain all their pre-merger clients and employees. Corporate clients are reluctant to reduce syndicate size, and institutions want to diversify their businesses. Further, talented professionals are often inclined to start their own firms or choose smaller firms with less bureaucracy and more personal upside, as opposed to continuing to work in a large firm that resulted from the merger. These factors would present new opportunities for mid-sized firms to grow and increase in number.

    Similarly, in the wealth management business, the IDA does not expect bank mergers to negatively alter the competitive environment. Today the banks and bank-owned firms are significant players, with 60% of the Canadian retail wealth management business by assets. They dominate in branch networks, retail brokerages, and private client business. However, alternate channels exist, including small independent financial advisers, direct sellers and dedicated sales forces for mutual fund companies, and insurance businesses with large marketing capabilities and service resources.

    Registered representatives, both bank and non-bank, have increased significantly in recent years. Between 1996 and 2001 licensed retail sales persons increased by 7.7%, from 125,000 to 181,000. Mutual fund dealers, financial planners, insurance agents and brokers account for 60% of total registered representatives, while banks, trusts, investment dealers, and brokers account for the remaining 40%.

    We're also seeing newer and very aggressive foreign banks like ING an HSBC competing for the retail wealth management market. Large global U.S. banks, like Goldman Sachs private client service, compete for the attention of the higher net-worth clients. In domestic retail banking, the co-ops and credit unions are also active competitors.

    In retail brokerage, our industry continues to add firms. In 2000 and 2002, two rough years in the brokerage business, the IDA welcomed to its ranks more than 20 new independent firms a year. Deducting members who dropped out, the number of independent retail dealers now stands at 136, compared to 114 two years ago.

    Clearly, wealth management is a broad, diverse, dynamic, and expanding business with many players. Should service levels or product choice deteriorate, or fees increase following a bank merger, many providers with significant products and services at competitive prices will be ready and able to take their place.

    The third area of capital markets that could be impacted by bank mergers is institutional stock trading--the buying and selling of large blocks of bonds or equities by institutional investors such as mutual funds or pension funds.

    On the fixed income side, bank-owned firms carry out approximately three-quarters of current secondary trading. This is a dominant position, but five years ago foreign and non-bank-owned firms held 50% of this business. The low barriers to entry mean we could see a return of the global banks to this sector, should concentration rise following the merger of existing players.

    A market with fewer fixed-income traders is unlikely to last very long. Institutions would actively seek the participation of global banks and other players to service their trading needs.

    In secondary trading of equities, threats to competition may be even less of a concern. Non-Canadian global banks will continue to be very involved, regardless of market conditions. Open access from the U.S. and the establishment of alternative trading systems to service the Canadian institutional investor will ensure that the marketplace remains competitive.

Á  (1140)  

    Indeed, institutional investors have actively supported the establishment and growth of new institutional boutiques to provide alternative sources of investment advice and product. So in investment banking and wealth management, we do not anticipate long-term erosion of competition in capital markets as a result of bank mergers.

    To sum up, it is our judgment that the potential mergers of large Canadian banks would not negatively impact the efficiency and functioning of our capital markets.

    Thank you.

    The Chair: Thank you very much for all your presentations.

    Now we'll go to a round of questioning. We'll have seven minutes for this first round.

    Go ahead, Mr. Harris.

    Mr. Richard Harris (Prince George—Bulkley Valley, Canadian Alliance): Thank you, Madam Chair; and thank you, presenters, for your excellent words of wisdom.

    My first question is to Mr. Peters.

    Mr. Oliver has just pointed out that competition in the financial services as a whole, in fact, over the years has increased rather than decreased. I think we can all agree that the exclusivity that our five major Canadian banks have is in a very narrow sector of financial services, such as deposit-taking on a retail basis, the cheque-clearing process, although it is now open for other players, should they wish to come in. Given that, and that it appears the trend for increased competition to the five major banks in areas of investment, insurance, mortgages, car loans, so many different areas, is going to continue to increase whether banks merge or not, despite the threats or the fears that competition is going to decrease, we've seen over the last 20 years the dramatic increase in financial services competition.

    With your banking background, I'm sure you can agree that banks no longer have such a large, exclusive.... The ability to do business in such a large, exclusive scale just doesn't exist any more. So I want to ask you, first of all, if you agree that competition in so many areas of financial services has in fact increased.

    The other thing is that on page 3 of your brief, you asked what I consider to be a hypothetical question: Would the mergers of Canada's banks lower the cost of banking? The reason I say “hypothetical” is because I think that question could be asked two ways. You could ask the same question a different way. For example, should there be no merger among major Canadian banks, would we necessarily see a lower cost of banking service, an improvement in level of quality? In other words, should they stay the same, these questions could still be asked, and maybe the results would be surprising, given the flavour of how you put them in your brief.

    Then, on page 3, there is your statement: “Bank mergers are about raising prices and reducing service to the public and concentrating economic power in the hands of a few.” Tongue in cheek, I had to look to see whether Duff Conacher was sitting there rather than Doug Peters.

    Have you ever asked these questions of the bankers? I dearly wish we had representatives of the banks here to try to answer. Have you ever run these questions by any of the major bankers and got their responses?

Á  (1145)  

    Dr. Douglas Peters: No, I haven't. But let me answer your question.

    First you asked me if I agreed with your statement of the dominant position of the banks. I think you're confusing, Mr. Harris, a couple of items. There has been a vast increase in financial services of various kinds over the past years. Over my history in banking that goes back over half a century, there's been a huge increase. But the dominant position of the banks has changed very little. The dominant position is now in retail brokerage; their dominant position is in personal lending; their dominant position is in car lending. None of this was the case when I started in banking.

    The banks' dominant position is in lending to small and medium-sized business; their dominant position is in lending to large business. These are not small segments of the financial services area. These are very large. They have a dominant position--probably not as dominant--in the provision of mutual funds. This is not a small segment of the financial services area; these are very large segments of the financial services sector.

    Your second point was that in our brief we asked these questions. But the issue is, would bank mergers, which are being proposed, change those...? What is the public interest? Those seven questions are what we feel is the public interest. It's up to you to decide. So if you're going to propose a bank merger, you should answer the questions. The question “Would a lack of mergers raise costs?” I think is not an issue. The issue is whether the mergers themselves would have operated in the public interest.

    Now, your third point was the question of whether mergers are about raising prices, reducing service, and concentrating economic power. That's the result of dozens of studies in academic papers, peer-reviewed papers, that have come out over the years. We looked at that in our larger paper written in 1998: that the results of mergers are increased prices, reduced service to the public. Those are clearly the results set out in a major number of academic papers. It's not just our opinion, and certainly we're not just repeating Duff Conacher's opinion. It is the opinion.

Á  (1150)  

    The Chair: C'est tout. That's your seven minutes.

    Mr. Richard Harris: Really?

    The Chair: You have actually ten seconds, but I don't think you can get the question and answer in.

[Translation]

    Now it's your turn, Mr. Paquette. Please begin.

    Mr. Pierre Paquette (Joliette, BQ): Thank you, Madam Chair.

    Thank you for your presentations. I have three questions, and I'll try to ask them quickly so you have a chance to speak.

    First, Mr. Oliver, you say that the Investment Dealers Association of Canada oversees more than 200 securities dealers. I would like to know how many of those belong to banks.

    Mr. Joseph Oliver: Our six largest banks each have a branch that is part of our industry, first as a brokerage.

    Mr. Pierre Paquette: Approximately what percentage of overall turnover do securities represent?

    Mr. Joseph Oliver: In the Canadian market?

    Mr. Pierre Paquette: I'm talking about brokerages controlled by the banks.

    Mr. Joseph Oliver: In the Canadian market?

    Mr. Pierre Paquette: Yes.

    Mr. Joseph Oliver: Generally speaking, that represents approximately 64% of industry revenue.

    

    Mr. Pierre Paquette: Thank you.

    Mr. Roy, I believe you've put your finger on something very important, something that induces the banks to merge. You said it very clearly: first they want to rationalize their management, and that obviously has effects on their work force. They want to increase their profits, particularly retained earnings, so that they can acquire other institutions in the global market and thus be more financially independent.

    You told us you were not too concerned about domestic competition because, if the banks, the large banks in particular, abandoned local markets, the consumer markets, there would probably be substitutes.

    What concerns me to the same degree is the risk of problems spreading at the international level. The bigger the banks are, the more internationalized and internationally fragile they are. In recent decades, we have seen major banks which seemed unassailable go bankrupt. What could the Bank of Canada or the Government of Canada do to assist a Canadian mega-bank in major financial difficulty? In that context, in creating one or more Canadian mega-banks, aren't we opening the way to the takeover of those banks by foreign interests? Aren't we leading Canadian taxpayers to assume the risk of those international players?

    That's somewhat Mr. Parizeau's argument. That's what he would have told the committee if it had wanted to hear him. Ultimately, he says that, when Canadian banks have gone into the field, onto the “skating rink” of the major international banks, taxpayers and consumers have ultimately paid for the mistakes they made. First, would we be able to assist those mega-banks? And second, is there any way of separating domestic and international operations so that a Canadian bank in trouble could address its own problems, since that involves its own management choices, so that there would be no impact on Canadian taxpayers and consumers?

    If I have the time, I will ask one final question.

[English]

    The Chair: Mr. Roy.

[Translation]

    Prof. Jean Roy: Note to Publications: M. Jean Roy. Mr. Paquette, your questions are very appropriate. I personally believe that, first, the provisions of Bill C-8 permitting formation of financial holding companies should be fully used to separate national and international operations as far as possible.

    We already know one thing. The greatest concern is obviously the protection of small savers, particularly by the Deposit Insurance Corporation. We know perfectly well that the Deposit Insurance Corporation only protects Canadian dollar deposits made in Canada. So, in that respect, the risk could be limited.

    Wouldn't there nevertheless be a certain residual risk? Probably. My view of these things is that I believe there are models of intermediate-size countries, such as Spain and the Netherlands, that have allowed a certain degree of concentration in their banking sector in order to obtain the benefits of international activity. Personally, I believe that Canada would have the same potential and that that would work to our benefit, but, at the same time, certain risks would have to be taken.

    As to promoting the acquisitions of Canadian banks, in my view, the bigger Canadians banks are allowed to become, the fewer potential buyers there will be. Those banks will be less likely to be acquired. That's my answer to your questions.

Á  (1155)  

    Mr. Pierre Paquette: Now I would like to turn to Messrs. Donner and Peters. The only argument that I think is valid with regard to bank mergers is the argument of international competition. We are told that the largest Canadian bank ranks forty-eighth, but we forgot to say that five of the 15 largest North American banks are Canadian.

    In your argument, you say that mergers don't appear to be necessary and do not serve the public interest because they would not likely increase the competitiveness of Canadian banks in international markets in any appreciable way. I would like you to elaborate a little on that argument. In my opinion, it's the only argument the banks can currently advance as valid with regard to the Canadian interest.

[English]

    Dr. Douglas Peters: The question is whether the size of the banks would increase their international results. Size is not the key factor internationally.

    The largest banks in the world for a number of years were the Japanese banks. As we said in our paper, banking is not sumo wrestling. If it were, the Japanese banks would have dominated the international position, but they don't. They're in deep trouble. They're in serious difficulty. The question of whether a major increase in size of the Canadian banks would make them more internationally competitive is moot.

    They're quite free now to combine together to operate internationally. If they wanted a larger size they could now. It's perfectly possible for the Royal, the Commerce, the Bank of Montreal, and the TD to form a major international corporation and go out there and compete internationally. Why aren't they doing that? If that were really a major profitable item, that's exactly what they would do. I don't see that as the question.

    You don't have to be enormous in size to compete internationally; you have to be good. Some of the major international banks are very good and not any larger than the Royal, the Commerce, or the TD.

    Indeed, each of the Canadian banks has been quite successful in dealing internationally. The Bank of Nova Scotia has a huge international operation in the Caribbean and South America. The TD has gone with the discount brokerage. They're the number two discount brokerage firm in the world. They've gone in different directions. The Bank of Montreal bought the Harris Bank and has a major position in the Chicago market. All of them have different styles.

    The question of whether they would be more competitive internationally is an interesting one when you compare them with some of the very large banks that are out there. HSBC, for example, was a combination of the Midland Bank in Britain and the Hongkong and Shanghai Banking Corporation in Hong Kong. What is their domestic operation? Is their Hong Kong operation their domestic operation, or their Midland Bank operation? I don't know, but when you have a combination like that you automatically add a huge international sector to it.

    The HSBC is virtually half a dozen or a dozen domestic institutions grouped together into an international one. The international size is not a major part. They are a domestic operation in Hong Kong. The British Bank in the Middle East was formerly Midland Bank. There's the Marine Midland Bank out of Buffalo, and the Hongkong Bank of Canada. There's one in Australia as well. They're all a group of domestic banks. I don't know that their operations are domestic.

  (1200)  

    The Chair: Thank you very much, both of you.

    We'll proceed now with Ms. Minna for seven minutes, followed by Mr. Wilfert for seven minutes.

    Ms. Maria Minna (Beaches—East York, Lib.): Thank you. I have a few questions. I hope I'll get through all of them, but it's kind of hard to do that.

    Anyway, my first question is to Mr. Peters. I had a question yesterday of some of the banks with respect to our current regulatory system for banks. I'm told that if we had mergers and we ended up with say two or three very large banks, our current regulatory system would suffice, in that OSFI and the Competition Bureau already take care of that. So it's not an issue for us to address.

    I guess I want to know from you or from Mr. Donner whether I'm just seeing problems where there are none. In other words, if we have megabanks, does our current regulatory system need to be strengthened to ensure Canadians that the problem of possible failure...? If a big bank fails it's a huge economic impact on the country. Yes, you can separate international and domestic, but you'd have problems. How do you get to the point where you can almost get to zero risk? I'm told not to worry about that.

    Dr. Douglas Peters: That's a very good question. If you had two bank mergers, you would have two huge banks and one medium-sized bank in the country. I think you have to think about what would happen if one of those huge banks failed. Right now, with five or six major banks, it's quite possible for one of the banks to fail and to have it absorbed by the financial system. If you had two huge banks, you would not have that possibility. They would indeed be too large to fail.

    If you look at that from a regulatory point of view, you have to ask the question, what regulations would be required for such an institution? It would seem to me that the regulations would need to be far steeper, far more detailed, and far more intrusive than any of the banks might imagine.

    It would seem to me that when they got too large to fail, the Superintendent of Financial Institutions would have to be on their doorstep, not just with an annual review but almost continuously, to make sure that the risk-taking in those very large institutions was so small that they would never risk the viability of the institution, because the effect on the Canadian economy would be massive.

    Ms. Maria Minna: Thank you.

    To go on to another issue, capital markets, Mr. Donner, you talked about the problem with regard to mergers and capital markets and the concentration. Mr. Oliver seems to suggest that it's quite the opposite, that it's beneficial; in the long run other markets will jump in, so the issue isn't really a problem. There are two completely opposing views with regard to that issue. Maybe you could expand on your points of view.

    The Chair: Dr. Donner will go first, and then we'll hear from Mr. Oliver.

    Dr. Arthur Donner: I must admit that I don't have Mr. Oliver's enthusiastic belief that market concentration at the banking end as it slips into the capital markets is good for the capital markets.

    I'm associated with a firm that is involved in bond trading. I'm told that there are very few effective bond dealers, and some of the important American bond dealers have left. Can you imagine what will happen if that shrinks down to three? It will affect the cost not only of the government raising debt but also the price of debt for private corporations. I see conflicts of interest all around, partly because we're already a very concentrated domestic banking system and as well because the banks are into so many subsidiary financial areas that are clearly important. I think we mentioned in our brief that the banks are involved in corporate lending, and through their dealers they are involved in the bond market. I don't have any confidence that additional concentration will lead to more competition. I'm sorry, but I just don't see that.

  (1205)  

    The Chair: Thank you.

    Mr. Oliver, please.

    Mr. Joseph Oliver: It's the buyers, not the distributors, who ultimately determine the supply of capital. We believe that while there is a fair degree of concentration now, as I pointed out in my testimony, there wasn't the same degree of concentration some five years ago. It was about 53% in the domestic bond trading business, and now it's 74%, which suggests that there's ease of entry and new competitors could arrive if the market were to become less competitive at any point. This is an extremely competitive industry by nature, and people and firms are constantly moving in and out.

    My overall point was that the aggregate proportion of the capital markets generally that the bank sector represented was unlikely to increase as a result of mergers. Individual banks, of course, would experience a greater market share if two of them combined. That's fairly obvious.

    The point, really, is whether as a result of that increase in market share on the part of one bank, say from 15% to 25%, depending on the sector, that would reduce competition or that 25% would automatically decline. It's sort of a truism in the investment banking business that two plus two does not equal four. It equals three, usually. Firms combining lose some of the combined market share, because clients of the firms on the buy side or the sell side are looking for alternative sources of capital distribution and information.

    The Chair: Thank you. We're out of time.

    Mr. Wilfert, please.

    Mr. Bryon Wilfert (Oak Ridges, Lib.): Thank you, Madam Chairman, and thank you to the witnesses for coming.

    Dr. Peters, as you know, OSFI and the Competition Bureau have a very prescribed role in terms of evaluating any proposed mergers. Our task is to look at how the public interest may or may not be served. We have to outline some public interest concerns. One that I have is on financial sovereignty. Yesterday I was interested that the head of the CIBC said that if Canadian banks do not merge, then our financial sovereignty will be threatened, because we will be more likely to be taken over.

    On pages 13 and 14 of your paper, you argue the issue of dollarization. You indicate that if we were to lose two or more players to bank mergers, we'd no longer have an effective capital market group for bond dealers. Then you go on and say that “Without an adequate and competitive capital market Canadian corporations would have difficulty with bond borrowing in Canada...”.

    Could you elaborate on this? As I say, I do not think the public interest would be served if our banks wound up in the hands of non-Canadians, yet that was the argument for moving forward in the public interest, according to what I heard yesterday, or in fact the very opposite.

    Dr. Douglas Peters: There is no question that Canadian banks cannot fall into foreign ownership right now. There used to be a 10% rule; it's now 20%. So you cannot have a takeover of Canadian banks. I don't think it would be allowed by either the finance minister or the government. So I don't think the issue of the sovereignty of the existing institutions is a real question.

    The other issue, though, is that where you lose your capital markets you lose the ability to issue bonds in Canada. You get more and more businesses going to a U.S. dollar market, becoming less and less oriented towards Canadian monetary policy or Canadian economic policy. Your Canadian dollar becomes less used in the country. Now this is a real risk to sovereignty. This is what we see as the real risk to sovereignty from the bank mergers.

  (1210)  

    Mr. Bryon Wilfert: To follow up, the CIBC indicated yesterday that because other countries allow foreign bank takeovers, we would be under tremendous pressure to follow suit. I realize the current regulations do not allow this. But as you know, we're reviewing a number of aspects, and this may be one.

    Dr. Douglas Peters: If you want to change the legislation to make sure that we have no Canadian banks left, that's a policy point of view. I would be against that particular policy as well.

    Mr. Bryon Wilfert: So would I. But again, I was putting that out there.

    In your paper you talk about Paul Krugman's clogged pipe theory, and you mentioned Japan. I'm certainly very familiar with Japan and the situation with Japanese banks there. You talked about the weakness there.

    You make the observation that size doesn't necessarily mean good. Yet there are many aspects to this, which I'd like you to elaborate on. In your view, what makes a bank internationally competitive other than its size, meaning that our banks would not necessarily have to go the route suggested by some?

    Dr. Douglas Peters: What makes a good international bank is the quality of their people who are dealing internationally, including their ability to enter international markets and to make some forward-looking decisions.

    I mentioned that the Bank of Nova Scotia's move into the Caribbean and South America has paid off handsomely. I would suggest you ask them about that; they'll tell you the move was a very good one.

    The TD Bank's move to buy Waterhouse and develop a worldwide discount brokerage and to buy Greenline in Canada was a strategic move that was managed extremely well.

    The Bank of Montreal's strategic move to buy Harris Bank was another move. I don't think they've capitalized on it nearly as much as they should have, but it was a strategic move that set them up in a very particular market.

    So, yes, you have to have good people, you have to have good management, and you have to know the international markets and make some effort to look into them and find a place for your business.

    The Chair: You still have a minute and a half.

    Mr. Bryon Wilfert: On the public impact assessment, obviously the committee doesn't want to duplicate what OSFI or the Competition Bureau may be involved in, but in terms of the second tier market, that's an issue that has been continually raised here, the fact that foreign banks that have come into the marketplace have had a niche approach in terms of not full service, necessarily, and therefore have not been able to fill the void. Do you have any comments? Could you elaborate on that, any of you gentlemen?

    Dr. Douglas Peters: I think one of the reasons the foreign banks have not had a great deal of success in Canada is that we have a very good and competitive banking system. We have a banking system where the service charges are 60%, I think, or something like two thirds of the service charges in the United States. We have a banking system where the interest rate spreads are narrower than they are in the United States. So why on earth would a U.S. bank want to come into Canada and develop its business here when they look at service charges that are a fraction and interest rate spreads that are considerably narrower?

    There's the main reason we haven't had many international banks come in here or look for a niche market. It's because we have a highly competitive banking system with half a dozen major banks. That's the importance, that we should keep those half a dozen major banks and keep them competing.

    Mr. Bryon Wilfert: Thank you.

    The Chair: Thank you very much, both of you.

    Mr. Nystrom, please, for seven minutes.

    Mr. Lorne Nystrom (Regina—Qu'Appelle, NDP): First of all, I want to welcome everybody to the committee, particularly Mr. Peters, a former colleague in the House of Commons.

    It's good to see you back at the finance committee. I've long respected you as a leading economist in this area, so I'm really pleased to see you and your colleagues here.

    I want to ask you a general question. We had some bankers here yesterday, the CEOs of the Royal, the CIBC, and the National Bank. They were certainly expressing the position that the wide ownership rule should be abandoned some day or changed.

    Also, there's an article in the Toronto Star today, quoting Les Whittington, that said that according to some officials he has spoken to, the trade deals may force us to abandon the wide ownership rule. I don't know why the trade deals would, because it applies to all people in the world equally. You can't buy more than 20% of a bank, and someone in the United States can't buy more than 20% of a bank. So I'm not sure how this ties in with the trade rules. Maybe I'm wrong on that, but perhaps, Mr. Peters, you could respond on that question, and respond as well as to what would happen if the wide ownership rules were abandoned. How do you see that unfolding in the future?

    The other part of this you may want to comment on as well, because you talked about dollarization, the threat of dollarization and the loss of monetary sovereignty. If we lose the wide ownership rule, do we jeopardize our monetary sovereignty, our banking sovereignty?

    It's that whole catchphrase that I sense people in my riding are concerned about. They want to make sure we have banks that serve communities, that they are basically Canadian-owned and Canadian-controlled, and that they look at the best interests or the common good of the Canadian people.

  (1215)  

    Dr. Douglas Peters: On the issue of wide ownership, I'm strongly in favour of widely held ownership in Canadian banks. I remember an issue some while back where one of the banks was asked what it would take to commit the capital of a bank if one individual owned it. How long would it take me to commit the capital to another project that was highly risky? I think one of the senior people at the bank figured it would take two days and it could be handled with only two or three people having knowledge of it.

    The single ownership issue is a question of how risky you want that institution to be. If one individual owns a major bank in Canada, they can change the risk profile of that bank in two days. I believe this point was made some years ago in a comment to one of the Senate committees. You could change that risk profile in two days, with only two or three other people knowing what you were doing.

    The reason for the widely held rule is that there is no single ownership, so there is no reason for a single individual to change the risk profile. The management of the institution under widely held ownership is interested in the continuity of the institution, whereas under single ownership an individual might be interested in his own personal wealth and his own personal ability, and could have other business interests as well.

    Dollarization is an issue of sovereignty. It's an issue that Dr. Donner has looked at more than I. We want to keep a strong Canadian currency, a strong Canadian capital market. It's essential to develop a Canadian capital market, and we've done it over the last 50 years. We didn't have much of a capital market 50 years ago. It's been developed substantially since then. We need a number of institutions--half a dozen large banks and other major institutions--to keep that capital market viable and to keep our Canadian dollar viable as well.

    Mr. Lorne Nystrom: The third part of my question is on Les Whittington's article from this morning that the trade deals may force us to abandon the wide ownership rule. I can't recall whether that was his opinion or if he was quoting somebody in the Department of Finance. I don't see why or how that would happen. What's your opinion on that?

    Dr. Douglas Peters: I don't see how that would be a necessary part of any trade deal, but I'm not a trade expert on it. I think you should ask the Department of Finance about that, or the Minister of Foreign Affairs and International Trade. I wouldn't think the trade deals would change that widely held ownership rule.

  (1220)  

    Mr. Lorne Nystrom: I want to ask you a question I'm often asked in my riding. You've already mentioned the case of having a couple of big banks too large to fail, and the impact on the economy. I want to bring it down to the person on the street, in terms of bank service charges and issues of that sort.

    What will the movie be like if we have bank mergers in this country, in terms of having even less control over bank service charges and ATM machines? I was lobbied this morning by someone who represented the Teamsters Union, which represents a lot of ordinary workers out there who make $30,000 to $35,000 per year. The big issue was concern that bank mergers might drive up the cost of servicing accounts, in terms of ATM machines.

    Dr. Douglas Peters: Studies again and again have shown that the service charges and interest rate spreads increase with the merged institutions. There was one in California. I don't think it's quite comparable with the Canadian situation, but there were two major bank mergers in California.

    The study we looked at some while ago showed that the pre- and post-merger interest rate spreads between the cost of funds at the banks and the price of funds that go out, the loan costs at the bank, widened something like 30 or 35 basis points. Well, 30 or 35 basis points is a huge, huge increase when you're dealing in hundreds of billions of dollars, because the California market, of course, is bigger than the Canadian banking market.

    Studies have also shown that service charges do increase with bank mergers. It's almost a necessity. We've seen that with the TD and Canada Trust merger. The Canada Trust higher service charges were applied to the TD Bank customers after the merger.

    Mr. Lorne Nystrom: This is my last question.

    The Chair: You're finished. You're out of time.

    We'll go now to Mr. Cullen.

    Mr. Roy Cullen (Etobicoke North, Lib.): Thank you, Madam Chair.

    Thank you to all the presenters.

    Dr. Peters, Dr. Donner, in your paper you pose the question, “Would the merger of Canada's major banks lower the cost of banking services, improve the level and quality of service, and increase the choices of Canadians?” I think those are legitimate and very positive outcomes that one would look for.

    I'm just wondering if you would envisage any circumstance under which.... Now this grouping here is a public interest test, maybe an important one, maybe the most important one. But there might be other public interest tests. Let's say that a proposed merger met the other public interest criteria, and in terms of those three criteria was neutral. In other words, there was no diminishment, there was no improvement in terms of lowering the costs or increasing access. Would that, in your mind, be an acceptable scenario?

    The reason I put that out particularly is that I think if two banks come forward with a merger proposal, what we've been hearing is that they would find a way to.... If the Competition Bureau asked for divestiture of various branches, let's say a National Bank or the credit unions would pick up those pieces at that level and at least keep those players in the field. I think probably the National Bank would argue that it would be aggressive in those markets, etc.

    Could you discuss that point?

    Dr. Douglas Peters: That's a very good point. This is the issue I'd have with that.

    Okay, let's say that a merger comes up and all those things are guaranteed by the banks involved. There are no increases in service costs. What happens if they do increase them afterwards? What happens if they don't meet the criteria? What are you going to do? Are you going to reverse the merger?

    A merger is a one-way street. You have to remember, a merger cannot be undone. You can't undo the merger, so you had better be very sure that you have the things all in line before you approve it. I'd ask you, are you absolutely sure that those undertakings would be met? I'm not absolutely certain that they would be.

    If they weren't able to, if the institutions came back to the government after a year and said, “Sorry, we can't meet those commitments; we have to have this and this and this”, what would you do? You know what you would do? You would say “Okay, we'll have to accept it because we can't turn the clock back”. Once the merger is approved it's gone, it's done, and you can't undo it.

  (1225)  

    Mr. Roy Cullen: Thank you.

    Professor Roy, your paper, it seems to me, is predicated on the notion that bigger banks are better. Maybe I'm wrong in making that assumption, but you use as a proxy the equity in relation to GDP.

    I have two questions, basically. You don't seem to make the case convincingly, at least to my mind, that size is so critical. In fact, given other testimony, I think others would argue that it isn't that critical--some here today, in fact. Could you address that?

    Secondly, it seems to be one-dimensional in the sense that you don't talk about other factors--for example, the question of market dominance, market power. If I recall, the last time we looked at these mergers, in 1998, if the two mergers that were on the table had gone ahead, it would have resulted in I think 63% of all deposits being concentrated in two banks. Of course the concern then was that in terms of market power and concentration that wouldn't necessarily be good for consumers. In fact, it might work against consumers.

    I wonder if you could comment on why big in your mind seems to be important or critical, and on some of the other aspects in terms of market power and consumers?

    Prof. Jean Roy: I'm very happy to have the opportunity to answer your questions. Obviously, size per se does not make an institution better. My point is that size gives more opportunities, and as Dr. Peters says, we are blessed with good banks in Canada. My impression is that they could operate at a greater level because they are good. Right now, because of their limited size, they don't have that opportunity. That's the first point. Size is just an option for more opportunities.

    The second point is the relationship between concentration and competition in a market, and I think here I would like to bring in what I consider to be a very important theoretical concept that was brought by an American economist, William Baumol. He created the notion of contestable markets. Basically what this means is you can have a few players dominating a market and these people will behave competitively if they are threatened, if they feel that if they don't behave, others will come in and really take their share of the market. What is really key is that if you allow some concentration, you must make sure that market is contestable, meaning that there ought to be no barriers to entry--or to exit, as a matter of fact.

    So in my opinion, to some extent in Canada we've been protective of our market in the past. But as I think you've heard from bankers, we don't want that any more. It's not a good approach to the modern world. It's better to be open and allow competitors from outside to come in, which also gives you an opportunity to get out, if you're good, to reap the benefits.

    So again, I think what is important is that there be no protection. As a matter of fact, in my opinion, the last “protection” for the banks was really their hold on the payment system. But with Bill C-8, this will be open to all kinds of other institutions.

  (1230)  

    Mr. Roy Cullen: Well of course one of the intents of Bill C-8 was to create more competition, although I think probably most would agree the take-up has been slow. These things do take time. But when you talk about the barriers to entry, if you look at the retail level, the whole bricks and mortar argument, and the dominant position of Canadian chartered banks, what would be the case if the barriers to entry were lowered? Or are you just saying that you have to deal with that question? I think, clearly, you do need to deal with that question, but what I'm saying is that it seems the barriers are quite high when you look at what's really important to Canadians, which is retail banking.

    Do you have any thoughts on that?

    Prof. Jean Roy: Certainly it's not as high as it used to be. All bankers will argue that they think they have too much brick and mortar, and we see that the newcomers, the HSBC and the ING banks, and all the other ones, are trying to distribute financial services differently. I think it's also the strategy for the insurance companies that are entering financial services. Sometimes, for many services it's cheaper to send the salesperson to one's house than to have a branch, and in the end, the customer is better served.

    Mr. Roy Cullen: Do I have any more time?

    The Chair: Not really, but there may be time later, if we go to a second round. So I'll take names for that.

    Mr. Discepola, please, for seven minutes.

[Translation]

    Mr. Nick Discepola (Vaudreuil—Soulanges, Lib.): Thank you, Madam Chair.

    I would like to continue in the same vein as my colleague Mr. Cullen. You seem to say that the size of a business or merger is very important to the extent that it can lead to business opportunities outside Canada that do not exist in Canada.

    In response to a question from Mr. Paquette, I believe you referred to the risks inherent in such a transaction. In analyzing your figures, we see that, even proceeding with the merger of two major banks, the merged entities would have equity of $20 billion, which would put them far below tenth place.

    Dr. Peters answered Mr. Paquette by saying that the banks had already had an opportunity to enter into a strategic alliance to create business opportunities outside Canada but that they did not do so.

    In your opinion, is it necessary to permit more than two mergers? I could put the question to Mr. Peters as well.

    If we rely on your figures, we could say that allowing two mergers might not be enough for the merged entities to be competitive outside Canada.

[English]

    Maybe while I have the floor I'd ask Mr. Peters a corollary question.

    I view the banks as much similar to maybe not small businesses, but medium-sized businesses, looking for growth opportunities, for expansion opportunities. We see consolidation in various sectors, in various industries. What is wrong with banks merging?

    If I look at your list of six or seven concerns, are you against mergers of any kind, or should we be looking, as a committee, at maybe limiting it to two mergers at the most? If you're against all mergers, then how did you answer the question that some of the bank CEOs have expressed on their ability to grow?

    If you take a look at the Canadian market, all they're doing is actually the same share. It just fluctuates a little bit from year to year. So if there isn't that expansion possibility here locally in Canada with 30 million people, then where else can these banks look towards further expansion and hopefully greater profitability?

    The Chair: Who would like to start on this one?

    Professor Roy, and then Dr. Peters.

[Translation]

    Prof. Jean Roy: First I'd like to mention that, if two Canadian banks were allowed to merge, I believe the gain in size would be quite significant. That could raise them to twentieth or thirtieth place globally. That's a significant change.

  (1235)  

    Mr. Nick Discepola: In terms of ranking, but not in terms of assets, since that would be between $20 and $25 billion.

    Prof. Jean Roy: Yes, that's correct, but their assets are currently $10 billion or less. Their assets would virtually double.

    Another very important point should also be mentioned, and that's the entire question of risk management. I would like to mention two things. First, a merged Canadian bank entering the international market would probably operate on three continents, America, Europe and Asia, and thus take full advantage of its diversification, whereas banks currently tend instead to focus on a single continent. So there would potentially be risk reduction here.

    Second, there is the question of overseeing the banks. It should be noted that, since the early 1990s, the major G-8 countries have observed that financial institutions have gone global and that it has been very difficult for a country to oversee them well, hence the entire movement that has grown up around the Bank for International Settlements and around regulatory standardization.

    Monitoring the banks, in terms of day-to-day operations, obviously remains the responsibility of the country of origin, but an entire debate has arisen over risk management methods and standardization of risk management rules, for both the management of market risk, that is to say the risks banks take when they conduct securities transactions, and the management of credit risk. Now there are also very strict equity standards. Lastly, since September 11, standards are starting to be put in place for what is called transaction risk.

    So I personally believe that we will always live in a risky world, but major steps have been taken in the last decade to reinforce controls.

    Mr. Nick Discepola: Mr. Peters asked how it was that banks had not participated in joint projects.

    Prof. Jean Roy: That's a good question. All I can say is that that doesn't seem to me to be an economically viable form of organization because we don't see it elsewhere either. It's difficult, if not impossible, for a bank to compete in a local market. In terms of operational infrastructure, that would require computer systems for domestic operations and other computer systems for international operations. All gains that could be achieved would be erased by the operating costs attributable to that artificial separation. That why you don't see that either in Canada or in foreign countries.

[English]

    Mr. Nick Discepola: Mr. Peters.

    Dr. Douglas Peters: You asked a very interesting question on the banks looking for growth: Where would they grow if they weren't allowed to merge? That's a very peculiar question, because merging two banks together isn't going to make them grow. They remain the same size. They're just in one institution instead of two. A merged bank isn't a growing institution. A merged bank, according to the investment dealers group, gets smaller because some of its customers leave.

    It's not a growth opportunity, a merger. Mergers are only an opportunity to increase monopoly power to better look after themselves. It's not the growth. It's a very interesting question when the banks ask how are they going to grow if they aren't allowed to merge.

    Mr. Nick Discepola: What you're saying then, Dr. Peters, is that when Daimler Chrysler and who was it, another company, merged in the automotive industry, it wasn't a growth strategy. What was it, then?

    Dr. Douglas Peters: It wasn't a growth strategy for Chrysler and it certainly wasn't a growth strategy for Daimler-Benz. They combined to get some significant synergies that you get in a manufacturing concern.

  (1240)  

    Mr. Nick Discepola: I would argue that they're also getting economies of scale, they're getting market share growth, and they get opportunities abroad. Are you not worried about the corollary, which would be that if we do nothing and our industry does nothing, the banks could be taken over by foreign competitors, for example? At $1.50 or $1.65, it would seem to be quite an attractive proposition to buy out one of these banks.

    Dr. Douglas Peters: That could be the case if you allow them to do that. If you eliminate your widely held rule, yes, you'll have takeovers.There's nothing to prevent takeovers if they are larger, either.

    The Chair: We have some time left, and we will go to a second round. This is a five-minute round. I'll take down the names of those who wish to be on the list.

    Go ahead, Mr. Harris.

    Mr. Richard Harris (Prince George—Bulkley Valley, Canadian Alliance): Thank you, Madam Chairman.

    I want to get back to the train of thought we had a little earlier where there were some suggestions that big is not necessarily better. In that exact meaning, big is not better; there might be some reasonable arguments that it isn't.

    Mr. Oliver, I would like to suggest to you--and tell me whether I'm totally wrong on this--that if two banks combine their assets, technology, and intellectual resources, it would enable them to look at a far more expanded market of opportunities than what would have existed for them as separate banks. I believe it would allow them, as Mr. Roy pointed out, to reduce their concentration of risk through diversification. At the same time, if we're talking about public interest, this should all have a beneficial effect on the bottom line of the operation and on the return on investment for shareholders.

    Speaking of public interest, about 10 million Canadians through their pension plans or RRSPs have an interest in bank stocks. One could easily argue that increasing the investment of Canadians' pensions and RRSPs and on a personal basis could be seen to be in the public interest of Canadians in large measure.

    I would like to have your comment on the statement that big is not necessarily better and it may not have a beneficial effect, the premise that Mr. Peters and Mr. Donner have put forward.

    Mr. Joseph Oliver: Professor Roy stressed the opportunity that size brings, and I want to go back to that in a second.

    I want to say that size also avoids the negative, which is the erosion of the client base due to global competition. An article recently published in the Report on Business dealt with the threat to the Canadian dealer community as a result of large global investment banking players. So that's very much an issue, and it's part of my earlier remarks. As Canadian companies grow and have an international presence, they look to firms that can supply capital globally.

    The Canadian capital market is only 2% of the global market. Therefore, for domestic players in the capital markets, growth must come as well from an international perspective. It can't all come domestically.

    To participate internationally does require size and heft. As a practical matter, large Canadian and U.S. firms will go to an investment bank that is able to meet their needs, rather than to one that might be able to partner with another unnamed organization possibly on an ad hoc basis to meet their needs. There are many examples of how U.S. investment banking firms have been able to erode the market share of very competent Canadian investment dealers, who simply don't have the retail distribution, the capital, or the lending heft to compete with U.S. and other international competitors.

  (1245)  

    Mr. Richard Harris: Could you briefly comment on the benefit to shareholders in the public interest aspect, shareholders who, through their pension plans or RSPs, have bank shares, and the beneficial effect overall to the public interests of those Canadians through increased profitability?

    The Chair: This is your last question.

    Go ahead, Mr. Oliver.

    Mr. Joseph Oliver: That moves a bit beyond my testimony, because what it really talks about is what the impact on the banks themselves would be, and what the capitalization of the banks would be. I think I should stop before I get into that.

    The Chair: Mr. Cullen, for five minutes, then Mr. Paquette and Mr. Discepola, and we'll try to keep it so that we're within our time.

    Go ahead.

    Mr. Roy Cullen: Thank you, Madam Chair.

    I would like to come back to this business of size. I have two questions that I will throw out to anybody in the group.

    If in Canada we allow, let's say, two mergers, we might be more competitive in our banking sector for a while, but if there's a lot of consolidation that continues, won't it be a matter of time before we have then shrunk again and there aren't many options in Canada unless we want to go with one bank, or whatever? That's one question.

    Secondly, do you think it would be appropriate or useful if this committee set out as a public interest criterion that it would not be in the public interest to allow a level of concentration, let's say, represented by deposits, beyond x%, 30% or 40%? Maybe there's a better proxy; I don't know. In other words, if a merger was going to concentrate deposits by more than 30% or 40%--I don't know what the magic number is--that would not be in the public interest.

    I raise that for two reasons. One, it seems to me there might be a public policy rationale and other benchmarks that we could draw, maybe Competition Bureau guidelines, I'm not sure; but also, I think we're going to have a huge problem with two mergers, frankly. That would be my take on it. Others may have different views.

    For one merger, a proposition might make sense. I don't know. I can speak personally: I might be open to looking at that. But when we have two mergers on the table, of course, we have to look at both. To me, that really complicates things. It makes concentration even that much more difficult.

    I wonder if anyone would comment. Dr. Peters, do you want to start?

    Dr. Douglas Peters: Let me suggest to you that if you allow one merger, you automatically have a second merger. If you allowed a second merger, how long would it be before you had a third merger? If you had any one of those institutions, how could you...?

    If there was a rationale for one merger or two mergers, why isn't there just one big bank? We could call it “Post Office”. Is that the direction in which you really want the financial institutions in Canada to move, so that the choices of Canadians are gone?

    How do you turn them down? If you accept one merger, how do you not accept a second merger? If you accept a second merger, how do you, a few years down the line, say to those two, we won't let you two merge?

    Mr. Roy Cullen: The point I was trying to make is that you could set the threshold, in terms of concentration, to a point where there would only be, let's say, one merger that would work.

    Dr. Douglas Peters: I think a good number would be 20% in any one of the various aspects, either deposits, personal loans, mortgages, corporate loans, commercial loans, a brokerage business. It seems to me that 20% would be a pretty good number.

    We've seen concentration in other areas. I remind you of the airlines. I remind you that when you get two major players in the market, you get destructive competition and you end up with a duopoly. In a duopoly you either collude, which is against the law, or you fight to the destruction of the other. So you do get that. There are real economic problems to this level of concentration.

  (1250)  

    The Chair: Professor Roy, you indicated you wanted to make a brief comment.

    Prof. Jean Roy: I would just like to say that the thresholds you're talking about exist right now in the study by the Competition Bureau. To my knowledge, 25% is the maximum share for the merged entity. Mind you, there is also a second rule that says the four biggest players for any merger in any sector should not have not more than 65% of the market. So the thresholds are there already.

    The Chair: Thank you.

    Monsieur Paquette.

[Translation]

    Mr. Pierre Paquette: Professor Roy, earlier we discussed the risks that bank mergers could present internationally. I would like to come back to the consequences for the domestic market. You say in your brief that if banks dropped a certain number of basic services, other sectors would be able to take charge of them.

    I have serious doubts about that. First, we can see that the priority of foreign banks that come here is not to meet consumer needs, but rather to respond first to those of investors, particularly the biggest ones. Given that, I don't think there's much hope.

    As for the cooperatives, we can consider the example of the Mouvement Desjardins, which, although in a restructuring phase, announced that it would reduce its number of branch offices to 800--if I'm not mistaken--over the next few years.

    The cooperative movement, or the credit unions, may not be highly developed in the rest of Canada, but the situation is different in Quebec. The danger is real. We see that branches are closed in places where clienteles are most vulnerable, and substitutes appear such as private automatic bank machines, which charge exorbitant fees.

    In terms of services to consumers, particularly those who are most socially vulnerable, and on a regional scale, I would like to know your reasons for being optimistic about this kind of substitution. As you know, some regions have already had problems.

    In the scenario you present, the banks would be required to make commitments to protect the public interest. I would like you to give us more details on that subject.

    In the current situation, I wonder whether we shouldn't wait a bit and see to what extent the banks will show good faith. The 2001 legislative amendment permits low-fee accounts to be opened; the banks have made a commitment to meet this kind of need.

    A bargaining process, which I imagine involves the Finance Department and the banks, is currently under way, but we haven't seen any tangible results showing whether these commitments constitute an actual obligation for the banks or whether they are just a way of enabling them to get what they want without having to offer anything in return.

    Prof. Jean Roy: I would like to start with the question of the restructuring of the Mouvement Desjardins in Quebec. From what I know, the mouvement had as many as 1,200 separate caisses populaires at one point; there are currently some 800, and the aim is to reduce that number to 600.

    Now that does not necessarily mean that the caisses will offer their members and shareholders fewer services. This is a restructuring. Now there are caisses populaires that cover more territory, and new service points are springing up. It's possible that, with fewer caisses populaires, there may be more service points. The service points for small transaction services may be smaller, better distributed entities.

    It's the same principle. Financial services restructure distribution. So you shouldn't necessarily conclude that caisses mergers will lead to cuts in services to people.

  (1255)  

    Mr. Pierre Paquette: Do you believe the banks can honour the commitments they make? Is there enough pressure on them to do so? Shouldn't we wait to see the effects of the 2001 legislation in order to determine whether the banks are in good faith in this commitments process?

    Prof. Jean Roy: Perhaps it would be good to see how the new Canadian Financial Consumer Agency works. Studies could be conducted on this and provide us with some good information.

    With regard to commitments, there is one that comes to mind. When the Bank of Montreal and the Royal Bank contemplated their planned merger, one of the issues was SME financing. If my memory serves me, they made a commitment to allocate $40 billion to SMEs and to introduce a separate and very large operation for that purpose.

    Bill C-8 states that, where bank officers make commitments, they will be held accountable by law for the performance of those commitments. So there is a way, under the legislative process, to exercise considerable pressure on the banks for them to meet their commitments.

[English]

    The Chair: Thank you very much.

    Mr. Discepola has the final five-minute round.

[Translation]

    Mr. Nick Discepola: Thank you, Madam Chair.

    I would like to ask Professor Roy a question concerning protection of the public interest.

    In your brief, you say that, if banks interested in merging were required to make firm commitments and give sufficient guarantees, the Office of the Superintendent of Financial Institutions and the Competition Bureau could make the decision regarding competition or the appropriateness of a merger. Bill C-8 requires that a review be conducted by a group of parliamentarians from the Senate and the House of Commons, by the Minister of Finance and possibly by the Prime Minister's office. Do you believe that review should be conducted or that we should remove all political aspects, do our work as a committee, develop very specific criteria and leave the decision to the two organizations? Do you have any other suggestions?

    Prof. Jean Roy: I believe the banks would prefer that the criteria be stated and that people, probably at the Department of Finance, be made responsible for verifying compliance with the criteria. That's one possibility.

    Personally, I have no specific preference to offer on what you say. However, as I said in my brief, to take a step toward clarification, if the criteria of the Competition Bureau were met, if there was a sufficient degree of competition, if solvency criteria were met, as regards the question of commitments for protecting the public interest, we should operate on the assumption that there will be a way to find a basis for understanding.

    Mr. Nick Discepola: Do you believe there is a reasonable timeframe? The banks are requesting 100 days, I believe, but, in practice, it goes on for months and months. Do you believe there is a reasonable timeframe that should be complied with?

    Prof. Jean Roy: I believe the objective of 100 days should be aimed for in order to accommodate the business dynamic. From what I understand of Bill C-8, an impact preassessment would have to be conducted, and that's very difficult. That's why I say it would be much faster to make commitments. That would make it possible to speed up the process and to meet this kind of deadline.

    Mr. Nick Discepola: Thank you, Madam Chair.

[English]

    The Chair: Thank you.

    On behalf of all of my colleagues, we very much appreciate the time you took to prepare your briefs, attend today, and answer our questions. We'll move forward to the end of these hearings and then prepare our report. Thank you very much.

    We are adjourned until this afternoon.