CHAPTER 1:THE 1990s: STEPS IN THE RIGHT DIRECTION
In 1992, the federal government made significant changes to the way
the financial services sector operates in Canada. These reforms virtually
put at end to the "four pillar" characterization of the financial
services sector. After 1992, any federally-chartered financial institution
could provide almost any financial service. In part this was achieved by
enhancing the in-house powers of institutions. It was primarily achieved,
however, by allowing one type of institution to own a subsidiary in another
financial field. As a result, we today see banks owning securities dealers,
trust companies and insurance companies. Insurance companies own trust
companies and banks. Vancouver City Savings, a large British Columbia credit
union, owns Citizens Bank. Trimark Trust is owned by a mutual fund company.1
Thus the industry is very different than it was prior to 1992, largely
as a result of these legislative changes.
The financial sector is also very different because of economic and
financial events. The independent trust company sector has virtually disappeared,
with only Canada Trust remaining as a significant force in the industry.
While a number of trust companies were purchased by the banks, the demise
of the sector had its origins in the inability of these firms to survive,
and compete with other institutions, in a changing world. The 1992 changes
that were intended to allow them to better compete with banks, in many
ways came too late.
The Collapse of the Pillars
Source Exhibit 2-18 McKinsey & Company
The government recognized that, in a rapidly changing world, reforms
need to be ongoing. Instead of reviewing the legislative framework for
banks every ten years, the government decided to undertake such a review
every five years, starting in 1997, and do so for the entire financial
sector simultaneously. In 1995, in response to the earlier failures of
several trust companies and life insurance companies, the Secretary of
State (International Financial Institutions) published a paper entitled
"Enhancing the Safety and Soundness of the Canadian Financial System."
It dealt primarily with measures to reduce risks, protect consumers and
enhance government oversight. That paper and the resultant legislation
were motivated by a desire to make the financial system more secure. As
a result of that process, a mandate for the Office of the Superintendent
of Financial Institutions (OSFI) was defined and the Canada Deposit Insurance
Corporation Act (CDIC Act) was amended to permit bylaws establishing premiums
based on risk assessment.
In 1996, a white paper entitled "1997 Review of Financial Sector
Legislation: Proposals for Change" was published and became the basis
for the legislative changes found in Bill C-82. The point of that examination
was to determine whether the framework set out in 1992 continued to be
adequate, and to establish if those earlier changes were achieving their
The white paper was the result of consultations with industry stakeholders
that started in 1995. One of the more significant results was the announcement
that the federal government intended to extend the demutualization option
to large life insurance companies as well as small ones-draft regulations
for such conversions were published in August 1998, and legislation tabled
on November 30, 1998. Yet it was clear to the government that the white
paper, and the process that led up to it, could not adequately deal with
some of the very significant forces of change that were shaping the global
financial environment, and hence affecting the ability of Canadian financial
institutions to adapt to economic, technological and demographic events.
Profound reforms would likely be needed if Canada were to enjoy the benefits
of a world-class financial services sector.
As a consequence, the government established a Payments System Advisory
Committee to examine the payments system. It was directed to provide input
into the work of the newly established Task Force on the Future of the
Canadian Financial Services Sector, which was given the mandate of studying
all aspects of the industry. It is the Report of that Task Force that was
the purpose of our own Committee study, and forms the subject matter of
As noted above, an entire pillar of the financial services sector (i.e.
the independent trust companies sector) has virtually disappeared in less
than a decade. This change, dramatic as it may seem, is nevertheless only
one of the many other developments that have occurred, and insignificant
when compared to what is likely to happen in even the near future.
While total deposits retain an important place among household financial
assets, their growth relative to overall assets has been stagnant and is
expected to decline over time. (This information bullet and all others
are drawn from the background documentation prepared for the Task Force
on the Future of the Canadian Financial Services Sector.)
Canadians are today buying financial services that are very different
from the ones they purchased only a few years ago. To underscore this change,
we need only look at the dramatic growth of the mutual funds industry.
Canadians have traditionally been characterized as cautious savers. We
placed our savings in bank accounts and guaranteed investment certificates,
comforted by the fact that they were protected by a system of deposit insurance.
We bought life insurance. We did not take risks. Yet from the end of 1991
to the middle of 1998, the net assets of mutual funds in Canada grew from
$50 billion to $323 billion. Deposits, on the other hand, have stopped
growing and are slowly declining from a peak of about $450 billion. The
fact that mutual funds are poised to exceed deposits2
within a few years demonstrates some of the rapid changes that are
taking place. We clearly no longer save via traditional products and financial
institutions. This not only provides evidence of changing consumer demands,
it has very real implications for institutions that have traditionally
raised funds through deposits. The loans and investments that have traditionally
been financed via deposits must now be financed in different ways.
Over the last 20 years, while the percentage of total household financial
assets in deposits has dropped from 31 percent to 25 percent, the percentage
in mutual funds has risen from 1 percent to 14 percent.
Canadians are being served in different ways and are being offered products
by institutions that did not serve Canadians only a short while ago, such
as ING Direct, Citizens Bank, MBNA, mbanx, and Wells Fargo. We are engaging
in financial transactions over the telephone and via the internet, and
have overwhelmingly embraced debit cards as a means of payment. It is these
developments, driven by consumer demand and a global financial marketplace,
that define the new financial services environment. Financial institutions
are also introducing innovative technologies to deliver their services,
and consumers have only seen a glimpse of what the future holds in this
In the 1980s, when the government was considering ways to enhance the
competition that would face the large Canadian banks, it envisaged other
institutions that would largely look like our own banks, Schedule II foreign
bank subsidiaries and domestic trust companies. Today, however, the new
competition that our banks face comes from institutions that do not want
to look like the traditional Canadian bank. Thus we now see banks that
have no branches, we are banking in supermarkets, we are obtaining credit
cards from foreign institutions that do nothing but issue such cards and
that dwarf the credit card operations of our own banks. And we are obtaining
small business loans from a California-based bank with no physical presence
in this country. We buy insurance over the phone, we bank over the internet
and we are increasingly becoming a cashless society. Paycheques are automatically
deposited into our accounts and monthly bills are automatically debited
from those accounts. The world of 1998 is far different from that of 1992.
Undoubtedly, the year 2002 will be very different again.
The other dominant development in the financial services sector is the
wave of consolidation that is taking place globally, especially in the
United States, but also in Europe. In Europe the trend to mergers is being
driven by a desire to cut costs and take advantage of the upcoming monetary
union. In the United States it is largely a response to legislative reform
that is finally allowing the creation of national banks, as is already
the case in Canada. BankAmerica, for example, has engaged in a series of
amalgamations that give it coast-to-coast operations and total assets that
would be about 75% greater than that of a combined Royal Bank-Bank of Montreal.
Yet it still has a presence in less than one-half of American states. The
other American merger that stands out is the one between Citicorp (a bank)
and Travelers (a non-bank financial institution). This proposal, which
pushes the limits of current American legislation, created a financial
conglomerate like those that already characterize the Canadian banking
industry, albeit much larger in size.
This trend to acquisition and amalgamation also exists in Canada. Since
1992, Canadian financial institutions have truly become financial conglomerates.
In 1997, Great-West Life outbid Royal Bank of Canada for the acquisition
of London Life. More dramatically though, some Canadian banks would also
like to participate in this merger trend-the Royal Bank of Canada proposed
a merger with the Bank of Montreal in January 1998, followed by an announcement
in April that the Canadian Imperial Bank of Commerce intended to amalgamate
with the Toronto-Dominion Bank. These mergers are not the subject of the
Task Force Report, and not the subject of this Committee Report. Nevertheless,
the shape of the financial services sector that will arise after the Task
Force Report is debated and acted upon is the environment in which these
and/or future merger proposals will be evaluated. Pressures to consolidate
and restructure will continue to exist in Canada and around the world.
What we will examine here are the measures that the Task Force recommends
to facilitate consolidation and the method by which the Task Force proposes
to evaluate such transactions, to ensure that they are in the public interest.
The Task Force Report will likely stand out as one of the most important
works on financial services ever produced in Canada. Like the Porter Commission
three decades earlier, it will redefine the financial sector. This Task
Force Report does not deal with the proposed bank mergers. The Task Force
Report is important because it deals with a vast, important and ever-changing
industry that is vital to the well-being of Canadians and the proper functioning
of our economy. This industry transcends banking and individual banks.
[T]he MacKay Report . . . is an excellent report. It's very well
balanced. Sometimes in reading it I thought they were trying to please
everybody in the financial community. That's a very difficult thing to
do. I think they did an excellent job.
Liam Hopkins (Executive Director, IFC Vancouver)
The financial services sector is in many ways an industry like no other.
Like any other industry, it serves customers by providing the goods and
services that are demanded. Canadian firms participate in the industry
and wealth and jobs are created. More than 550,000 Canadians are directly
employed in the sector and it is responsible for 5% of our GDP. It contributes
20% of federal corporate income taxes and pays a total of $8.5 billion
in taxes annually. And it is a major export industry, with more than 30%
of bank and life insurance revenues coming from outside Canada. In the
case of some institutions, the export orientation is much greater. The
Bank of Montreal gets 58% of its revenues from abroad while the life insurance
company Manulife earns 55% of its income outside Canada. Newcourt Credit,
one of the fastest growing domestic financial institutions, is now originating
about two-thirds of its loans outside Canada.
As someone who works in the policy environment and has read many
reports over many years of this work, I must say we found this report to
be one of the better ones. It was balanced, clear and well written, so
I'd like that noted by you if you would.
Mr. Peter Nares (Executive Director, Self Employment Development
According to The Banker magazine, Canadian banks are very much
globally oriented. If banks are ranked by the proportion of their assets
that are non-domestic, Canadian banks rank 20th (CIBC), 21st (Bank of Montreal),
27th (Scotiabank) and 39th (Royal) amongst world banks. Both CIBC and the
Bank of Montreal have 44% of their assets overseas, and the Bank of Montreal
earns 58% of its earnings overseas. Scotiabank earns 49% of its income
overseas, while Royal earns 28% abroad.
More than 50 percent of all Canadian corporate bonds are issued abroad
today as are 20 percent of all Canadian government-issued bonds.
By this measure, the Bank of Montreal and CIBC are more global than
Chase Manhattan, Bank of Tokyo, and ING.
The export orientation of Canada's financial sector demonstrates that
customers far afield can be served from Canada. But we are beginning to
recognize that institutions from far afield can also serve Canadians.
One vision of Canada would have us at the table as a major North
American financial centre (Canadian-controlled and Canadian-headquartered)
that is influential in global financial affairs. The other would see us
slip further from the top tier and become a gradually declining influence
in financial affairs, and indeed in world affairs. Canada might remain
a healthy domestic financial marketplace, but it would not be a global
Mr. A. Charles Baillie (President and Chief Executive Officer,
Toronto Dominion Bank)
The Greater Toronto Area (GTA), which is the primary Canadian financial
centre with over 165,000 direct financial sector jobs in 1995,3
has the potential of becoming a North American regional financial centre.
After New York and San Francisco, the GTA has the third highest concentration
of financial services in North America. On the other hand it could easily
find itself with a much diminished role and much diminished employment,
as over one-half the financial services jobs in the GTA could move elsewhere.
The Boston Consulting Group analyzed the various categories of jobs
in the financial services sector to see which ones are mobile and might,
therefore, migrate away from the GTA, and even away from Canada. Jobs were
classified as either traded (i.e. those which could be located elsewhere)
or non-traded (i.e. those which, at present, must be performed locally).
Fifty-five per cent of jobs were classified as traded while 45% were non
Of the traded jobs, one-third were considered well anchored in the GTA
whereas the other two-thirds were potentially mobile. Well-anchored jobs
include the following, among others:
- Bank headquarters functions
- Some corporate banking functions
- Trading in Canadian-dollar based products
- Investment functions related to insurance.
The jobs related to bank headquarters are based on the assumption that
Canadian control is maintained.
The two-thirds of traded jobs that are potentially mobile include the
- Back office functions, especially computer centres, processing centres
and call centres
- Most investment bank functions
- Life and health insurance business.
Forty-five per cent of all jobs are considered to be in the non-traded
category. Technology is increasingly affecting the mobility of jobs, however.
Of those non-traded jobs, 40% will evolve into traded and mobile jobs.
These evolving functions include:
- Retail sales functions handled over the phone or the internet
- Processing centres.
Those functions that are likely to remain non traded in the future include:
- Personal advisory services
- The retail bank network
- Face-to-face financial planning.
These non-traded functions represent just over one-quarter of total
It is technology that is responsible for the changing nature of work
and the location of employment opportunities. Declining telecommunications
and computing costs, combined with developments in imaging technology,
mean that job functions that in the past were undertaken at the local level
could now migrate to a centralized location. But these developments also
mean that job functions that are now performed near the Canadian headquarters
of financial institutions, could also migrate elsewhere, even outside Canada.
These jobs will only stay in Canada if the financial sector is sufficiently
competitive so that it would be efficient to locate those jobs here.
Canadians have benefited from the fact that our financial institutions
have global ambitions, and in the process created domestic jobs to serve
world markets. There is no guarantee that this will continue. Virtually
all factors of production are becoming increasingly mobile. To attract
and keep them requires a framework that allows financial institutions to
The financial services sector is, therefore, a very important contributor
to the economy in its own right. But its greatest importance comes from
the special role it plays in the economy. Unlike other sectors, it is an
extremely vital component of virtually all economic transactions. Because
its effects are so pervasive, the financial sector influences the functioning
of the economy in ways that no other industry can. It truly determines
whether the economy runs smoothly and efficiently. It does this through
the process of financial intermediation. Those who have funds to save,
do not have to find credit worthy borrowers. Financial institutions do
that for them. This not only reduces substantially the transactions costs
associated with saving and borrowing, it reduces substantially the risks
that savers face. They do not need to be able to assess the risk of individual
borrowers or individual investment projects - specialized institutions
do that for them. And because this task is provided by specialists, those
institutions are able to take advantage of economies of scale and scope.
The other important function of the financial sector is the provision
of an efficient payments system, and in Canada our payments system is the
envy of the world. With safe and efficient transactions media, economic
exchange is encouraged. This allows economic participants to specialize
and hence maximize the returns from their activities.
For Canada to enjoy a thriving economy, it needs a financial services
sector that is stable and sound, that is efficient and competitive, that
is innovative, and that offers Canadians a wide range of choices. It must
adapt as the world around it changes. In short, we need a world class financial
Rapid changes are affecting the financial sector. Technology
is one of the driving forces behind this. With the rapid decline in the
costs of telecommunications and data processing, financial services can
now be provided in ways and in places that were not possible before, and
that may be obsolete and uneconomic tomorrow. Transactions can be completed
with great speed. These changes are causing some institutions to restructure
themselves quite dramatically. They are providing services centrally rather
than locally as they did previously. Some institutions are now outsourcing
certain activities. Some are taking on new activities, some are abandoning
services in which they cannot compete, and others are entering into joint
ventures. All of these changes are being driven by the quest to reduce
costs. And the need to reduce costs is being driven by the appearance of
No doubt, the power of computers will continue to escalate as the
price continues to drop. In 1982, microprocessors with a computing capacity
of one million instructions per second (i.e., one MIP) cost almost $1,000.
Today, one MIP costs about $1.30; within a decade, we estimate it will
cost about $0.001.
Leading global wholesale banks, on average, develop a new product
every week. Most leading investment banks have a dedicated group or groups
of trained mathematicians and statisticians who continuously focus on developing
product bundles for both issuers and investors.
The other impact of technological change has been the introduction of
new financial products, most evident in the payments system but also in
products that are designed to reduce risk and enhance opportunities to
gain better returns on savings. Derivatives trading, debit cards and stored
value cards are only a few examples. What is striking about these changes
is the fact that they do not benefit just large institutions or wealthy
individuals. Typical Canadian families receive tangible benefits as well.
For example, Canadians who have no room to make additional foreign property
investments in their RRSPs may buy mutual funds whose return is linked
to certain American stock indexes. This helps to circumvent the effect
of the 20% foreign property limit on individual investors. Canadians who
want the protection of a Guaranteed Investment Certificate (GIC) but wish
to take on some of the risks of equity investments can purchase a GIC whose
return is linked to certain Canadian stock indexes. In both cases, it is
the development of derivatives that allows this to take place.5
Advanced data analysis software, for example, has allowed financial
institutions to develop sophisticated, highly predictive database marketing
programs. These have been implemented successfully by high performing credit
card companies such as MBNA to target high-value customers more effectively
in both their domestic and their foreign markets.
Changes in "intellectual" technology are also changing the
industry. With the development of credit scoring techniques to evaluate
risk, institutions are able to quickly assess loan applications at little
cost. The Internet application and approval process established by mbanx
is able to approve a mortgage application in 30 seconds, eighty per cent
of the time. The administrative costs of loans that can be evaluated this
way are dramatically reduced. Institutions can now profitably deliver small
loans that they could not offer in the past.
New intellectual technology and new marketing approaches also enable
distant lenders such as Wells Fargo to serve the Canadian market. This
has the effect of dramatically opening up the domestic market and satisfying
consumers' desires for more choice, independently of government initiatives.
Some 9.8 million Canadians, or about one third of our population,
dominate the market for retail financial services.
A further trend that is affecting the development of the industry is
demographic change. The population is ageing on average. Moreover,
the age structure of the population is such that those for whom savings
accumulation is of paramount concern are becoming more important relative
to those for whom access to credit is of most concern. Financial institutions
are increasingly looking upon households not just as customers who need
credit, but as customers who need help in managing their wealth. They are
increasingly trying to develop a holistic relationship with their best
The boomer population will soon inherit an unprecedented amount of
wealth from their parents. One estimate is that $1 trillion of wealth will
transfer between generations.
The focus on wealth management is the result of several developments
in addition the ageing of the population. There is a large transfer of
wealth that is taking place from one generation to another. Such lump-sum
transfers need to be managed wisely. Finally, Canadians are working for
themselves in increasing numbers. Self-employment means self provision
of health and retirement benefits. Servicing these Canadians presents a
new set of challenges for our financial institutions and a new focus in
terms of the services they offer.
Self-employment represents 17.9 percent of Canada's total employment
in 1997, up from 13.3 percent in 1986. Eleven percent of employed Canadians
report that they work primarily from their home. Almost half of working
Canadians (48 percent) say they work out of their home regularly or some
of the time.
When coupled with the emergence of a low inflation/low interest rate
environment, these trends have led to a substantial shift in the products
that Canadians want. They want better rates of return, and because of their
increasingly long-term investment horizons, they are willing to take on
Technology and demographic change are factors that are largely beyond
the control of government. Governments have, however, increased access
to domestic markets by non-resident institutions through a variety of international
agreements. When coupled with the transformation of centrally planned economies
into open market economies, we see a dramatic change in the opportunities
available to commercial and financial enterprises. Most nations are opening
up their domestic markets to non-resident institutions in anticipation
of reciprocal actions on the part of other countries, leading to a very
real globalization of markets. These measures increase competition
locally but also assist commercial firms in enjoying seamless access to
financial services across the world. Scotiabank is a prime Canadian example
of a financial institution that has followed its customers abroad, making
it the most internationally focussed of the Canadian banks, one that takes
pride in noting that it was in Kingston, Jamaica before it was in Toronto.
Over time, the relative positions of different institutional types has
changed. Banks used to be the dominant financial intermediaries. Today,
their proportionate share of financial assets is far lower, having lost
market share to a variety of others, who have come and gone over time.
The House of Commons Standing Committee on Finance is undertaking this
examination to consider ways in which the recommendations of the Task Force
on the Future of the Canadian Financial Services Sector can contribute
to the establishment of a world-class financial sector in Canada. We must
recognize clearly that the role of government is limited. As the Task Force
Discussion Paper noted, "Parliament cannot legislate that Canadian
financial institutions must provide world-class services. Parliament cannot
legislate that our small business sector will flourish, or that Canadians
will remain at the cutting edge in the development of knowledge-based industries."6
What it can guarantee is a commitment to sound and efficient regulation,
coupled with an environment that allows flexibility, innovation, competition
and the opportunity for financial institutions to profitably serve Canadians.
The Committee recognizes that the future brings with it both opportunities
and challenges. We see some of that today. While we cannot, and should
not, hide from the challenges, we must also ensure that we do not fail
to seize the opportunities. That is really what the Committee seeks to
achieve; to create a legislative and regulatory environment in which the
financial sector can meet and beat the challenges it faces, in which it
can seize new opportunities and in which all Canadians can enjoy the benefits
of a world-class financial system.
Future review, whether in the year 2002 or earlier, will be decisive.
If successful, it will meet the challenges of globalization, innovative
technologies, the promotion of a progressive financial services sector,
and the protection of consumers.
Meeting the International Challenge: We wish to ensure that Canadians
do not miss out on the varied and beneficial developments that are taking
place around the world. This includes not only Canadians as consumers of
financial institutions but Canadians as providers of financial services
as well. New products and institutions will threaten the market share of
existing Canadian firms. At the same time however, the government should
not block efforts by Canadian institutions to become internationally competitive
- indeed, the Government of Canada should encourage and facilitate such
efforts. While the Committee does not believe that we should promote bigness
simply for the purposes of having larger institutions, we should not let
a fear of bigness stand in the way of the ability of our financial institutions
to take on new opportunities, provided they are in the public interest.
Rather, the government should put in place a rigorous framework to assess
the effects of consolidation, and to ensure that the market in Canada is
subject to as much competition as possible. Only in this way can we guarantee
that the industry will be able to meet the globalization challenge and
that Canadian consumers of financial services will have access to the best
that the global financial sector can offer.
Meeting the Technological Challenge: Technology is helping to
drive financial change. Not only can we now access financial services in
ways that did not exist before, for example via virtual banking, we can
also purchase products that were not previously available. Technology offers
an opportunity for residents in rural and remote communities to have access
to better financial services than they did in the past, albeit in different
Technology can also bring challenges. As institutions find ways to use
technology to cut costs, competitive pressures cause institutions to abandon
traditional face-to-face contact. Unfortunately, not all Canadians can
adapt rapidly to the new technological environment. The challenge is to
ensure that all customers are served during this transition period, as
we move from one paradigm to another.
Growing the Economy through the Financial Services Sector: For
the Canadian economy to prosper, it needs access to capital and a variety
of financial services. Generally, the financial sector provides these services
well. There are, however, certain sectors that are not so well served.
Even worse, those sectors that are perceived to be poorly served are the
ones that have the potential to offer most to the economy, the small business
sector and the knowledge-based economy.
It is vital that the financial services sector find ways to serve these
important parts of the Canadian economy. Reform of the sector should be
of benefit to both Small and Medium-Sized Enterprises (SMEs) and Knowledge-Based
Industries (KBIs). If existing players cannot serve these sectors well,
maybe new entrants can, especially if these entrants bring with them new
ways of doing business such as new ways of assessing risk or new attitudes
to risk. And to the extent that such new entry brings about enhanced competition,
it will force incumbent institutions to find better ways to serve their
If the financial services sector is to contribute to the functioning
of the Canadian economy, the sector must be efficient. Financial services
are an input into the production process. The more efficient is this sector,
the better will the economy be served. When competition and efficiency
are combined, prices will be lower and service quality will be higher.
Achieving a Prosperous and Productive Financial Services Sector:
Given the trends in the financial sector, it is sometimes difficult to
define the extent of, and the participants in, that sector. Competition
increasingly comes from surprising and novel sources. Increasingly it is
coming from institutions that are immune to Canadian government regulation.
It is important that the financial sector be flexible enough that it
can adapt to the changing needs of Canadians. If the Canadian financial
services sector cannot adapt to these changing needs and the changing environment,
Canadians and non-Canadians will seek services elsewhere. Not only should
the Government of Canada work to ensure that this does not happen, it should
actively work to ensure that domestic institutions do not miss similar
opportunities to serve markets outside our own.
The future of the financial services sector cannot be predicted. We
do not know what new products could be offered in the future and we do
not know what kinds of products consumers will want. We do not know how
they will be delivered and who, in fact, will offer them. Consequently,
the only safe thing to say about the future is that any attempt to impose
a rigid model for the financial services sector in the future will likely
be counterproductive, both from the point of view of financial institutions
and Canadian consumers.
Preserving Confidence, Safety and Soundness: The financial sector,
has been and will continue to be heavily regulated when compared to other
sectors of the economy. In many respects this regulation is a source of
strength as it provides consumers with confidence in the industry. Confidence
in the sector is a public good in the sense that it cannot be appropriated
by any one firm. It benefits all participants in the sector and thus makes
it stronger. Too much regulation, inefficient regulation and inappropriate
regulation is a burden, however. Such a burden is either borne by consumers
directly via higher costs of services or less choice, or indirectly via
an unlevel playing field that penalizes some institutions over others.
It is important that the government find the right balance between prudential
regulation that enhances the industry and excessive regulation that harms
In the following chapters, the Committee provides more details on the
four themes contained in the Task Force Report, namely enhancing competition
and competitiveness, empowering consumers, improving the regulatory framework
and meeting Canadians' expectations, and the recommendations that follow.
CHAPTER 2: THE CHANGING FACE OF THE FINANCIAL SECTOR IN CANADA
Globalization, consolidation of existing firms, the arrival of new Canadian
entrants, technological innovations driven by more sophisticated consumers
who are demanding better and more convenient delivery modes, and demographic
trends are all about to impose dramatic changes on the Canadian financial
services sector that were unthinkable just a few years ago. Some of these
changes are already noticeable, on both the supply and demand sides. What
we are about to see is even more rapid evolution. What will happen to the
landscape of Canadian financial institutions is not unique to Canada. Major
restructuring is taking place around the world and in Canada. Based on
what happened in the last decade, based on what will happen in the years
to come, it is difficult to imagine how our collective future will look.
The changes in the relative importance of the various financial institutions
can be seen in the following table.
Sources: "The Canadian Financial Services Industry; The Year in Review,
1991-1992 and 1997 Editions", The Conference Board of Canada.
Globalization means increased competition and more choices. It means
new opportunities for Canadian firms and households. This increased competition
will translate into better quality financial services, more choice and
lower prices. Canadian financial institutions have known for years that
there are benefits and growth potential in investing abroad. In Canada,
new entrants such as Wells Fargo, MBNA, Capital One, and ING Direct have
already had an impact on the industry and on consumers. New entrants by
way of acquisition (Merrill Lynch buying Midland Walwyn, for example) will
also change the face of the industry.
The Task Force views consolidation and industry restructuring as a legitimate
strategy for financial firms. Indeed, in some circumstances, it is desirable
and the Task Force Report makes numerous recommendations that would facilitate
consolidation. It is one way to adapt to changing circumstances and a changing
Of course, this phenomenon is not new. Restructuring and consolidation
have always been a feature of the Canadian financial landscape. It was
used as a policy tool to respond to the failure of financial institutions.
More significantly, however, it was past instances of consolidation that
produced our national banks.
There are also more recent examples of this phenomenon. The recent,
failed attempt by Royal Bank to acquire London Life, which was finally
acquired by Great-West Life, is one striking example. One can also look
at the restructuring that took place in the trust industry. At the peak
of their influence, between 1988 and 1991, trust companies accounted for
about 22 per cent of deposits in Canada. With the failure of a number of
large and smaller trust companies in the 1980s and early 1990s, many of
which led to acquisitions by banks, there is now only one large independent
trust company (Canada Trust), and about 30 much smaller players, compared
to 81 trust companies in 1993. Collectively, these companies now have about
9 per cent of deposits.
Mergers are among the most visible and, in consequence, among the
most controversial strategies to achieve restructuring goals in the financial
services sector. While the actual number of mergers in Canada has declined
slightly since 1994, the number of transactions per year from 1993 to the
present is considerably higher than in the late 1980s. The Conference Board
of Canada reports over 350 mergers in the Canadian financial services sector
in the last 10 years.
One could also look at the restructuring that took place in the securities
industry when the banks were allowed to enter the business in 1987. Almost
all the mid-sized players have disappeared. In total, there have been over
350 mergers and acquisitions in the Canadian financial services sector
in the last 10 years.
The most visible example of new entry into the Canadian financial services
sector came about as a result of the 1980 changes to the Bank Act
that allowed foreign banks to establish subsidiaries in Canada. There are
currently 44 of these foreign bank subsidiaries operating in Canada, down
from 56 in 1991. Only one, the Hongkong Bank of Canada, has an extensive
branch network with a significant share of the market. Overall, these foreign
banks now control approximately 10 per cent of domestic assets.7
This history of barriers to foreign bank entry is evident in the
1997 World Competitiveness Survey conducted by the World Economic Forum,
which ranked Canada 41st out of 53 countries in terms of the degree of
competition from foreign banks.
If enacted, the Task Force recommendations will further alter the opportunities
available to financial institutions, changing the competitive balance and
fostering additional restructuring as financial institutions seek alliances
that will make them stronger and more efficient. Every Canadian financial
institution, large or small, will have to assess its market position, in
some cases repositioning itself and in other cases re-evaluating business
strategies. Some financial institutions might decide to sell uncompetitive
components of their operations. Others might decide to merge or acquire
institutions so as to broaden product lines. Yet this is another reason
why the landscape of the Canadian financial services sector will likely
be totally different in the years to come.
The changing face of the financial services sector is coming from both
the institutional side (being pushed by rapid technological change) and
the consumer side where more convenience is being demanded (more and more
Canadians are embracing new technologies). For technological change to
take place, both sides of this equation must be aligned. If new, electronic
delivery channels are offered by institutions, there must be consumers
who accept and use them on a large-scale. If consumers want new products,
there must be institutions who are willing and able to provide them. Institutions,
products and delivery channels are all changing rapidly as a result. To
address this technological challenge and to be in a position to deal with
increased competition, the Canadian financial services sector has been
forced to invest heavily in new technology. In 1996, the industry spent
$2.92 billion in information technology (of which $2.42 billion was spent
by the six large chartered banks)8.
Information technology budgets for Citicorp and Chase Manhattan -
spending leaders - are estimated to have approached US$2 billion each in
1997. Another handful of major U.S. and European banks are estimated to
be spending well over US$1 billion. By comparison, the largest Canadian
banks are estimated to be spending in the range of US$400 to US$600 million
The industry is in the midst of a major transformation in the method
of product delivery, which is one of the most visible aspects of the financial
services sector. Bricks, mortar and indeed paper are being displaced by
digital signals. The Task Force Report indicates that from 1988 to 1995,
the volume of paperless payment transactions grew at an average rate 13.9
percent per year, while chequing transactions fell by an average of 1.5
In just three years, the proportion of bank-related transactions undertaken
in branches has fallen from one-half of all transactions to 30%.10
This is equal to a 40% reduction.
Leading international financial institutions are each spending well
over US$1 billion annually on technology; the budgets of some, such as
Citicorp and Chase Manhattan, are estimated at close to US$2 billion.
The major alternative to the branch is the ATM, but in many respects
it could soon become yesterday's alternative.11
ATMs have been around for more than two decades. It took many years for
this delivery channel to overtake in-branch transactions. Just 4 years
ago, debit cards were offered to Canadians. They have experienced extraordinary
growth since then: 30 million cards in circulation, 235,000 retailers offering
Interac Direct Payment and over 1 billion transactions in 1997, compared
to 185 million in 1994.
The availability of payments services in Canada appears good compared
to other countries. The number of ATMs per person is second-highest in
the OECD, and the number of point-of-sale (POS) terminals per person is
and telephone transactions are more than doubling every year and they now
account for 18% and 10% of transactions respectively, still substantially
less than the 38% for ATMs. Telephone and EFT/POS transactions, are however
growing at far higher annual rates (50% and 91% respectively) than ATM
transactions (11%). These two channels will likely be the successors to
ATMs very shortly.
Over the past 10 years, the number of Canadian households with computers
jumped from 10 to 35 percent. Customers are also linking into the Internet
at a rapid pace. Canada currently ranks seventh in terms of Internet hosts
per capita, and these services are growing each year. Some experts are
even forecasting that personal computer and Internet penetration levels
will equal that of current telephone penetration within the next 5 to 10
Next in line will be PC banking. It still has a very small share of
transactions but growth is rapid. Combined, telephone and EFT/POS transactions
will be more important than in-branch transactions as soon as next year.
Then it will be the turn of PC and Internet banking. The percentage of
Canadian households with personal computers grew from 10% in 1986, to 36%
in 1997. In addition, 28% of households now have access to the Internet.
These are usually the younger households that conduct a disproportionate
share of financial transactions and will rapidly embrace the new forms
of banking such as E-money and smart cards. With these new financial vehicles
and electronic commerce becoming more and more important in our economy,
ATMs as we know them will become increasingly obsolete. They will have
to be transformed, as their role as cash dispensing machines diminishes
Canadians appear to be openly embracing new technology. Over the
past 10 years, the number of households with home computers has more than
tripled. Statistics Canada reports households with home computers climbing
from 10 percent in 1986 to over 36 percent last year.
To see why there is pressure for change in distribution channels, one
need only look at the nature of those channels and their associated costs.
In-branch transactions involve face to face contact with customers and
are largely paper-based. This is by far the most expensive way to undertake
a simple bank transaction. The next most expensive channel is the automated
teller machine (ATM), at about one-third the cost of an in-branch transaction.
These are also partly paper-based transactions, but labour is used more
From 1988 to 1995, the volume of paperless payment instruments
(i.e., other than cash and cheques) grew at an average yearly rate of 13.9
percent, while chequing transactions fell y an average of 1.49 annually.
Telephone banking is slightly less expensive than ATMs. It uses labour
efficiently and is paperless. Finally, by far the least expensive distribution
channel is the internet, with a cost per transaction that is about 99%
less than an in-branch transaction. Not only is this paperless, it also
needs virtually no labour.
Two thirds of Canadians (67 percent) felt that it was extremely
important to be able to do their banking in person at a branch.
The transition away from branches is meeting with resistance from some
Canadians. In part this is a generational phenomenon. In part it may also
be due to the fact that deposit-taking institutions do not charge transactions
fees commensurate with the costs of the different channels.13
Instead, they may be expecting the convenience of the alternatives to be
the factor that attracts consumers.
Consequently, we are seeing more than just the move away from bricks
and mortar. We are seeing not just rapid change but accelerating change,
and flux in the form of the new delivery channels offered to Canadians
by domestic and foreign financial institutions. If monoline companies are
succeeding the way they are, it is because they were able to properly customize
their financial products using technological resources. These new technologically
intensive delivery modes will increase competition and the choices available
to consumers willing to accept them.
Demographic trends play two important roles in terms of services provided.
As mentioned above, a younger more educated and more technologically inclined
generation will mean rapid technologically advances in banking services.
On the other side, an older generation of Canadians moving into their pre-retirement
years and a "boomer" generation (many of whom are self-employed
individuals) that will soon be benefiting from the intergenerational wealth
transfer are demanding new innovative savings products, brokerage services
and pension and wealth management services.
Canadian customers are moving their assets from traditional, government-protected
products like deposits to market-based securities and mutual funds. In
1992, 31 percent of financial assets were composed of basic deposits; by
1997, deposits' share of financial assets had fallen to 26 percent. Going
forward, Canadians will likely take on more risk by shifting a greater
share of their discretionary financial assets to long-term vehicles. Long-term
assets as a percentage of total discretionary assets are forecasted to
increase from 40 percent in 1996 to over 60 percent by 2006.
Demographics are also contributing to one of the most prominent changes
in the characteristics of Canadian households, namely the way in which
those households hold their wealth. We are all aware of the fact that mutual
funds have grown dramatically this decade. There is an even more impressive
development that has taken place over the past 25 years. This is the fact
that households are increasingly holding their wealth in the form of financial
assets (mutual funds, deposits, stocks, bonds and insurance products) rather
than real assets (houses and other property, cars, etc.) In 1997, Canadian
households held 55% of their wealth in financial assets and 45% in real
assets. Twenty-five years ago the proportions were reversed.
This increasing reliance upon financial assets is important in explaining
the growth of financial services in relation to the economy. At the same
time that household financial asset were growing, Canadians were changing
the forms in which those assets were held. The most dramatic shift was
into mutual funds. Also impressive was the growth of pension claims. Deposits,
shares and bonds all declined in relative importance over the past two
decades. These changes are largely in response to the pull of consumer
demand, which in turn has been affected by economic and demographic factors.
Low interest rates in recent years, combined with a sense that individuals
need to become increasingly self reliant for their economic security, has
led to an acceleration in the trend to disintermediation, i.e. the process
by which savers invest directly in financial securities, especially longer-term
rather than using a deposit-taking institution as an intermediary. Demographic
changes have led to an increasing proportion of the population being in
their prime saving years. All of these developments have had an impact
on the financial services sector and its various participants.
Household Financial Assets by Product
(as a % of Canadian household financial assets)
Source: Change, Challenge, Opportunity, Exhibit 4.1.
The Canadian financial services sector is about to evolve as never before.
Instead of resisting the forces of change, instead of seeing the status
quo as a viable option, policy makers and regulators should put in place
a policy framework that will help the industry and consumers adjust rapidly,
easily and orderly. We now have in front of us a unique opportunity to
shape the future of the financial services sector. Governments are being
offered an exciting challenge that will influence the lives of millions
for many years to come.
CHAPTER 3: COMPETITION AND COMPETITIVENESS
Competition is a characteristic of economic markets. The financial services
sector, in its broadest sense, constitutes an economic market. It is a
market for savings vehicles for consumers and it is a market for credit
opportunities for households and businesses. In the past, however, it tended
to be segregated into a number of separate markets. Every "pillar"
provided a group of financial services that were not good substitutes for
the services of other pillars. A savings account in a bank was not the
same as a stock portfolio, or a mutual fund. The same was true on the credit
Today, financial institutions are becoming increasingly similar, and
this convergence is aptly recognized by the MacKay Report. Thus we increasingly
face a single financial market in theory as well as fact. New products
and new ways of delivering them are blurring the distinction between financial
instruments and institutions. This convergence takes away the ability of
existing institutions to hide behind a "pillar" so as to protect
themselves from competition. Examples of convergence include the fact that
consumers can now buy virtually any financial product from a bank or one
of the subsidiaries of a bank. Life insurance companies are increasingly
becoming suppliers of savings instruments rather than providers of insurance.
Similarly, a consumer wishing to purchase a savings instrument that offers
a return linked to Canadian equity markets can buy a TSE-linked Guaranteed
Investment Certificate (GIC) sold by a bank, a segregated fund from an
insurance company, a mutual fund sold by an independent mutual fund company
or a bank-marketed mutual fund.
The tendency towards convergence does not preclude specialization and
niche marketing. Consumers who wish to benefit from one-stop shopping can
increasingly do so while still being able to take advantage of specialist
institutions (also known as monoline institutions) that provide expertise
in a limited range of products. What convergence does mean, however, is
that niche players must still be able to compete with full service providers.
Competitiveness, on the other hand, speaks to the ability of domestic
institutions to successfully compete in the marketplace. Often the concepts
of competitiveness and competition go hand in hand, but they need not always
With open markets and competitive domestic institutions, Canadian consumers
are more likely to enjoy the benefits of competition, and thus receive
the best products at the lowest prices. The reverse is also true. The greater
the degree of competition in the domestic marketplace, the more successful
will be Canadian institutions in the global marketplace. Competition forces
firms to be efficient, to use up-to-date technology, business practices
and management skills.
Consequently, we can think of competition as a feature that is important
primarily from the point of view of consumers, while competitiveness is
a characteristic of individual institutions or groups of institutions that
enables them to operate successfully in a world of competition.
There are three primary methods by which competition can be enhanced
in the market for any specific financial service. This can come from new
domestic entrants, new foreign entrants or by enabling existing financial
institutions to offer a wider range of products than is currently allowed
to them. In the view of the Task Force, the empowerment of consumers is
also vital as it better enables the market to discipline financial institutions,
ensuring that consumers are well served. We shall examine each in turn
and consider the ways in which the Task Force Report recommendations enhance
competition. To this we can add a fifth dimension, namely regulation. It
is vital that regulation not prevent the adoption of efficiency enhancing
techniques and technologies, or prevent the offer of efficient combinations
of products. It is one thing to expand the numbers of institutions that
can offer services to Canadians, but if they must do so in ways that are
excessively costly not only will consumers fail to enjoy the full fruits
of competition, the institutions will not be able to acquire the competitive
advantage that might otherwise be theirs.
In order to make an assessment of the existing degree of competition
in the Canadian marketplace, the MacKay Task Force sought to establish
a set of benchmarks against which the market could be evaluated. The standards
that it used were essentially measures of performance in other developed
nations. It is against these standards that the Task Force asked: How well
are Canadians served by the financial services sector?
Because most of [SNC's big] projects are done outside of Canada for
most of them we need to provide the financing for those projects. And the
financing is becoming something as important as the technical aspect related
to those projects. And to put together this financing we need a stronger
Canadian banking system to keep us competitive and successful in the global
M. Jacques Lamarre (président et directeur général,
Groupe SNC-Lavalin Inc.)
It concluded that Canadians are generally well served by the financial
services sector. We do not enjoy the best services or prices in the world
but we do, nevertheless, enjoy a high standard of service quality. A similar
conclusion was derived from the results of consumer surveys. However, while
the sector provides a high standard of service quality overall, it is clear
that certain sectors of the economy do not feel well served at all.
Large corporations are very well served. This should not be surprising
as they have a great deal of choice. They already enjoy the benefits of
globalization, they increasingly make use of capital markets and they represent
the market segment of most interest to the foreign bank subsidiaries. Indeed,
the interest rate spread that large companies face on bank loans in Canada
is about 75 basis points less than in the United States.
Small businesses are not as well served and again this is not surprising
as their choices are more limited. They pay service fees that are lower
than in the United States but more than those in Europe.16
More importantly, SMEs frequently complain about the lack of available
credit and there is evidence to suggest that the lower interest rate spreads
in Canada actually reflect the greater risk aversion on the part of Canadian
banks. Those SMEs that get credit enjoy low interest rates, but the complaint
of SMEs is about the fact that as a group they do not get enough credit.
This is consistent with the frequently-made observation that Canadian financial
institutions are unwilling to move up the risk scale and offer loans to
In wholesale banking, the bond market is now truly global - as evidenced
by the convergence in bond pricing between major markets. The total net
issue of debt securities is roughly US $2.5 trillion and growing at a 17
percent CAGR*. Of this amount, international issues account for $540 billion,
with Canada representing a 2 percent share.
The performance of the sector vis-à-vis Canadian households is
also mixed. Residential mortgage markets are characterized by a high degree
of competition. Consumers have a great deal of choice in mortgage providers
and consequently enjoy very low spreads on the cost of mortgages. For one-year
mortgages, the interest rate spreads here are approximately equal to those
found in the United States and are one-third less than in the Netherlands,
almost two-thirds less than in France and more than three-quarters less
than in Italy. For personal loans, Canada again enjoys close to the lowest
spreads of all major countries. The spreads here are less than one-half
those found in Switzerland, Sweden, Germany or Australia. But Canadian
households are not so fortunate when it comes to credit cards. We pay higher
spreads (about 200 basis points) and higher service charges than do Americans
and our bank service fees are just slightly above the average of the countries
sampled by the Task Force.
On the other hand, Canadian payments system related services are the
envy of the world. Our cheques clear nationally as quickly as American
cheques clear locally. Our one-day cheque clearing system puts to shame
the Swiss and Australian systems that take five days for a cheque to clear,
and the British system that takes four days.
Clearly then, Canadians enjoy very good financial services, but there
are areas where improvements can be achieved. The fact that the Canadian
financial sector is world-class in some segments suggests that it can also
be world-class in the others. The objective is to discover, and remove,
the factors that hinder the development of world-class service standards
in those particular market segments.
But even in those product lines where we appear to enjoy high standards
of service, we should not be complacent and bar Canadian consumers from
the potential of even better services in the future. Public policy should
not be put into a straightjacket by the doctrine of "if it ain't broke,
don't fix it." Canadians were not badly served by independent hardware
stores and chains prior to the entry of Home Depot. Yet as a result of
that entry, the market was altered considerably, competition was enhanced
and consumers benefited significantly through greater choice and lower
prices. The fact is, by looking only to the present, we blind ourselves
from what might be. We do not know what benefits new institutions and new
products can bring.
The same principle should apply to the financial sector. The burden
of proof should rest with those who wish to restrict entry, not those who
wish to encourage it. It should rest with those who wish to resist change,
not those who promote it. As long as there is no clear threat to safety
and soundness, competition, or the public interest, change should always
A striking feature of the Canadian financial services sector has been
the lack of new domestic entrants, especially in the deposit-taking field.
Canadians are proud of the fact that our financial sector has been more
stable than that of our neighbour to the south. But this has both good
and bad sides. While the Canadian sector has seen far fewer withdrawals
through insolvency, we have also seen far fewer new institutions coming
into the market. In a global market, where consolidation is increasingly
common, the shortage of new domestic entrants is clearly not a tradition
we would like to uphold.
We support the recommendations of the task force that will encourage
more competition in the bank sector. In particular, we believe every effort
should be made to encourage the development of new Canadian-owned banks.
We would really like to see, to a significant extent, a made-in-Canada
solution for more competition, not only opening the floodgates to the foreign
Mr. Paul J. Lowenstein, (Chairman, Canadian Corporate Funding
The Task Force identified a number of barriers to the creation of new
domestic financial institutions. The most prominent is the 10% ownership
rule that applies to domestic banks. Although a new domestic bank may be
closely held initially, it must meet the 10% rule within ten years. Given
the fact that it takes many years for a bank to become profitable, entrepreneurs
are unwilling to take on the risk of forming a new bank, realizing that
they must divest themselves of the vast majority of shares just when it
has the potential to become profitable.
The Task Force deals with this barrier by recommending a new ownership
regime that is based on size, not the type of institution. (see recommendations
29 to 43.) Thus, according to recommendation 32 of the Task Force Report,
a new bank (or federal insurance company or trust company) could be established
and retain a single shareholder until equity reaches $1 billion, and a
dominant shareholding could be maintained until equity reaches $5 billion.
This dominant shareholder could own as much as 65% of shares if the remainder
are publicly traded and widely held. It is only once equity exceeds $5
billion that a federal financial institution would need to be widely held.
This recommendation effectively eliminates the existing barrier to the
establishment of new domestic banks and the Committee supports the recommendation.
Existing federal financial legislation (the Bank Act, the Trust and
Loan Companies Act, and the Insurance Companies Act) also hinders entry
via the minimum capital requirement that it imposes on start-up institutions.
At present, the legislation requires a minimum of $10 million in capital.
While this requirement may have been justified on the basis of safety and
solvency, it implies that $10 million in equity represents the minimum
efficient size of financial institution. There are in fact many safe and
sound institutions that are smaller than that, with capital that is adequate
for the activities they undertake. Credit unions, being owned by members,
are different from entrepreneur-owned institutions and pose somewhat different
prudential risks. Nevertheless, they are deposit-taking institutions like
banks and trust companies and generally have far less than $10 million
in equity. The following chart, showing the average equity in Canadian
credit unions and caisses populaires as of the end of 1996, shows that
only in British Columbia do credit unions have $10 million in equity on
average, and this result is skewed because of the existence of five quite
The Task Force recommended that the Minister of Finance should have
the flexibility to authorize the establishment of new institutions that
engage in limited activities and have less than $10 million in equity.
This is consistent with the 1994 report of the House of Commons Standing
Committee on Industry, "Taking Care of Small Business," which
argued that, subject to provisions designed to protect safety and soundness,
the government should allow the creation of small financial institutions.
The Task Force also recommended that approvals be granted within 120
days and that the regulatory burden on institutions should be commensurate
with their size and activities. The Committee agrees with all of these
initiatives which are contained in recommendation 4.
The final component of the strategy to enhance the establishment of
new Canadian financial institutions concerns the capital tax that is applied
to financial institutions. Capital is the foundation of a sound financial
institution, yet Canadian governments have chosen to tax financial capital
quite substantially. For large and profitable institutions, this may not
be an onerous burden, but for new and small institutions, who typically
register losses in their early years of existence, these taxes could be
prohibitive. The Task Force reports that a financial institution with $10
million in capital faces a capital tax that erodes 2.2% of its capital
base annually. As these young companies are at greatest risk, the existence
of these taxes constitutes a significant barrier to entry. The Task Force
recommends, therefore, a 10-year federal capital tax holiday for new financial
institutions and suggests that provincial governments should do likewise.
(See recommendation 5) When combined with the other recommendations, this
package would significantly enhance the desire of Canadian entrepreneurs
to establish new financial institutions.
The objective of this recommendation is supported by the Committee,
however we have difficulty in agreeing with recommendation 5 on the capital
tax holiday. The financial sector is changing rapidly - institutions are
disaggregating and re-aggregating. The proposed holding company structure
offers the potential for even more complex corporate structures. Just what
then would be the definition of a new financial institution for the purposes
of this tax holiday? It is this impractical aspect of the recommendation
that leads the Committee to reject it and to suggest instead that the government
put greater emphasis on creating a viable and efficient tax system in general
for the financial sector. This issue will be discussed in further detail
at the end of this chapter.
Foreign financial institutions are increasingly important source of
competition. While foreign institutions have in the past had only a marginal
impact on the financial sector (Schedule II banks, for example, never captured
more than 8% to 10% of the banking sector's total assets) they are now
having an impact far in excess of their actual size in Canada.
These foreign institutions are adding substantially to competition not
because there are many of them or because they have captured a large share
of the market, but rather due to the fact that they are introducing Canadians
to new and innovative ways of doing business. The new foreign bank entrants
do not resemble the traditional Canadian bank, and the impact on competition
is far more significant than it would have been had they tried to enter
the market resembling Canadian banks.
The real benefit to Canada of the new entrants is the fact that they
are introducing new and innovative ways of doing business into the Canadian
market. The amount of small business lending offered by Wells Fargo is
extremely small in relation to the lending now available to Canadian SMEs.
What is important is the way in which the lending is offered and the group
that it targets. By using techniques such as credit scoring, Wells Fargo
is able to lower its administrative costs by a substantial amount and thus
serve markets that were ignored by incumbent institutions. More importantly,
it has now introduced a new technique of banking that others may wish to
copy in the appropriate circumstances.
A similar benefit exists from the entry of new monoline financial institutions.
By offering only one service, but offering quality at a low price, these
firms are forcing full service competitors to meet that competition. If
they used these sub-markets in the past to cross-subsidize other products,
that option is now removed.
Increased foreign ownership is once again being proposed as a remedy
to increased competition. It's clear that when it comes to foreign entries,
foreign banks will head for profitable niches. They're not going to head
for the hard-to-reach low-profit corners of the retail sectors; they'll
be skimming off profitable large urban centres, catering to the more lucrative
commercial and corporate clients.
Mr. Peter Bleyer (Executive Director, Council of Canadians)
Some critics of monoline institutions denigrate their services, arguing
that they are only "cherry-picking" clients in Canada, i.e. they
are only taking from incumbents the best and safest, and most profitable,
clients. This is clearly not the case of institutions such as Wells Fargo,
Capital One and Norwest, who are taking on above average risk clients.
But even if the cherry-picking claim were valid, it would be evidence of
a lack of existing competition, as good clients could only be lured away
if they were being charged excessively high rates for services. If the
monolines can, through lower operating costs, reduce market prices for
services or improve the quality of those services, then those are the prices
and quality levels to which Canadian consumers should have access. The
Committee does not believe that legislation and regulation should be used
to shield high-cost service providers from lower-cost ones as this only
harms the consumer interest.
Canada has now agreed under the WTO to allow foreign banks to establish
branches directly in Canada as of 1999. Canada is one of only two countries
that prohibit direct branching, Mexico being the other. This proposal has
wide support. We concur and hence support recommendation 9.
In our view, . . . there should be no connection between the proposed
bank mergers and allowing foreign bank banking. No matter what decision
is reached on the proposed mergers, it is clearly sound policy to allow
foreign banks to operate in Canada as direct branches of the parent institution.
All sectors of the financial and business communities, as well as the major
political parties, media and general public strongly support direct branching
by foreign banks, and acknowledge that it would be very beneficial to Canada
Mr. Gennaro Stammatti (Chair and C.E.O., Foreign Banks Executive
Committee and President of Banca Commerciale Italiano)
As clearly stated by Mr. Gennaro Stammatti of the Canadian Bankers Association
Foreign Banks Executive Committee, delay creates uncertainty which in turn
prevents financial institutions from establishing appropriate plans to
serve the market. As he told the Committee, " The government should
clearly not delay any further any planning in foreign bank branching, it's
almost impossible for a foreign bank to develop and implement coherent
business plans for its Canadian activities when the basic ground rules
are constantly anticipated to change, but never do". Hence we believe
that the government should move expeditiously to allow foreign banks to
operate through direct branches.
The Committee also endorses the view of the Task Force Report that Canadians
should not be prohibited from using technology such as the internet to
shop the world for financial services. The government should not try to
erect barriers to this practice but should work to provide as much information
as possible and participate in international endeavours designed to provide
a more consistent regulatory framework.
International integration is a clear feature of wholesale financial
markets. International integration has expanded as deregulation removed
many of the barriers to cross-border transactions. Technology has assisted
in this as it has increased the convenience and lowered the cost of those
Canada has always embraced globalization. Our history as a trading nation
is evidence of this. As a result of increasing globalization in financial
markets as well, competition is shifting to global markets rather than
national or even local ones.
Canadian households have not yet been subject to the effects of this
globalization. The explosive growth of the Internet will change this, however.
One factor currently holding up market growth is the lack of consumer confidence
in the security of on-line transactions. Once this confidence threshold
is crossed, however, globalization of financial markets will reach the
household level in a dramatic and irreversible manner.
Once this takes full effect, Canadian households and businesses will
have access to products and institutions from all over the world. Business
innovations will make their way to Canadians at a rapid pace that cannot
even be contemplated today. Canadian institutions that wish to retain their
domestic customers will have no choice but to be as good as the best in
the world, no matter where those institutions are physically located and
no matter how big or small they might be. In effect, foreign institutions
will be next door to any Canadian financial institution.
In the future, it will be this form of foreign competition that could
have the most dramatic impact on Canadian financial institutions. These
institutions will not be entering the Canadian market so much as Canadians
will be virtually travelling abroad to seek financial services.
The Task Force recommendations 119 to 124 address the issues related
to the provision of financial services from outside our own borders. These
recommendations are designed to create an international regulatory regime
for such cross border financial service providers, develop a framework
for electronic commerce and provide timely information for consumers and
a certification process for financial institutions. These recommendations
are endorsed by the Committee and will be examined in more detail in Chapter
Finally, the tax treatment of cross border interest payments also creates
a barrier to enhanced competition from foreign institutions. A withholding
tax of 25% is imposed on interest payments to non-residents. In some cases
the rate falls to 10% as a result of tax treaties. As it applies to gross
interest payments and not spreads or profits, it actually constitutes a
very high rate of tax. The impact is to either increase the borrowing costs
of Canadians or deny them access to foreign sources of credit. This withholding
tax directly affects lenders such as Wells Fargo, which told the Committee
that the tax would amount to approximately one-half the spread it earns
on loans to Canadians.17
The Committee agrees with recommendation 8, that calls for the elimination
of all withholding taxes on arm's-length borrowings.
This recommendation has its origins in the Report of the Technical Committee
on Business Taxation (the Mintz Report). There already exists an exemption
in Canadian tax law with respect to longer-term borrowings. If a borrower
is not required to repay more than 25% of the principal amount within five
years, no withholding tax applies to interest payments.18
Recommendation 8 is consistent with this, and simply extends the measure
to shorter-term borrowings.
The Task Force Report sees the greatest potential for enhanced competition
arising from existing financial institutions. This is a continuation of
past trends whereby the crumbling of the financial pillars expanded the
choices available to Canadian consumers, introduced new innovations into
the delivery of services and forced existing financial institutions to
adapt to the new economic reality.
To some extent this was based on market forces. Financial institutions
sought ways to expand into new markets: insurance companies began offering
insurance-based savings products, trust companies became more like banks
and banks started to underwrite debt securities for their corporate clients.
These trends prompted the government to legislate the end to the pillar
system, further reinforcing market-led trends.
Clearly, these developments have benefited consumers. The measures,
however, went only part way. Most notably, federally-chartered deposit-taking
institutions were denied the ability to retail insurance and all federal
institutions were prohibited from leasing automobiles. The prohibition
on insurance retailing was re-affirmed in the 1996 budget on the grounds
that the financial sector had not yet fully adjusted to the 1992 financial
reform. The government, at that time, did not close the door permanently
to insurance networking.
The other area in which the collapse of the pillars has not evolved
fully is with respect to access to the payments system. The 1992 reforms
were designed to permit insurance companies into the payments system via
the ownership of deposit-taking subsidiaries. Other financial and commercial
enterprises have long had the ability to do so through ownership of a trust
company. This has not had much impact, however, as it has proved to be
an expensive route to take and still did not resolve many of the barriers
faced by indirect clearers.
[W]e are urging the committee to endorse the task force recommendations
relating to the payments system and to reinforce the task force's suggestion
that action be undertaken as soon as possible.
Mr. Chris McElvaine (Chairman, Canadian Life and Health Insurance
Association Inc., President and CEO, Empire Life)
In this respect the Task Force has recommended that life insurance companies,
mutual fund companies and investment dealers have full access to the payments
system (see recommendation 13). These three groups of institutions offer
products that are quasi-deposits and therefore the Task Force thought they
were logical participants in the payments system. John Kaszel of the Investment
Funds Institute of Canada argued "access to the Canadian Payments
System would help us immediately. By being participants in the payments
system we can provide a seamless flow of funds between us and our clients.
This will result in efficiencies for all, reduced costs, better returns.
By better returns I mean there will be a minimum loss in returns during
the flow period, and of course greater competition". Donald Stewart
of the Sun Life Insurance Co. stated "Development in technology, consumer
expectations and increased competition now make access to the payments
system a necessity in order to retain and attract customers".
[The] payment system is also a long-standing grievance of the insurance
industry. . . . Basically, what it means is that every time we pay one
of our consumers, and we pay billions of dollars every year to our consumers,
we in fact send the money to a competitor's-a bank, or a credit union or
M. Claude Garcia (président et directeur général,
Compagnie d'assurance Standard Life)
Access to the payments system would enable security firms to offer
chequing privileges on client accounts directly. It would create a more
level playing field for security firms to compete with banks for client
business and for their financial assets and it would enable our customers
to engage fully in electronic commerce through direct access to the Interac
Mr. Joseph Oliver (President and CEO, Investment Dealers
Association of Canada)
We agree with these witnesses and further recommend that the federal
government closely monitor new CPA rules and bylaws to ensure that no new
barriers to entry are erected, so as to circumvent the spirit of Task Force
recommendation 13. As well, we support recommendations 14 and 15 that give
the Minister of Finance the power to approve CPA bylaws and issue directives
to change bylaws. An example of a rule that the Committee believes hinders
competition is Rule H-4 of the CPA which prohibits one-time electronic
debits or sporadic debits between financial institutions. The Committee
believes this sort of rule should not be in place unless it has a clear
But it also recommended that the minister had the power to review
all new or revised CPA rules and to revoke any rule or revision which the
minister determines to be contrary to the public interest. Well, given
the number of CPA rules, the very technical nature of most of them and
the need for the CPA to be able to respond quickly to emerging issues,
the task force approach, in our view, would clearly be more efficient than
requiring all the rules to be approved in advance by a government body.
Mr. Robert Hammond(General Manager, Canadian Payments Association)
Equally important to the enhancement of competition is the development
of other networks, in particular Interac. As argued by Donald Stewart of
the Sun Life Insurance Co. " . . .[M]aximizing the competitive potential
of existing players requires open access on reasonable terms to other networks,
in particular, we very much support the proposal that functionality in
the Interac system be broadened". The Task Force recommendations 16
and 17 recognize the importance of this network. Again we are in accord.
The Minister of Finance should monitor Interac developments closely to
ensure that it allows competition to flourish. Improving the functionality
of the systems will also add dramatically to competition as it can help
to create the equivalent of large-scale networks, even for small local
institutions. Technical and security problems must be resolved before allowing
inter-bank deposits to be made at ATMs. In addition, the enhanced functionality
envisaged by the Task Force could reduce the efficiency of the electronic
payments system if it imposes a greater reliance upon paper-based transactions
when the system is increasingly going electronic.
We recognize the potential benefit to consumers of added services.
However, it is our view that the experts who devise and develop technology
solutions are in the best position to determine how to implement innovative
solutions to consumer needs. The solution in recommendation 17 is one way
of addressing service to consumers but I think this committee needs to
be aware that it is a costly and a complex solution.
Ms. Judith Wolfson (President, Interac Association)
In the same vein, the Committee believes that deposit-taking institutions
can, under the correct circumstances, add to competition by being granted
expanded powers with respect to insurance networking and automobile leasing.
Expanding the powers for federally-regulated financial institutions can
be a pro-consumer initiative. Nevertheless, the issue has proven to be
extremely contentious. As a result we consider the matter in much more
detail later in the Report.
In recommendation 13, the Task Force recommends expanding CPA membership.
I want to emphasize that early in the review process, the CPA made it known
that it had no objection in principle to expanding membership in the CPA.
However, it was suggested that when doing this, the decision maker should
be careful to consider the ramifications for the attributes of the Canadian
clearing and settlement system that Canadians value so highly, and that
is, it's efficiency and it's safety.
Mr. Robert Hammond(General Manager, Canadian Payments Association)
While governments, through such initiatives as competition policy, can
seek to promote competition in the marketplace, it is the behaviour of
consumers that ultimately ensures that competition will be effective. They
must have choices and they must feel confident in their ability to take
advantage of those choices. Earlier we discussed the potential that monoline
institutions presented for the introduction of enhanced competition. But
if consumers feel coerced by their full-service financial service providers,
they might not be able to take advantage of these new opportunities. All
sorts of niche players could, in such circumstances, become impotent competitors.
The Committee believes it is important for consumers to feel that they
are free to choose from amongst financial services and financial service
providers. It is important not only to have the ability to shop around,
but to understand clearly that they have this ability. They must believe
that government policy is on their side. Consequently the Committee also
recommends that these safeguards be well publicized, not only by financial
institutions to which they apply, but by the federal government as well.
At the same time, the Committee recognizes that policies to provide
consumer protection are costly to institutions and that these costs are
ultimately borne by consumers. Thus there is a trade-off - more legislated
and expensive consumer protection is not necessarily good for consumers.
The Committee endorses many of the Task Force recommendations with respect
to greater consumer empowerment, even though they go well beyond what currently
exists and might increase compliance costs. The Task Force argues that
these recommendations are measures that would provide consumer protection
against abuses that might result from expanded business powers.
The package of consumer protection measures recommended by the Task
Force is extensive and warrants more detailed discussion later in our Report.
The final tool for enhancing competition lies with the regulatory environment,
which has traditionally been of vital importance to the financial sector
and which is now becoming even more important. The regulatory environment
has a large impact in defining the look of the financial sector, for good
or for bad. While this is often recognized as a critical factor in determining
the competitiveness of financial institutions, it is clear that the structure
of regulation can also have a direct impact on competition as well.
The Committee has earlier expressed its support for recommendation 4
that is designed to help promote new entry into the financial sector. Recommendation
4(c) deals specifically with small institutions when it calls for an end
to a "one size fits all" approach to regulation. Complying with
regulation is an activity that exhibits economies of scale. Small institutions
bear a disproportionately high compliance cost while posing only small
risks to the financial sector. If we wish to foster greater competition
by developing a second tier of financial institutions, it is important
that the government not hinder the financial prospects of such second tier
institutions. It is important that regulatory measures such as risk based
CDIC premiums or consumer protection arrangements not harm the competitiveness
of any group of institutions.
A market is characterized by the existence of, or lack of, competition
on the basis of the behaviour, or potential behaviour, of participants.
The number of participants is a useful indicator of the structure of an
industry but does not tell the entire story.
If a market is characterized by a lack of entry barriers and if there
exists a group of institutions that could enter the market, it would likely
exhibit signs of competition. If the participants engage in dynamic rivalrous
behaviour, actively seeking to gain market share, the market will again
be likely characterized by competition. Any attempt by a firm to exploit
market power through increased prices will lead to a response by others,
who see these higher prices as an opportunity to gain market share and
increase their own profits.
The MacKay Report seeks to enhance competition by affecting both of
these variables. By reducing barriers to entry, it helps to make existing
markets more contestable. With entry comes rivalrous behaviour as new institutions
seek to acquire additional market share.
The obvious ways in which entry barriers are to be lowered is by making
it easier for foreign financial institutions to serve the Canadian market,
by granting greater access to the payments system for certain classes of
financial institutions, by reducing the capital requirement for new institutions
and reducing their capital tax burden, by promoting the creation of co-operative
banks and enhancing the powers of credit union centrals so as to enable
them to better serve their members. Another way of lowering barriers to
entry is by allowing existing financial institutions to offer products
that have been denied them in the past, or to enable them to use new and
more efficient delivery mechanisms. This is the issue considered here.
Such moves would appear to enhance competition by increasing rivalry and
by effecting new entry.
As part of its quest to increase competition in the Canadian financial
services sector, the MacKay Task Force recommended that the powers of financial
institutions be expanded. Recommendations 13 to 17 that deal with the payments
system and other networks such as Interac, have received widespread acceptance
and have not been very controversial. These recommendations would expand
access to the payments system to life insurance companies, mutual fund
companies and securities dealers. The recommendations would also expand
the functionality of the ATM network in Canada, a move that the Hongkong
Bank of Canada believes would effectively create a whole host of new competitors
to existing institutions.
Financial institutions are increasingly looking alike. They offer savings
products that are close substitutes and these institutions are discovering
that customers want a broader range of financial products from the institutions
with which they deal. It is the payments system, in particular the electronic
payments system, that will increasingly define the financial sector in
the future. It is the expansion of access to the payments system that will
finally constitute the elimination of the traditional four pillars system.
As long as new participants are able to satisfy solvency and liquidity
requirements, their entry is not seen as posing any threat to the soundness
and high quality of the payments system we now have.19
These recommendations were widely accepted and non-controversial.
What the MacKay Report comes down to is doing what's in the interest
of banks and the financial services industry. It does not take into account
what is good for small business, or small towns, or for the auto industry,
or even for the consumer.
Mr. Gilles Richard (Outgoing President, Corporation des concessionnaires
d'automobiles de Montréal and President, Le Circuit Mercury (1977)
Such is not of the case with recommendations 18 to 21, which would grant
to federally-regulated deposit-taking institutions the power to retail
insurance products (whether life, or property and casualty) within their
branches, and use customer information, subject to enhanced and legislated
privacy safeguards, to target market those products. These recommendations
would also allow all federally-regulated institutions to engage in light
vehicle, i.e. automobile, leasing. The Task Force sees these recommendations
coming into effect only after the appropriate privacy and tied selling
regimes have been put into place. These, recommendations 64 to 75, would
legislate a comprehensive privacy regime in which privacy is a basic right.
Consumers would have to expressly consent to the disclosure of and expanded
use of personal information, and there would be a binding privacy code.
These recommendations would also expand the scope of the current prohibition
against tied selling and require financial institutions to provide a written
description of coercive tied selling along with the advice that it is an
illegal practice, prior to the signing of any contract.
Smaller institutions would be able to take advantage of these expanded
powers once the consumer safeguards are in place. Large institutions, i.e.
those with equity over $5 billion, would not be able to take advantage
of the new powers until the year 2002.
The primary rationale put forward by the Task Force for branch retailing
of insurance is that it would expand consumer choice without imposing any
great threat to consumer privacy or enhance the possibility of abusive
practices. According to public surveys, less than one-third of Canadians
are concerned about potential abuses. Lower income households could be
served better, and at lower cost if, insurance is sold through branches
of deposit-taking institutions. Furthermore, Canada is an international
anomaly in this regard. Whether it be France, Germany, the Netherlands
or the United Kingdom, deposit-taking institutions may own insurance subsidiaries,
retail insurance in branches and use customer information to market that
insurance. The "warm leads" that customer information provides
enables agents to be more productive and hence lowers the cost of distribution.
American deposit-taking institutions may not own insurance subsidiaries
but may retail insurance and use customer information.
[W]e welcome the ability to sell insurance, especially ourselves,
the National Bank of Canada because our main competitor in Quebec is selling
insurance. It has power both in life insurance and the P and C business.
And I think it's the duty of the federal government to harmonize legislation
of financial institutions, and if there's a problem with one institution
being a federally incorporated institution in one province, I think that
we have to do something about it. We cannot let it go.
Mr. Léon Courville (President, Personal and Commercial
Bank and Chief Operating Officer, National Bank of Canada)
The Task Force further concludes that deposit-taking institutions will
not drive traditional institutions and distribution networks out of the
market. Both channels continue to co-exist in other countries, and with
the strengthening of life insurance companies in Canada via demutualization
and direct access to the payments system, the ability to co-exist with
deposit-taking rivals will likely not be jeopardized.20
Property and casualty insurance should experience the same outcome.
Alternative distribution channels are already gaining market share with
respect to household and individual auto policies. This is a result of
the "commodity-like" nature of the product. Commercial insurance
lines, being more complex, are likely to continue being provided by traditional
The P&C sector is dominated by foreign-owned institutions. While
there are many vigorous Canadian competitors, foreign-owned companies accounted
for about 68 percent of net premiums earned in Canada in 1997, up from
about 63 percent in 1991.
With respect to auto leasing, the Task Force again notes that Canada
tends to stand apart from other industrialized nations. In the United States,
where banks may lease automobiles, consumers have greater choice. This
choice has come at the expense of the captive finance companies, firms
which hold 80% of the Canadian leasing market, and of which three firms
hold 70% of the market.
Despite the very stringent consumer safeguards that are required before
these additional powers with respect to insurance networking and auto leasing
are to be made available, the recommendations have proven to be extremely
controversial. The Committee heard wide-ranging testimony, especially from
property and casualty insurance brokers, in opposition to the extension
of bank powers. These criticisms centred around several basic themes, including
the ability of banks to engage in coercive tied selling, the unfair advantage
banks have from the use of private information, their ability to engage
in cross subsidization so as to purchase market share, and the general
accusation that by driving independent brokers out of the market, competition
would be diminished rather than enhanced.
Pro forma estimates accounting for the recent mergers indicate that
the five largest life insurance companies will now have approximately 59
percent of the individual market and 62 percent of the group market, up
from 42 and 43 percent respectively in 1991.
In addition to these complaints by insurance brokers, automobile dealers
and manufacturers complained about the conflict of interest that would
arise if banks were allowed to lease automobiles directly, at the same
time that they finance the inventory of those dealers. It was also suggested
that banks have a significant cost of funds advantage over traditional
lessors, enabling them to drive incumbents out of the market.
The vocal opposition to these MacKay recommendations is not shared evenly
by all of those who would be affected by these recommendations. Life insurance
agents and brokers, for example, are not as strong in opposition as are
property and casualty brokers or automobile dealers. The same is true of
life insurance companies. Great-West Life, and its parent Power Corp.,
told the Committee that it could not compete with banks marketing through
their branches, although they had no problem with the current situation
in which banks owned insurance companies and sold the products in traditional
ways. Sun Life, on the other hand, indicated to the Committee that it believed
in greater consumer choice and hence could not reject the Task Force proposal
to allow the retailing of insurance within bank branches. Canada Life also
did not object. Seventy-five per cent of its assets are related to savings
rather than insurance products, and it could compete with bank-sold insurance
products. Moreover, it has been able to compete effectively with banks
in the United Kingdom and Ireland where "bancassurance" has been
available for more than 10 years. ManuLife also felt that it could be as
competitive as banks, even with in-branch retailing of insurance products,
as long as the power was phased in gradually. Mutual Life, while tentative,
did not oppose expanded powers to retail insurance. Rather, it suggested
that time would be needed for the competitive inequities between life insurance
companies and deposit-taking institutions to be erased. New powers to retail
insurance should await such developments.
The Task Force Report recognized that life insurance and general insurance
products are quite different, but it also concluded that the regulatory
issues surrounding the co-mingling of deposit taking and insurance sales
are the same for both types of products. Hence its analysis concentrated
on life insurance products, where the bulk of the international experience
[The Task Force's] assessment of jurisdictions, and by that I mean
provinces in Canada and other countries, where deposit taking institutions
are allowed to sell insurance and offer lease financing shows that traditional
insurers, lease financing companies and auto dealers can and indeed do
co-exist, compete and thrive in the market place alongside deposit taking
Mr. Raymond Protti (President and Chief Executive Officer,
Canadian Bankers Association)
The background studies and technical papers examined the international
experience in delivering life insurance through the banks. European countries
have, for some time now, allowed "bancassurance" or "allfinanz"
models to exist. The development of these models was the result of demographic
changes and tax advantages available to certain insurance products. In
France, where bank sales of insurance products has been allowed since the
1970s, the bank market share exceeds 50%. The bank share is also high in
Italy, at over one-third. In other countries, banks have not been able
to acquire as significant a share of the insurance market. The advantage
of new distribution channels is largely cost related. The cost of bank
distribution of life insurance products is about one-half the cost when
an independent broker is used. Further substantial cost reductions occur
when direct sales are undertaken.
Most of the insurance sold by banks is life insurance, although the
Royal Bank of Scotland pioneered the sale of general insurance through
telephone call centres. In the United States, banks sell insurance products
and many Canadian life insurance companies have their products sold this
Our industry therefore urges this committee to recommend that enactment
and implementation of effective action relating to the payment system and
consumer compensation arrangements should precede any change whatsoever
in the current legislative and regulatory framework for insurance distribution
by deposit takers.
Mr. Chris McElvaine (Chairman, Canadian Life and Health Insurance
Association Inc., President and CEO, Empire Life)
The Committee is not convinced that competition cannot be enhanced if
federal financial institutions are granted additional powers. What is needed
is a set of other prerequisite reforms to ensure that enhanced powers prove
beneficial. The Committee's assessment of the various arguments is presented
In general, opponents of expanded powers assume that the banking sector
is not characterized by competition and will not be characterized by competition
in the future. They have little faith in the effects of current market
trends that are increasing competition. They also get little solace from
the recommendations of the Task Force, that are designed to increase competition
and enhance consumer protection. Thus any initiatives that enable banks
to gain market share must be at the expense of competition. This is however,
a conclusion that must be established rather than just asserted.
Increasing bank presence in certain industries does not mean that competition
has been lessened. Much is made of the fact that banks now dominate in
the provision of certain services that were denied them in the past. If
banks have gained market share because they proved to be more efficient,
and therefore able to offer services at a lower price, consumers gain -
they do not lose.
The consumer finance market is a good example of this. Finance companies
lost market share to banks because those banks were able to undercut the
rates charged by the incumbent institutions. Consumer loan rates fell with
the entry of banks into the market. The spreads between consumer loan rates
and the bank rate are lower today than in the 1950s, when banks had one-half
the market share they have today.21
Finance companies are largely unregulated, so there are few barriers
to entry. If banks were exploiting market power via higher prices, these
unregulated companies could easily enter the market to re-capture market
share. The fact that they have not done so in large measure over the past
40 years is indicative of competition in the market. The fact that banks
now have over two-thirds of the consumer lending market is an indication
of the results of competition, not its absence. The same can be said about
residential mortgages. Banks have gained over half the market, compared
to about 10% in 1970, yet there is widespread consensus that this is probably
the financial service that has the most competition of any other. The mortgage
rate spread, measured by the mortgage rate and the average yield on 3yr.
to 5yr. government bonds, is substantially below that of the 1970s.22
The securities sector is no different. Banks have captured three-quarters
of the market through acquisition over the past decade, yet in many respects
fees for services have come down, partly due to changes in regulation and
partly due to directly increased competition.23
Again this is not something that one would expect of a market in which
the banks can exercise market power.
It is equally important to consider the evolution that is already taking
place and that will continue to take place, even in the absence of new
powers for federal institutions. The threats to incumbents are already
manifesting themselves. P&C insurance is very much a commodity rather
than a financial service, which will increasingly be sold in non-traditional
ways such as direct marketing, call centres, etc.
P&C insurance companies in many ways face the same dilemma as the
banks. They have an existing distribution network that has served them
well in the past, but technological changes and consumer demands are creating
pressures to find better ways to deliver those products. They must work
their way through this transition without alienating customers who are
comfortable with the existing distribution channels. According to a study
done by Coopers & Lybrand for the Task Force, " . . .in other
countries, a substantial proportion of the broker market overall could
quickly erode as insurers continue to seek new channels of distribution
that offer advantages of speed and convenience to consumers."24
The P & C sector is a mature industry in Canada. The fact that
the majority of insurance is distributed through independent brokers is
not an affinity on the part of the insurers towards brokers, but rather
it's a recognition that the broker distribution system is efficient and
is cost effective. These and many important industry-related facts have
been totally ignored by the MacKay Task Force.
Mr. Gil Constantini (President Elect, Insurance Brokers Association
Similar developments are taking place in the sale of automobiles, which
might help to explain the opposition of dealers to bank direct leasing.
The emergence of internet brokers such as Auto-by-Tel, is reducing dealer
margins on car sales,25
something that will be increasingly common in the future. Bank direct leasing
of automobiles would further this trend.
Cross Subsidization: One particular criticism of bank entry into
insurance retailing concerns the ability of banks to cross subsidize insurance
products so as to gain market share. Cross subsidization, however, does
not rely upon branch distribution. It is possible now. At issue though
is the extent to which it would actually take place and the extent to which
it undermines competition if it does take place.
To cross subsidize one product means that the price of that product
is kept below the cost of production, with the difference financed by revenues
in another product line. The ability to engage in such a practice requires
that there be a product line that is not subject to competition, and hence
generates the excess profits that can finance the subsidized line of products.
It requires a lack of competition amongst deposit-taking institutions,
which is precisely how opponents characterize the financial sector in Canada.
Banks are increasingly facing enhanced competition. It is coming from
monoline institutions that are entering the credit card market. It is coming
from capital markets where commercial firms are bypassing banks to get
It is coming from mutual funds that are an alternative to bank deposits
The issue, however, is whether these trends and the effects of the Task
Force reforms are sufficient to address the perceived anti-competitive
impacts of insurance networking.
The portion of business funding derived from bank loans reached a
peak of over 50 percent in 1982-83 and has since declined to less than
one third. Corporate customers have turned to lower-cost capital markets
and asset-backed finance firms for their funding needs.
The other important fact to consider is the structure of the market
in which cross subsidization might take place. If it is characterized by
trivial entry barriers, no predator will ever be able to exploit the market
share that it purchased via cross subsidization, because once it did so,
new institutions will always be able to respond to profit opportunities
by entering the market.
The property and casualty insurance sector has few barriers to entry,
as admitted by the industry. The same is true of automobile leasing, which
is a largely unregulated industry.
Use of Client Information: Another allegedly anti-competition
effect of allowing deposit-taking institutions to retail insurance comes
from the unfair advantage that banks and others have in being able to use
client information to target market that insurance. Banks know more about
Canadians than does any other type of financial institution.
The MacKay Report addresses this by recommending the establishment of
a number of measures designed to protect consumers. These include a legislated
system of privacy safeguards, enhanced tied selling prohibitions and an
independent ombudsman regime. With consumers being given the ability to
define their relationship with a financial institution the potential for
abuse is substantially reduced. Today, many Canadians feel that they are
not adequately protected against abuse of their privacy. Unless the standard
of consumer protection is substantially enhanced, insurance networking
could subject them to even greater potential abuses.
Abusive Tied Selling: Finally, there is the matter of economic
power and coercion that might be exercised through tied selling. The Committee
deals with this matter elsewhere in the Report, and has accepted the MacKay
recommendations that would significantly tighten up the prohibitions against
tied selling. When combined with the other consumer protection measures
recommended by the Task Force, we believe the package would constitute
an effective set of safeguards for consumers when enacted.
In sum, MacKay is all about a vision of what is good for the banks.
It is not about what is good for small business.
M. Gérald Drolet (President, Canadian Automobile Dealers
All financial institutions have a reputation to maintain and it is that
reputation that enables them to attract and keep customers. Several institutions
have made it clear to the Committee that ill-advised behaviour on their
part brings with it significant threats to their customer relationships.
Attempts at coercive behaviour do not just risk the potential that the
additional business might not materialize, it brings with it the risk that
other, existing business may be lost as well. This constraint on abusive
practices would only be effective if consumers had the mobility to change
Unfair Cost of Funds Advantage: The automobile dealers who vehemently
opposed direct leasing by federal financial institutions often cited the
unfair advantage that banks have over traditional lessors, because of their
ability to raise funds through low-cost deposits. Lessors could never be
competitive with banks as a result.
Deposit-taking institutions have a wide variety of costs in addition
to the interest they pay on deposits. The interest rate spread is not indicative
of profit margins. More importantly, the large leasing companies are some
of the most stable and profitable firms in the world. With their strong
they are able to raise very low cost funds via commercial paper, without
the need of an extensive retail branch network to support.
Secondly, deposits are becoming less and less relevant as a source of
funds, primarily because consumers are shifting to mutual funds. Mutual
funds already exceed personal deposits in the banks and they will soon
exceed all deposits in size. At the margin, deposit-taking institutions
that would finance auto leases in the future will raise funds in ways that
are probably not much different from the way existing lessors raise funds.
They will have no significant advantage as a result.
As you undertake this review, it is important that you be aware of
the fact that the MacKay Report contains several crucial errors. For example,
it claims that the caisses populaires in Quebec are able to lease vehicles
directly, so why shouldn't banks be allowed to do so as well? In reality,
that statement is false. In Quebec, the caisses populaires have signed
an agreement with auto dealers stating that that they will not engage in
any direct leasing.
Mr. Gilles Richard (Outgoing President, Corporation des concessionnaires
d'automobiles de Montréal and President, Le Circuit Mercury (1977)
Conflict of Interest: One of the most longstanding arguments
against bank direct leasing of automobiles is that it would place them
in a conflict of interest position in relation to dealers, whose inventories
are also financed by banks. On the one hand dealers would be their customers,
on the other they would be competitors.
The Montreal Automobile Dealers Association quoted the former Assistant
Deputy Minister of Finance in this regard, when he said in 1990
Fundamentally, the government in devising this policy (of limiting bank
lease powers) has been driven by a view that there is a large potential
conflict of interest here at the very local level. If banks were also in
the leasing business we are not confident that we could deal with those
conflicts through regulations and limitations . . . . I am the bank manager
in Perth, Ontario . . .I am sitting there making credit decisions related
to the car dealer down the street's leasing activities, but I am in the
same business in the back of my bank. I do not know how to deal with that
in a fundamental, inherent kind of way.
This concern has merit if dealers have no alternatives but banks for
financing. However, all of the vehicle manufacturers have captive financing
arms. These are designed to provide financing so as to help move the cars
that are manufactured. Today, most of that activity is concentrated in
providing leasing, but it need not be so. The captives do provide loans
and if dealers felt that banks were treating them unfairly, they could
seek financing for inventory acquisition from these captives. More importantly,
if the state of competition is increased sufficiently, these dealers would
have more options available to them to finance their inventory.
Finally, the conflict of interest as expressed in the above quote refers
to a situation in which the bank branch has its own inventory of cars.
This is not the way the banks say their leasing products would be offered.
Canadians cannot avoid dealerships when obtaining a new car. This is true
whether they purchase through the internet or lease from a credit union.
What banks claim to want is the ability to provide another alternative
for dealers. Instead of only being able to draw upon captive finance institutions
(e.g. GMAC, Ford Credit), independent lessors like Newcourt and GE Capital,
and some provincial institutions such as caisses populaires and credit
unions, the dealer would be able to draw upon the services of banks as
well. Dealers would always be the ones brokering the lease. While banks
cannot buy cars directly from manufacturers, it is possible that they could
in fact have an inventory of used cars at the expiry of the initial leases.
At this point there is a fear that they could become direct competitors
to auto dealers.
But some banks already offer near lease products such as buy back loans
that can lead to their taking possession of cars at the end of the loan
contract. They pre-arrange the sale of those cars with other institutions
and do not market the cars themselves.
Leasing and Risk: While opponents want banks out of automobile
leasing because they will unfairly harm existing lessors, they also want
banks out of the business because banks do not understand the market. They
don't understand residual risk the way incumbents do. The American example
where banks lost money in this area and subsequently exited the market,
is cited as proof of this lack of knowledge.
It is important that banks understand the risks associated with all
of the activities they undertake. OSFI is concerned with this as well.
But financial institutions are in the business of assessing a whole host
of risks. When they engage in derivatives trading, they must assess risks
that most ordinary individuals could not understand. It is unlikely that
the risks associated with automobile leasing are so unfathomable, especially
since banks are already offering near-lease products that require them
to understand the nature of these risks.
Capital Cost Allowances: An argument that has been raised late
in the hearings concerns the capital cost allowances associated with direct
leasing. Banks want to engage in leasing so that they can capture the capital
cost allowance and shield their already high profits from taxes.
Capital cost allowances (CCA) are available to all lessors and to the
extent that they reduce current taxes, they do so for all, not just the
banks. What is more important to realize, however, is the fact that the
CCA can only be applied against income from the lease of the capital goods
that are subject to the CCA. It cannot be used to shield other sources
of income from current tax.
In conclusion, the Committee believes that the arguments made by opponents
to expanded powers are not definitive. Consumer demands are evolving and
the methods by which products are distributed are also changing. These
factors are putting pressure on incumbent suppliers in all sectors of the
economy. The Task Force recommendations will speed up these trends but
they are not the source of the pressures that insurance brokers and automobile
dealers will face in the future.
The Committee does believe that there are some legitimate consumer-related
concerns that relate to the expansion of powers for federal financial institutions.
That is why we recommend that an enhanced system of consumer protection
be implemented quickly. There are also some legitimate concerns about competition.
That is why we also support the task Force recommendations that would promote
The Committee believes that, subject to the concerns for safety and
soundness, individual financial institutions should be able to establish
their own business strategies, delivering the products that they see fit
to deliver and to deliver them in what they think is the most efficient
way. They should be able to respond to the changes taking place in the
economy. These are business decisions. Similarly, consumers should be able
to buy their financial services in ways that are most beneficial and convenient
to them. These are individual decisions. As long as both sets of decisions
are taken in markets that are competitive, consumers will benefit.
Leasing of new vehicles in 1997 was a $35 billion business, with
the financing arms of the major auto manufacturers having 70 to 80 percent
of this market.
The retail automobile market is changing rapidly, with leasing becoming
increasingly popular largely as a result of rising car prices. Forty-six
per cent of new cars are now leased vs. only 4% in 1990. Why should federal
financial institutions be shut out of this market which they have traditionally
served through car loans, because of changing consumer trends? Why should
they be shut out of this market when some of their provincially-regulated
competitors are not? Why should foreign finance companies be shielded from
bank competition here when they are not so shielded in their home country?
In the United States, banks have been able to lease automobiles since the
1960s, and it appears that they have done so mainly at the expense of captive
finance companies. Most other countries do the same. What is so different
about the Canadian economy that our consumers should be prevented from
enjoying this option?
A similar tale could be told with respect to insurance. Many countries
now allow banks to retail insurance, which provides customers with lower
cost distribution channels. Indeed, in countries where banks are allowed
to distribute insurance products, productivity in the distribution system
is higher than in Canada. Why should Canada not take advantage of this
and why should it continue to be the international anomaly?
A recent C.D. Howe publication had this to say about bank entry into
the Australian and New Zealand insurance market.
Despite the relatively large number of incumbents in the Australian
and New Zealand insurance markets, bank entry has increased the level of
competition substantially. This result has occurred because the banks have
introduced a new distribution technology to the industry, rather than because
of any pre-existing lack of competition . . .29
This is an interesting example because it deals directly with some of
the arguments used by opponents of expanded powers. Whether it be insurance
retailing or auto leasing, these opponents will frequently cite the large
number of current market participants and assert, as a result, that the
market already benefits from competition. "If it ain't broke, don't
fix it" they say. The Committee believes that there are potential
benefits to consumers from new suppliers of auto leases and new distribution
methods for insurance products. We do not believe, however, that the conditions
are right today.
The Committee believes that the state of competition in the Canadian
financial services sector will be enhanced by the recommendations of the
Task Force Report. We also believe the current system of consumer protection
to be inadequate. We recommend therefore that the government give high
priority to the establishment of a new consumer protection regime, and
act quickly to do so. Such a regime would include:
- An improvement in the transparency of contracts and the full and timely
disclosure of contract terms (Task Force recommendations 57 to 62)
- Enhanced, legislated privacy safeguards that that would allow the consumer
to control the use of personal information, by requiring explicit customer
consent which may subsequently be withdrawn (Task Force recommendations
64 to 69)
- A legislated and expanded ban on coercive tied selling, along with
a redress mechanism and a requirement that financial institutions inform
customers as to what practices constitute coercive tied selling, prior
to a transaction being completed (Task Force recommendations 70 to 75)
- A redress mechanism that includes an independent financial services
sector ombudsman (Task Force recommendations 76 to 80)
- The establishment of a Consumer Protection Bureau.
The Committee recommends that the House of Commons Standing Committee
on Finance be instructed to evaluate the new consumer protection and competition
regime in order to determine whether or not it is effective and raises
the standard of protection for consumers. This evaluation is to be conducted
prior to the next scheduled review of federal financial institutions legislation,
and receive input from stakeholders.
Therefore, the existing prohibition against federally-regulated deposit-taking
institutions retailing insurance in their branches, as well as the existing
prohibition against federally regulated financial institutions leasing
automobiles, will only be reconsidered in light of the results of the above-mentioned
The Committee's interest in enhancing competition reflects its concern
about the welfare of consumers. As many witnesses have stated, the ultimate
goal of financial reform is to benefit the consumer. It is the consumer
interest that ultimately produces the greatest benefit to Canadians. Whether
consumers are households or business firms, a financial sector that is
good for consumers is good for the economic welfare of all Canadians.
I feel that the best protection for our Canadian banking system is
to give them the size and the economies of scale that they need to compete.
The competition is there. I don't believe that this will create any kind
of monopoly as market forces will prevail. Market forces say to me that
mergers would be good, giving us world class financial institutions.
Mr. Glen Calkins (Owner/Operator, McDonald's Restaurant of
Saint John and Lquispansis)
But having expressed the primary consumer interest, the Committee wishes
to make clear that financial policy should also allow Canadian institutions
to pursue the measures that will make them globally competitive. In other
words, we should pursue those measures that allow our institutions to become
world class in all respects. After all, this sector directly employs more
than one-half million Canadians and has a significant impact on our economy
in its own right. Furthermore, as was argued earlier, Canadian consumers
are more likely to enjoy the benefits of competition with open markets
and competitive domestic financial institutions.
Competitiveness is a characteristic of an institution, a group of institutions
or the entire sector. If Canadian financial institutions are to compete
effectively and profitably with their counterparts around the world, they
must be equipped with the appropriate tools. They must offer the same products
as their competitors, or better products. They must offer them at prices
that are no higher. And, if they are to do so at a profit, their costs
must be in line with those of others.
Canadian financial institutions have for many years now faced this competitive
challenge from their foreign counterparts when operating in the international
marketplace. Increasingly, they are facing the same challenge at home.
Canadian bank profitability compares reasonably well with that of
foreign banks in major countries.
Canadian financial institutions generally rank favourably in terms of
international competitiveness. While not the best, they generally are in
the top ranks of financial institutions. Moreover, banks and life insurance
companies typically have an international orientation that surpasses many
of their much larger international competitors. According to The Banker
magazine, for example, Canadian banks are very much globally oriented.
If banks are ranked by the proportion of their assets that are non-domestic,
Canadian banks rank 20th (CIBC), 21st (Bank of Montreal), 27th (Scotiabank)
and 39th (Royal) in the world. Both CIBC and the Bank of Montreal have
44% of their assets overseas, and the Bank of Montreal earns 58% of its
earnings overseas. Scotiabank earns 49% of its income overseas, while Royal
earns 28% abroad. By this measure, the Bank of Montreal and CIBC are more
globally oriented than Chase Manhattan, Bank of Tokyo, and ING.
In its 1997 report, the World Economic Forum ranked Canada's financial
system fifth in competitiveness, among a sample of 53 more-developed countries.
In addition, the Canadian regulatory environment has helped to make
Canadian institutions more competitive. The reforms of 1992 and earlier
have permitted the emergence of nation-wide domestic financial conglomerates,
unlike the situation in other countries such as the United States.
Nevertheless, there are certain areas in which initiatives can be undertaken
to enhance the competitiveness of domestic institutions and the competitiveness
of Canada as a centre of financial services.
As noted above, the Task Force Report recommended that financial sector
convergence be allowed to proceed further. The primary effect of this would
be to expand consumer choice. But it would also enhance the international
competitiveness of those institutions by allowing them to better serve
consumers and thus become more profitable. As a Bank of Canada report concluded,
it is profitability that really matters in determining whether financial
institutions are truly efficient. It concludes that, " . . .the key
issue may not be so much the size of FSPs [Financial Service Providers],
but rather the nature of the activities they undertake."30
It is vital, in our view, that Canadian financial institutions be able
to serve Canadians they way they want to be served. This will allow them
to be competitive. The Committee recommends that both aspects of the recommendations
be considered when they are assessed by the government.
Manulife supports the task force recommendations of the widely-held
ownership regime also referred to as the 10% shareholding limit be retained
for large institutions in perpetuity. This policy has served our industry
and our country well. Without it, I am convinced that our financial services
sector would not have evolved into as strong and competitive sector that
it is today nor would it be domestically controlled as it is today.
Mr. Dominic D'Alessandro (President and CEO, Manulife Financial)
The other primary way in which competitiveness is to be enhanced is
via the rules governing ownership and structure of financial institutions.
We consider here the four principal groups of recommendations contained
in the Task Force Report, namely the ownership regime, the flexible definition
of wide holdings, the process of demutualization of large life insurance
companies and the financial holding company model. In addition, we discuss
the problems that the co-operative sector has in becoming a competitive
force in the domestic marketplace.
The ownership regime recognizes existing and potential trends towards
greater convergence and thus recommends that all federal financial institutions
be subject to the same rules, based on size. As the ownership regime can
confer certain advantages on the one hand and certain costs on the other,
it was felt by the Task Force that all institutions, who will eventually
be able to do similar things, should enjoy the same benefits and bear the
same regulatory costs.
Recommendations 29 to 41 deal with the ownership regime that is to apply
to federally-regulated financial institutions. According to the Task Force,
there should no longer be one set of rules for banks and another set of
rules for non-bank financial institutions. These recommendations also effectively
address the issue of the ownership regime that is to apply to mutual insurance
companies after converting to stock companies. The following chart, based
upon Task Force data, ranks the large Canadian financial institutions by
equity and places them within the context of the new size thresholds.
Recommendations 29-41 propose a number of changes to the rules concerning
ownership of financial institutions. If these recommendations were to be
accepted, they would alter the current rules in important ways. Some schedule
one banks and mutual insurance companies which chose to be de-mutualized,
would no longer be required to be widely held. Ownership requirements would
be based on the size of the institution. It's our view, and it's a view
shared by most regulators, that closely held ownership of financial institutions
provides greater scope for risk than widely held ownership, and that commercial
links further exacerbate the risk. The history of financial institution
failures in Canada tends to support this view.
Mr. John Palmer (Superintendent, Office of the Superintendent
of Financial Institutions)
Recommendation 29 sets out the three guiding principles for a set of
ownership rules. This regime should foster entrepreneurship and thus enhance
competition. It should maintain safety and soundness of the system and
it should preserve Canadian control.
The task force recommendation permitting new banks to be closely
held or single ownerships of banks with less than $1 billion in shareholders'
capital and up to 65% ownership for banks with shareholder equity between
$1-5 billion, with the remaining 35% to be widely held and publicly traded,
we believe will go a long way to broaden the choice of providers of financial
services to Canadians. This will be particularly well received by Canadian
mid-market corporations, as well as smaller corporations.
Mr. Paul J. Lowenstein, (Chairman, Canadian Corporate Funding
By requiring large institutions (i.e. those with equity of $5 billion)
to be widely held, the Task Force believes it is promoting safety and soundness
of large financial institutions by avoiding the problems and conflicts
associated with commercial links. It also maintains Canadian ownership
because no foreign institution could take control of a domestic institution
via an unfriendly take-over. On the other hand, by allowing small institutions
(i.e. those with no more than $1 billion in equity) to have a single owner,
new entry and entrepreneurship is promoted. At present, entrepreneurs may
start up and keep control of trust companies and insurance companies. The
Task Force proposes to allow, for the first time in recent history, entrepreneurs
to create and maintain control of domestic banks. Financial institutions
with equity between $1 billion and $5 billion may be closely held as long
as 35% of shares with voting rights are publicly traded and widely held.
The rules for this middle category are roughly equivalent31
to the ownership rules that now apply to federal non-banks with equity
in excess of $750 million.
The task force is proposing widely held ownership for the large institutions,
whose failure would have systemic implications. Widely held ownership is
not just a Canadian ownership rule, it's a safety and soundness rule because,
all other things being equal, widely held institutions tend to be safer
than closely held institutions.
Mr. John Palmer (Superintendent, Office of the Superintendent
of Financial Institutions)
Where an individual holds an interest in more than one federal institution,
it is the combined equity of the institutions that will determine the appropriate
The Committee believes that this proposed regime offers a good compromise
between the conflicting ownership rules now in place and the size distribution
of existing institutions. Only Canada Trust and Great-West Lifeco violate
the proposed rules, the former because its 35% public float is not in the
form recommended by the Task Force, and the latter because it is closely
held and has equity in excess of $5 billion. The Report recommends that
the current ownership rules applying to both institutions be grandfathered.
Control of the institutions could change hands once without affecting the
grandfathering provision. Any subsequent change of ownership would require
eventual compliance with the new ownership regime.
Under this proposal, all of the big Canadian banks must continue being
widely held, as the smallest of the big five, i.e. the TD Bank, had equity
of $7.3 billion in October 1997. Sun Life and ManuLife, once converted
into stock companies, would also have to remain widely held. All other
financial institutions in Canada could continue to be closely held, some
with a 35% public float and some without. Some widely held companies such
as Canada Life and Mutual Life could eventually be closely held. And the
National Bank, Laurentian Bank and Canadian Western Bank could all choose
to be recategorized and become closely held.
This regime offers great scope for entrepreneurs to create and/or grow
their financial institutions into major players before having to give up
ownership control. The $5 billion limit for wide ownership is a level one-half
the size of the Royal Bank and the CIBC, the two largest Canadian financial
This new ownership regime could change the look of the Canadian financial
sector. There are, for example, currently a number of initiatives underway
between banks and retail chains that provide consumers with new ways of
obtaining financial services. Examples are PC Financial offered by Loblaws
and CIBC, the TD Bank/Wal-Mart marketing agreement, and the plan to have
ING deliver services through Canadian Tire stores. These initiatives create
new distribution channels, they do not create new financial institutions.
With the new ownership regime proposed by the Task Force, new possibilities
arise, a Loblaws Bank or a Wal-Mart Bank, for example. Such banks would
be truly new institutions, not just new ways of delivering the services
of existing institutions. There is no guarantee that firms would take up
the opportunity offered by the Task Force changes. As long as that flexibility
exists, however, the door to new entry is open.
As part of this proposed regime, the Task Force proposes a flexible
approach to the definition of wide ownership, which currently means no
individual or group of individuals may own more than 10% of any class of
shares. According to the Report, wide ownership is no longer to apply to
Schedule I banks but to apply instead to all large federally-chartered
financial institutions. Wide ownership guarantees Canadian control, something
that the Report sees as important to the preservation of Canadian jobs
and also vital to the service of the Canadian market. But wide ownership
also restricts institutions in their ability to forge alliances and make
acquisitions. As recognized by the Task Force, share equity is often a
currency that is used in corporate acquisitions. By limiting individual
shareholdings to 10%, the value of this currency to Canadian financial
institutions is diminished, especially when making very large acquisitions.
Consequently it recommends that the Minister of Finance be given the power
to permit somewhat more concentrated shareholdings in certain circumstances.
With global consolidation to achieve greater efficiencies a reality, the
Task Force attempted to facilitate the participation of Canadian financial
institutions in that trend. The Committee endorses the proposals contained
in recommendation 33.
Holdings in excess of 10% are not to be allowed for purposes of portfolio
investment, but rather as part of a business strategy designed to foster
alliances and acquisitions that would enhance the competitiveness of the
financial institution. Recommendation 33(b), that limits to 45% the total
shareholdings of individuals who have received permission to hold more
than 10% of any class of shares, limits the number of times that a financial
institution may use this strategy - it could have three shareholders with
15% each or two with 20%. Should a transaction that is in the public interest
be prohibited just because an exemption from the 10% rule has been used
previously? Consequently, the Committee believes that the intention of
any restriction, such as that found in recommendation 33(b), should be
The third part of recommendation 33 allows the Minister to temporarily
permit a shareholding in excess of 20% in certain circumstances, although
voting rights could not be exercised on the excess. Again, the Committee
agrees with the recommendation in principal, but we believe that it is
too vague. Does the Task Force have in mind a temporary shareholding of
25%, or 35%? The 45% limit in 33(b) would presumably include this temporary
excess and thus could work to prevent future strategic alliances. Again,
the Committee believes that the government should clarify the conditions
under which such an exemption would be granted and the consequences it
would have for financial institutions. It should also indicate the time
period in which divestiture is to take place. The Committee believes that
if the government were to accept recommendation (33), it should establish
parameters that would clearly define the limits of such discretionary power.
The Committee also supports recommendation 32(e) which states that "A
widely held, regulated financial institution that is incorporated in Canada
should be able to hold up to 100% of the shares of another regulated financial
institution, regardless of size. This is an interesting recommendation
that has some potential to effect profound change upon the financial sector.
It means that, subject to the merger review process, the large Canadian
banks could, for the first time in recent memory, be subject to a hostile
take-over bid by another bank or another widely-held financial institution.
While there is a very obvious size difference between the Schedule I banks
and Sun Life or ManuLife, it is not inconceivable that they could mount
a take-over bid for one of the current group of Schedule I banks. The ability
to mount such a challenge could be enhanced by the flexible definition
of wide ownership that the Task Force recommends.
As noted above, the new ownership regime proposed by the Task Force
includes a grandfathering provision that would allow Great-West Life and
Canada Trust to maintain their current ownership structure. Both could
grow and acquire other institutions, without their parents having to divest
Grandfathering still imposes certain restrictions on these two institutions,
however. Although both can acquire other institutions, neither may acquire
an institution with over $5 billion in equity, as such an institution must
be widely held. These rules do not restrict them from acquiring several
smaller institutions. Thus, referring back to the earlier chart, it is
evident that Great-West Life could buy Canada Life or Mutual Life, or even
National Bank. It could not buy ManuLife, unless its owner is willing to
sell its controlling interest in the insurance company. ManuLife, on the
other hand, could buy Great-West Life.
Canada Trust is also similarly restricted by these grandfathering provisions.
On balance, both these firms gain much more from the reforms proposed by
the Task Force than they lose from being subject to a new ownership regime.
The reforms envisaged by the Task Force open up a whole new array of options
in terms of acquisitions and powers. Their ability to grow into strong
institutions is heightened by the Task Force recommendations, not diminished
by them. The Committee therefore supports these grandfathering provisions.
The Task Force recommends a flexible and innovative ownership policy
for Canadian financial institutions. It would facilitate the creation of
strategic alliances, helping financial institutions become more competitive
in the Canadian market place and become world-class financial institutions.
It would allow entrepreneurs and commercial entities to own smaller institutions
and it would ensure that large institutions are free from commercial linkages
that, in some circumstances, could be damaging to the safety and soundness
of the financial services sector. With the Task Force proposals, the Governor-in-Council
would be able to consider foreign acquisitions of large Canadian institutions
in exceptional circumstances, if it is in the Canadian interest.
This new regime is structured to preserve domestic control of the largest
Canadian financial institutions. Indeed, there was virtual unanimity expressed
during our hearings on the need to maintain domestic control of our financial
services sector. New foreign entry was generally welcomed, but most thought
that the industry should be primarily Canadian and the largest institutions
should be domestically owned and controlled.
Canadian ownership of global concerns ultimately means keeping more
jobs in Canada. As a strong financial centre, we have the opportunity to
maintain and to continue to build a world-class talent pool, but if we
are held back and the giants to the South are able to penetrate our markets
while keeping many of those jobs offshore . . .where does that lead?
Mr. A. Charles Baillie (President and Chief Executive Officer,
Toronto Dominion Bank)
The Task Force defines a Canadian-controlled financial institution as
one " . . .managed by Canadian-based executives subject to Canadian
governance requirements and not subject to the direct influence of a dominant
foreign interest." 32
By this definition, an institution that is widely held by non-Canadians,
could still be Canadian controlled. Domestic ownership helps, however to
promote domestic control.
The Committee believes that domestic ownership and control has served
us well in the past and will continue to do so in the future. Canada is
not alone in ensuring domestic control over large financial institutions.
New Zealand, for example, stands alone among developed countries in having
its banking sector foreign-controlled.
Important benefits flow from Canadian control. The first benefit is
regulatory. By having decisions made in Canada, regulators can exercise
effective moral suasion in a way that would not be possible when decisions
are made elsewhere. As the Task Force suggests, it is the governance of
institutions that matters from a regulatory perspective. Domestic control
ensures that governance rests with Canadians, in Canada. Indeed, New Zealand
has essentially given up its direct supervision of financial institutions
in light of the fact that the industry is not domestically controlled.
There are other direct, economic benefits of a Canadian-controlled financial
services sector. It means institutions headquartered in Canada, with senior
management jobs here. Other high-quality and high-skilled jobs would also
be located in Canada, creating a large talent pool of Canadians with specialized
skills (lawyers, computer specialists, software analysts, marketing specialists,
lending officers, economists, accountants, etc.) There are, for example,
165,000 employees directly employed by the financial services sector in
the Greater Toronto Area alone. Canada's banks are major private-sector
employers. In 1997, the banks and their subsidiaries directly employed
more than 221,400 people in Canada. Without Canadian control, many of these
jobs would be located abroad. Canadian institutions largely serve international
markets from Canada, employing Canadians and paying Canadian taxes. Without
domestic control of our financial services sector, the reverse could easily
be true. Foreign institutions serving Canada from abroad, employing non
Canadians and paying taxes elsewhere.
A domestically controlled financial services sector also means more
sensitivity to the needs of Canadians. It has been argued that foreign
controlled institutions could withdraw from the Canadian market during
periods of weak economic conditions. Such behaviour was characteristic
of Japanese banks operating in the United States in the late 1980s.
Canadian control means more contribution and involvement in Canadian
communities. For example, Canadian banks donated $66 million to Canadian
charities in 1997. Through corporate giving and sponsorship initiatives,
banks contribute to programs in support of youth, education, health and
welfare, arts and culture and economic development.
Canadian-based financial institutions, headquartered in Canada, pay
taxes in Canada. In 1996, all financial institutions paid a total of $8.4
billion in federal, provincial and municipal taxes.
Finally, even though Canada is a small player in the world financial
services arena, it is important for us to have domestic financial institutions
participate and compete. Part of Canada's economic power is derived from
the presence in international markets of a strong, sound and safe, Canadian-controlled
financial services sector. Part of Canada's sovereignty comes from having
strong domestically-controlled institutions that are more likely to be
immune to the extra-territorial effects of foreign laws.
The Committee believes that control of Canadian financial institutions
should remain primarily in Canada. Non-Canadian institutions should of
course be allowed into our market. What is essential, however, is the ability
of domestic institutions to continue to prosper. As proposed by the Task
Force and endorsed by this Committee, the new ownership regime will be
more flexible. We believe it will act in the best interests of Canadians.
The most important way to keep domestic control of the industry is to
ensure that, in a world of increasing international competition, our domestic
institutions are able to compete and thrive. The greatest threat to a domestically-controlled
financial services sector is inefficiency and poor profitability. The Task
Force recommendations in general foster continued Canadian control as they
help in the achievement of enhanced competitiveness.
Many of our largest life insurance companies operate under a unique
ownership structure, whereby certain categories of policyholders have rights
that are somewhat akin to ownership rights. This mutual form of ownership
has protected the institutions from take-over but has also hindered their
ability to raise capital and therefore grow, whether internally or via
acquisition. Consequently, the largest mutual companies have announced
their decisions to convert from mutuals to stock companies.
The MacKay task force pointed out that it believed de-mutualization
will be in the best interests of the mutual companies, their policy holders
and the future evolution of the financial services sector. We believe that
this is true and our board has asked Canada Life to prepare a plan for
de-mutualization and we are actively engaged in doing that.
Mr. David A. Nield (President and CEO, Canada Life)
Like the Task Force, we support the government's proposals to allow
large mutual life insurance companies to convert into stock companies.
We also support the government's policyholder safeguard measures as well
as the desire to protect these companies from hostile take-over in the
period immediately following conversion. The Committee agrees with the
Task Force Report that converted companies should have more flexibility
in seeking affiliations that would enhance their own competitive position.
In ManuLife's case, given the quality of our franchises and the strong
potential of our businesses around the world the reality is that once demutualized
we, and in my view, other demutualizing companies would represent attractive
take-over targets. The task force has recognized this situation and has
recommended a three-year transition period free of hostile take-overs and
merger proposals. It is our view, however, that this is too brief a transition
period and that a five-year period would be a more realistic timeframe
in which to establish ourselves as strong, stand-alone public companies.
Mr. Dominic D'Alessandro (President and CEO, Manulife Financial)
A two-year transition period is proposed in Bill C-59. The MacKay Report
recommends a three-year transition. We reject the call to extend it to
five years as the MacKay recommendation provides an adequate transition
period. The Committee sees the transition period as one which protects
the newly-converted institution against certain circumstances, not as one
which confines the institution to a straightjacket, limiting its ability
to pursue business strategies. Just as these companies have expressed the
need to proceed with the demutualization process quickly, we believe that
the newly-converted companies should be able to expeditiously undertake
the business strategies that would allow them to better compete with the
bank-centred financial groups that now exist, as well as other foreign
conglomerates that have been formed or that are being formed. The financial
world is evolving rapidly. Delay can be costly. With two bank merger proposals
on the table, and consolidation taking place around the world, it is vital
that the rest of the sector be able to undertake the measures necessary
to permit the creation of new, strong competitors. Thus the Committee recommends
that the Minister be permitted to consider applications for amalgamation
or acquisition from the Boards of Directors of converted institutions during
the transition period. Such an application is not to be considered unless
it has been approved by shareholders.
Another component to the strategy to enhance competitiveness rests with
the proposal to allow financial institutions to organize themselves under
the umbrella of a regulated financial holding company. The parent holding
company would be a non-operating company whose sole purpose is to raise
capital that would subsequently support the activities of subsidiary financial
institutions. It would be subject to a very light form of regulation, with
OSFI being concerned primarily with transactions amongst affiliate institutions
and the parent and its subsidiaries.
Although the Task Force Report did note that the use of the holding
company model could permit more nuanced regulation, it did not specify
what these nuances would be. Indeed, the Report did not go very far in
exploiting the possibilities for regulatory reform that a financial holding
company model could permit. Many analysts have recommended the use of financial
holding companies as a way of targeting the appropriate form of regulation
to those activities that most deserve regulatory attention and relieve
from regulation those activities that do not present any prudential concerns.
By doing so, the use of holding companies could transform our regulatory
system to one that effectively regulated functions. This would lead to
greater regulatory consistency and resolve some of the imbalances that
currently exist, or that have the potential to arise.
The Committee believes that the Task Force could have gone further in
taking advantage of the opportunities presented by the use of the holding
company model. Indeed, the Task Force acknowledges that its quest for greater
competition could actually produce a competitive imbalance between domestic
and foreign financial institutions. The proposed financial holding company
model, as recommended by the Task Force, does not necessarily resolve this.
Just as competition should not be sacrificed to allow domestic institutions
to become more competitive, competitiveness should not be sacrificed in
the quest for enhanced competition. The Committee believes strongly that
competition and competitiveness are natural allies and financial sector
policy should reflect this.
The Committee is well aware of the benefits that the holding company
model could offer to smaller institutions wishing to form alliances with
other institutions, so as to better enable them to compete. We believe
this recommendation should be enacted quickly.
We are pleased that the task force agreed with our submission that
federally-regulated institutions should be given the flexibility to organize
into holding company structures. This would achieve a level playing field
with minimally regulated businesses in areas such as wholesale leasing
Mr. Joseph Oliver (President and CEO, Investment Dealers
Association of Canada)
The government could go further, however. While we feel that the model
has promise and should be pursued, we are struck by the general lack of
enthusiasm amongst the witnesses that we heard. Few financial institutions
and witnesses expressed great interest in it. Donald Stewart of the Sun
Life said "We believe there are potentially significant business advantages
to the holding company structure, including more efficient regulation,
greater flexibility for raising capital, and the potential for greater
value for shareholders of the holding company." Such enthusiasm was
The Committee recommends therefore that financial institutions that
take advantage of the FHC model be allowed to incorporate unregulated subsidiaries,
creating a consistency with the treatment of current unregulated holding
companies. This would also provide a greater consistency with the treatment
of foreign financial institutions which may enter Canada as both a regulated
financial institution and an unregulated institution. The Committee also
recommends that the regulation imposed on the FHC be as light as possible
and that over time, unregulated financial holding companies become regulated
ones. This would be triggered when such an institution is sold a second
The accounting rules that apply to Canadian financial institutions in
the face of certain types of consolidation have come under criticism because
the rules make it more difficult for these companies to undertake the transactions
necessary to become more efficient. These rules adversely affect the perceived
income of financial institutions, adversely affecting their market value
and therefore their ability to use share equity as currency in acquisitions.
They also create a bias towards mergers amongst equals.
Furthermore, these accounting rules produce an inconsistency in the
way that assets must be reported on the books and the way in which OSFI
views those assets for purposes of the capital base of financial institutions.
The Task Force suggested that Canadian accounting rules be changed in order
to eliminate the adverse impact they have on the ability of Canadian institutions
to restructure. (See recommendations 42 and 43.)
The most articulate observer of the problems associated with accounting
rules was Henri-Paul Rousseau of the Laurentian Bank. When financial institutions
of differing size merge, goodwill is created. That goodwill is not recognized
as part of the capital base by OSFI. It must, however, be included in the
assets listed on the corporate balance sheet, and then depreciated over
a certain period of time. This depreciation creates a charge against reported
income and, as a result the future reported profit stream of the institution
will be lower, and the market capitalization will likely be reduced as
well. In addition, the acquiring institution must satisfy OSFI that it
has sufficient capital to support its acquisition, at the same time that
it must write off some of the assets that it purchased. Mr. Rousseau summarized
the problem very well: "On the accounting side it is a recognized
asset, but on the regulatory side it is not an asset, so we create the
first difference between the accounting balance sheet and the regulatory
balance sheet. . . .[N]ot only do you need additional capital, but part
of the cash that you paid for has disappeared because we now recognize
the good will as an asset. This is a double-whammy situation we have."
These rules reduce the incentives for Canadian institutions to restructure
themselves, and create a competitive imbalance with American institutions
who are better able to restructure without the creation of depreciable
goodwill. While the generous American accounting treatment is likely to
change in the future, it will likely go to the UK model where goodwill
is treated as an asset but only expensed if it is impaired.33
The Committee was told that the CICA announced a few weeks ago that
new accounting rules should be in place by the Fall of 1999. The Committee
supports this initiative. In our view, a revision of the accounting rules
would not only enhance the competitiveness of financial institutions, it
could also help to enhance competition. Financial institutions wishing
to consolidate will have more options, domestically and internationally,
and not be forced into mergers of equals as is now the case.
Across Canada, co-operative financial institutions offer an alternative
to the for-profit, entrepreneurial institution that characterizes most
of the sector. Credit unions and caisses populaires account for 10% of
the assets held by deposit-taking institutions in Canada. Their strength
varies enormously from province to province, however. In both Quebec and
Saskatchewan, these co-operatives hold more than 35% of assets. In Manitoba
the share is 25%. In Newfoundland, Nova Scotia and Ontario, the share is
5% or less.
These data clearly illustrate the strength of the co-operative movement.
Its strength and appeal obviously varies across the country, however, reflecting
differences in social culture or market alternatives.
Nevertheless, there is a great deal of strength in the co-operative
movement. The question is, then, how to tap into this strength so as to
make them more competitive and hence add to competition? These institutions
are typically very small and thus suffer from the fact that they have not
been able to achieve economies of scale. Only in British Columbia, does
the average credit union have more than $200 million in assets.34
This is due to the fact that five credit unions have more than $900 million
in assets, with Vancouver City Savings having close to $5 billion in assets.
The average asset size in Alberta is about $50 million, while it is slightly
higher in Manitoba. In all other provinces, credit unions and caisses populaires
have less than $50 million in assets, on average.
The fact that they are co-operatives makes it difficult to raise capital
for growth. As a result of this small size, they are not able to take advantage
of the powers available to them - only 75% of credit unions offer a full
slate of services, for example. This is evidenced by the fact that credit
unions and caisses populaires earn fee income equal to about 20% of net
interest income. For banks, however, this ratio exceeds 50%,35
indicating that they sell a large volume of services other than direct
The restrictions that credit unions face are compounded by the fact
that they may not provide services across provincial boundaries.
There are two ways to address these problems. One solution that has
been proposed is the creation of one or more co-operative banks. (See recommendation
22) The Committee accepts this recommendation. As co-operative institutions
are effectively widely held we see no reason to deny them the option to
collectively own banks. This is consistent with current federal policy.
Citizens Bank is owned by Vancouver City Savings, a credit union. If a
single credit union may own a bank, why should a group of credit unions
not be able to do likewise? In addition, mutual insurance companies are
allowed to own banks, due to the fact that those insurance companies are
effectively widely held.
Finally, we note that the new ownership regime proposed by the Task
Force allows greater flexibility. Small institutions, i.e. those with less
than $1 billion in equity, may be owned by a single shareholder. Consequently,
a co-operative bank would not conflict with this proposed ownership regime.
When the proponents of such a co-operative bank appeared before the
Committee in Vancouver, they recommended that deposits be insured to a
maximum of $100,000. This was justified on the grounds that deposit insurance
for members of credit unions varies across the provinces and is often more
generous than it is for CDIC insured deposits. In some provinces there
is, in effect, an unlimited guarantee. Despite the fact that the Chairman
of the CDIC did not express any major objection to this suggestion, the
Committee rejects this. A co-operative bank would have all the powers of
existing banks. This is as it should be. Such a bank should enjoy no special
benefits and should be treated like other banks that are members of CDIC.
Not all credit unions, however, want to be part of a bank. For them,
it is more important that the federal and provincial legislation governing
credit union centrals be amended to allow them to provide better and more
efficient services to their members. The Co-operative Credit Associations
Act prevents this, however. The Committee endorses amendments to the
CCA Act and recommends quick action on the part of the federal government.
Thus we support recommendation 24 that would allow centrals to offer services
to individual credit union members, not just the credit unions, as is now
The other aspect restricting the ability of centrals to better serve
credit union members is the requirement that they must set up service corporations
to serve third parties, and then are limited in serving only financial
institutions that own a substantial stake in that corporation. These backroom
services enjoy significant economies of scale. A central can achieve such
economies of scale only by serving non-credit union institutions as well
as credit unions. The above noted restriction prevents them from achieving
these economies. Bill Knight of Credit Union Central of Canada clearly
summarized the problem " . . .[I]f Centrals wish to provide services
to other financial entities or wish to provide retail financial services,
they must do it through a subsidiary which they own. . . .This is extremely
costly in terms of the establishment of these subsidiaries." To achieve
economies of scale, credit union centrals should be able to incorporate
subsidiaries that offer services to other financial institutions without
requiring those clients to first make an investment in that service providing
subsidiary. We therefore support the changes recommended by the Task Force
We have earlier dealt with the impact of taxation on the state of competition.
Here we deal with the effects it could have on the competitiveness of financial
A recent study by Statistics Canada indicates that the financial
sector accounted for 25 percent of all corporate taxes paid in 1994 (compared
with 14 percent in 1988) and only 12.5 percent of total operating revenues.
From 1988 to 1994, the financial sector's contribution to total corporate
taxes roughly doubled, whereas the contribution of the non-financial sector
increased by 5 percent.
In 1996, the Canadian financial services sector paid more than $8.4
billion in taxes to federal, provincial and municipal governments. The
financial sector paid nearly 20% of federal corporate income tax even though
it represented only 17% of total corporate profits. The average tax rate
for deposit-taking institutions was 26%, (compared to 6% for the mining
industry, 12% for agriculture, forestry and fishing and 17% for the communications
The federal large corporations tax of 0.225 percent of capital is
applicable to companies with capital of more than $10 million, capturing
almost all financial institutions.
Federally regulated financial institutions are subject to unique corporate
taxes. In addition to the 0.225% large corporation tax imposed on corporations
with capital of more than $10 million in Canada, the industry is also subject
to unique federal and provincial capital taxes. The federal capital tax
(Part VI tax imposed on institutions with more than $200 million in capital)
has been imposed at a rate of 1.25% on deposit-taking institutions since
1986 and on life insurance companies since 1990. Unregulated financial
institutions are exempt. Since 1995, there has also been a temporary surtax
(Part VI capital surtax) imposed on the largest deposit-taking institutions
which is set to expire in 1999. There is also a graduated surtax for life
In 1996, regulated financial institutions paid $350 million in federal
capital tax and $522 million in provincial capital taxes.
Over 60 percent of the $872 million in capital taxes paid by financial
institutions in 1996 was collected by the provinces.
Capital taxes have numerous perverse effects. These taxes are counterproductive
since they increase the cost of capital, hence the cost of doing business.
Our financial services sector is less competitive as a result.
Capital taxes are also perverse from the point of view of sound prudential
management. Financial institutions are required to maintain capital for
prudential reasons, yet the tax produces incentives to minimize the amount
of excess capital they hold.
As mentioned in the Task Force Report,37
a small deposit-taking institution with only $10 million in capital, could
expect to pay $219,500 in annual capital taxes (2.2% of its capital base)
even if not profitable. This is particularly critical for new financial
institutions having no income against which to credit the capital taxes.
Under these circumstances, new entrants could be obliged to drain monetary
resources, undermining their strength.
With respect to taxation, I think the MacKay commission also said
that a capital tax was a bad tax. We certainly adhere to that point of
view, but, again, would like to make the point that there is again a discrepancy
here in our own treatment. The Mouvement Desjardins in Quebec doesn't pay
or pays very little capital taxes and we pay a lot. They start at the beginning
of the year with $100 million less taxes than we do. This is a big gift
on January 1.
Mr. Léon Courville (President, Personal and Commercial
Bank and Chief Operating Officer, National Bank of Canada)
Canadian banks paying the large corporations tax and the Part VI surtaxes
face a much higher effective tax rate than credit unions or non-financial
institutions. There is clearly not a level playing field in the tax treatment
of lending activity in Canada. This places them at a tax-induced competitive
disadvantage in the domestic marketplace.
Capital taxes are costly to comply with due the lack of co-ordination
among the various governments. The capital tax base varies from jurisdiction
to jurisdiction. The Task Force also raises the issue of the effect that
cascading taxes such as the GST, sales taxes and premium taxes can have
The Committee agrees with the general observation that the level of
taxation of Canadian financial institutions is damaging to their competitive
position and is increasing costs to Canadian users of financial services.
It is urgent that the government introduce a method of taxing financial
institution that is fair, appropriate and reflects the real economic activity.
Robert Astley of the Mutual Life Insurance Co. identified the true problem
when he told the Committee: " . . .I would argue for an effective
income tax regime to supplant and replace a capital tax regime that has
all the wrong incentives built into it".
The imposition of the capital taxes penalizes those institutions
whose operating principles call for higher levels of capital for the protection
of their consumers. We endorse the task force recommendation to eliminate
the special capital taxes and look to legislators to take action in this
Mr. Richard May (Vice-President, Canadian Fraternal Association)
The recommendations made by the Task Force relative to capital taxes
and cascading taxes (see recommendation 44) should be acted upon as soon
as the budgetary position of the federal and provincial governments will
allow. Recommendations 44 b) (ii) and (iii) do not have adverse revenue
implications for governments.
As mentioned earlier, capital taxes can be seen as a significant barrier
to entry for new and smaller institutions. The Task Force proposes a 10-year
holiday for new financial institutions from federal capital taxes (see
recommendation no. 5). The Committee does not support this recommendation,
in light of what was just recommended, i.e. the replacement of capital
taxes by profit-sensitive taxes. Even though what is recommended by the
Task Force would favour new entrants and likely increase competition, all
the perverse effects of the actual special capital tax on existing financial
institutions would remain. For example, as stated by Mr. Gerald Soloway
of the Trust Companies Association of Canada: " . . .[C]apital taxes
are a significant barrier to entry for smaller institutions. We would say
why limit a ten-year holiday for capital tax to new institutions. We would
suggest both existing and new members of this sector need this kind of
support. We believe the government needs to go further and eliminate capital
taxes for small institutions both new and existing."
Furthermore, if defined broadly, this tax holiday could benefit foreign
financial institutions (including large deposit-taking institutions), further
enhancing the unlevelled playing field observed in the domestic market.
Finally, it remains to be seen what the definition of a "new"
financial institution would be. Would it only be Canadian-controlled institutions?
Would it apply to subsidiaries in which a financial institution held only
a small interest?. The immediate solution lies in recommendations 44 b)(ii)
and (iii) and not in further enhancing the unlevelled playing field. In
the long term, the priority should be recommendations 44 a) and 44 b)(i)
that deal with neutrality of the tax system and the elimination of special
capital taxes imposed on financial institutions.
CHAPTER 4: FINANCIAL SECTOR CONSOLIDATION AND THE MERGER REVIEW PROCESS
Around the world, financial institutions are consolidating their activities,
repositioning themselves to face a new market environment. Not only are
they merging with other domestic financial institutions but they are increasingly
aiming at institutions operating in the rest of world. Grant Reuber of
CDIC described this as ". . .an era of turbulence in the financial
services sector everywhere in the world." This new dynamic environment
is characterized by the arrival of world-wide mega-financial institutions.
The face of international banking is being transformed by the wave of
mergers and acquisitions sweeping across Europe, North America and Asia.
An accelerating world-wide consolidation movement exists in the financial
services industry, with an estimated 4,000 mergers and acquisitions taking
place globally every year.38
In Europe, many important mergers and acquisitions have been announced
since 1997. These include Unicredito/Credit Italiano (April 1998), Generale
Bank/Fortis (May 1998), UBS/SBC (December 1997), ING/BBL (November 1997),
Crédit Suisse/Winterthur (August 1997) and Vereinsbank/Hypobank
The forces driving consolidation in European banking are numerous:39
overcapacity in the industry, increased competition from US powerhouse
banks, loss of national protection, deregulation, weak earnings growth
in many banking sectors and rising demands on the part of shareholders
for better returns. The imminent arrival of the European Monetary Union
is magnifying these forces.
European bankers argue that size matters. They believe that European
banks need the increased scale to spread growing information-technology
and processing costs over a larger revenue base. Another important key
driver behind many bank mergers in Europe is the need for greater market
capitalization. European governments and their regulators appear to have
accepted the view that greater size is crucial to cost cutting and the
creation of strong banks.
In Europe, governments in smaller countries such as Holland and Belgium
have encouraged their banks to consolidate to improve efficiency and ensure
that their industries can remain strong in the face of growing competition
from much larger financial institutions in neighbouring countries.
Mr. Al Flood (Chairman and Chief Executive Officer, Canadian
Imperial Bank of Commerce)
In the United States, things are also moving very rapidly. Within a
three-day period in April of this year, three major mergers were announced:
the cross-country marriage of NationsBank/ BankAmerica, the mid-west linking
of First Chicago NBD/BancOne and the Travelers Group acquisition of Citicorp.
Since then, Wells Fargo announced an agreement with Norwest. To partially
complete the list of mega-mergers that took place over the last 18 months
in the United States, one would have to add the mergers announced by National
City/First of America, Salomon/Travelers and NationsBank/Barnett Bank,
as well as all the mergers between US banks and securities firms (such
as BankAmerica/Robertson Stephens, NationsBank/Montgomery Securities and
Bankers Trust/Alex Brown).
As a measure of the pace of consolidation, between 1980 and 1997,
the total number of banking organizations fell from 12,333 to 7,122 in
the United States. This was accompanied by an increased concentration of
the market, as illustrated by the fact that the percentage of total deposits
held by the top 25 organizations rose from 29 percent to 47 percent over
that same period.
The trend in the United States can be explained by many reasons, such
as the belief that size matters in order to compete in a global banking
environment, pressure for increased spending on information technology,
economies of scale in areas such as asset management and global custody,
pressure to cut costs in the domestic market by consolidating overlapping
organizations and the advantage of having banking and other financial services
provided under one roof. There is also a uniquely American force at work,
namely the elimination of the longstanding prohibition against nation-wide
The total value of bank-related mergers in the US in 1997 was US$73.5
billion, roughly double that of 1996, despite the fact that the number
of consolidations fell from 357 to 304 between 1996 and 1997. This is partly
explained by the record premiums paid for new acquisitions in 1997.
As the corporate clients of banks, and their financing needs, become
increasingly global, and as technological innovation continues, the pressure
to merge is becoming more powerful. Not only are financial institutions
trying to realign themselves by merging across business lines and within
domestic markets, they are increasingly attempting to cross international
borders. For years now, financial institutions have been looking at foreign
financial institutions as possible take-over targets. For example, the
Dutch Bank ABN Amro owns LaSalle National Bank of Troy New York, Midland
Walwyn was recently bought by Merrill Lynch and the Bank of Montreal previously
bought Harris Bank of Chicago. This trend is not about to end. Many American
financial institutions are prime take-over targets, for example: UBS of
Switzerland is looking to buy JP Morgan; ING Group of the Netherlands is
looking at Lehman Brothers; Dresdner Bank of Germany is apparently interested
in buying Paine Webber.
[L]ast quarter we saw Nations Bank commit to two loans of almost
$4 billion Canadian each. At our size, we would only be able to commit
to around half that amount on a single loan. The fact is that as more and
more of our clients merge they will be seeking larger loans. Larger banks
are better positioned to provide these loans.
Mr. A. Charles Baillie (President and Chief Executive Officer,
Toronto Dominion Bank)
As the Committee is writing this report, Deutsche Bank, Germany's largest
bank, is about to complete a take-over of Bankers Trust, the eighth-largest
bank holding company in the United States. This transaction is valued at
$9.7 billion US. At the same time, rumours in Europe suggest that French
insurer Axa and American bank Chase Manhattan both see Barclays PLC, Britain's
second largest bank, as a take-over candidate. GE Capital Services is negotiating
to buy Long-Term Credit Bank of Japan Ltd. Swiss Re, the world's second-biggest
life and health re-insurer, has just acquired Life Re Corp. of the United
States for about $1.8 billion US.
According to a March 1998 report by two Bank of Canada economists
profitability, not size, is the most important factor for the success of
banks. According to Fortune magazine three of our big five banks, the Royal
Bank, CIBC and the Bank of Montreal are among the top 15 profitable banks
in the world and they're more profitable than five of the ten largest banks
in the world.
Mr. Leo Broderick (Member of the Board of Directors, Council
A recently published report by the Bank of Canada argued that "many
large financial institutions are turning themselves into large financial
conglomerates by means of mergers, acquisitions, and strategic alliances,
instead of continuing to operate as relatively specialized institutions.
Some of the very largest institutions will try to become global financial
conglomerates, offering all types of services to all types of customers
in all or virtually all major financial centres. There is, however, probably
room for only five to ten such global institutions world-wide. The rest
will probably have to specialize in certain areas."40
No one knows exactly where all this consolidation will lead the world financial
All of these recent and past mergers have presented public policy makers
in other countries with the same dilemma that large-scale mergers would
present in Canada. How can the desire to create strong and efficient domestic
institutions through consolidation be reconciled with the desire to protect
consumers and maintain competition? Public policy in many countries has
evolved, with mergers, even very large ones, becoming more acceptable to
governments. Switzerland and the Netherlands are notable examples of nations
where governments have allowed mergers to take place so as to create truly
large and international financial institutions. In Australia, the Financial
System Inquiry rejected the notion that large institutions should not be
allowed to merge (the Australian equivalent of "big shall not buy
big"). The government has, however, stated that mergers would not
be allowed until competition was enhanced in the domestic market.
Even though these three nations are taking different approaches to mergers,
their bank concentration ratios are not substantially different, and do
not differ substantially from that found in Canada. Recent merger behaviour
is not, therefore, the dominant determinant of bank concentration. Indeed,
when we see concentration measures well outside of the Canadian norm, it
is generally factors other than mergers that are important. A perfect example
of this is the United States, where national concentration ratios are low
simply because of the historical policy that prevented the creation of
The banking and life insurance sectors in Canada are both highly
concentrated in terms of market share, capital employed and profitability.
The five largest banks account for over 85 percent of banking sector profits,
and with the recent mergers in the life insurance sector, the five largest
life insurance companies' share of the life sector's profits will likely
begin to approach that of the five largest banks.
Canada cannot isolate itself from the effects of the world consolidation
trend, nor can it isolate itself from the pressure to consolidate that
financial institutions face. Instead, it is vital that regulators put in
place a policy framework that will allow our financial services industry
the freedom to make the best business decisions possible and take advantage
of the best business opportunities that are consistent with the public
interest. Canada's financial services sector is about to face major new
consolidation, according to Edmund Clark, CEO of Canada Trust. He believes
that ". . .some further consolidation is inevitable in Canada, and
is in the public interest in order to ensure strong Canadian-based institutions."
The Canadian financial services sector has seen significant consolidation
in the past. One need only look at the Canadian trust companies, brokerage
services and life insurance companies to see the significance of this trend.
There have been over 350 mergers and acquisitions in the Canadian financial
services sector in the last 10 years. What is new with the two proposed
mergers is the magnitude of the consolidation41.
Source: The Conference Board of Canada, The Canadian Financial Services
Industry: The Year in Review, 1997 Edition.
The Committee's task in undertaking this study was clear. We did not
have the mandate to examine the two proposed bank mergers per se, but to
examine the recommendations contained in the MacKay Task Force Report.
Many witnesses nevertheless tried to convince the Committee in favour of,
or against, the proposed mergers. The merger issue could have skewed the
consultation process and important recommendations would have been left
by the wayside had the Committee succumbed to the pressure to address those
Let me also say outright that we support the bank mergers. We support
them because we believe in free markets and we believe that size is important
in today's global, financial markets. In many respects we wish it weren't
so, but it is.
Mr. David Banks (Chairman, Newcourt Credit Group)
Pro-merger witnesses referred to economies of scale (especially in the
area of technology spending), economies of scope, reduction in costs through
the elimination of overlapping networks, revenue gains from a broadened
product range, the need for an increased capital base, the effects of increased
competition from monoline foreign banks, the ability to compete in global
markets, the growth of stronger international competitors, and the possibility
of lower prices and better service for consumers.
Canada can approve the proposed mergers and thereby give the bank
and other financial institutions the ability to achieve the scale and the
productivity they need to grow, to compete and to fund the nation-wide
full-service, multiple-access banking system Canadians have always known.
Mr. Matthew Barrett (President and Chief Executive Officer,
Bank of Montreal)
Merger opponents referred to reduced competition (translating into reduced
services, limited choices, higher service charges, less lending to SMEs,
the negative impact on small communities, and imminent branch closures),
reduced employment and the increased concentration of economic power.
First of all the bank mergers will kill jobs in our communities.
If the bank mergers go ahead the banks already have flatly refused to protect
jobs. We can look to the Americans to tell us what to do about bank mergers.
In that country when banks merge, and quite recently up to 30% of employees
were dismissed. If that happens in Canada tens of thousands of Canadians,
and the industry is saying as many as 30,000 could lose their jobs.
Mr. Leo Broderick (Member of the Board of Directors, Council
While the Committee resisted the pressure to debate the proposed mergers,
the issues raised by witnesses are nevertheless the ones that will need
to be addressed by any future review of consolidation proposals.
The impact of bank consolidation in rural communities is uncertain.
In the face of bank mergers, the American experience has been often a result
and reduction in lending to local businesses.
Ms. Carol Rock (Executive Director, Women in Rural Economic
Most research has concluded that economies of scale and scope are
limited for large financial institutions. ...for a traditional large multi-product
bank, efficiency gains from growth in size are limited. Neither were economies
of scope found to be important; in fact, in some instances movement into
new products was associated with cost increases.
It is far from certain that size and efficiency are positively correlated.
Larger multiple-line financial institutions might not be as innovative,
flexible and responsive as smaller multi-line institutions or larger monoline
financial services provider. As argued in the technical paper published
by the Bank of Canada: ". . .the key issue may not be so much the
size of financial services providers, but rather the nature of the activities
In work prepared for the Task Force, a sample of 125 U.S. banks revealed
no clear relationship between efficiency and size Neither did there appear
to be much correlation between the size and efficiency of the six major
The evidence on economies of scale suggest that efficiency gains based
on size are generally exhausted at asset levels well below those of the
big Canadian banks, although smaller institutions such as credit unions
clearly could still enjoy such economies through consolidation. But the
argument that large institutions cannot achieve efficiency gains through
mergers is not conclusive. As the Task Force argued ". . . the dynamics
of today's business environment may be changing the relationships between
size, costs and profitability"43.
It is possible that the economic literature that fails to demonstrate economies
of scale is based on data that does not take into account the factors that
are relevant today and that will be relevant in the future. As the Governor
of the Bank of Canada told the Committee, ". . .the evidence on this
point really doesn't allow you to come to a hard conclusion. . .yes there
are economies of scale up to a certain point but after that we're just
not sure. It's also true that a lot of the changes with respect to technology,
at least the major ones, are quite recent and a lot of the analysis is
looking at somewhat older information. So you don't want to be too adamant
on the point but you can't go to the other side and say we can find economies
of scale for megabanks."44
This point is further developed in one of the Research Reports prepared
for the Task Force. According Donald McFetridge, "the widely held
and well documented view that there are no significant economies in banking
is of U.S. origin and is drawn from a period in which banking technology
(both product and process) was changing less rapidly, U.S. banks were limited
in the ways they could expand and in the additional financial services
or products they could offer."45
A major challenge for our industry is that our productivity, which
is measured as the ratio of our non-interest expenses to our revenues,
is consistently worse than that of the best United States and international
financial institutions and as the MacKay report points out, this difference
has tended to widen in recent years. The reason is that our industry has
increasing difficulty in funding the massive investment required by new
technologies compounded by the continuing high costs of maintaining traditional
bricks and mortar branch distribution networks alongside these new alternative
Mr. Matthew Barrett (President and Chief Executive Officer,
Bank of Montreal)
The evidence on the effects of mergers is inconclusive. The Committee
believes that one should not just look at the state of the industry today
and what consumers now demand. One should not rely too heavily on yesterday's
data. Even the best academic analysis cannot capture the insight of market
participants whose decisions require a vision of the future and an understanding
of the challenges and opportunities that market forces present.
First of all, these mergers are not necessary, since Canada's major
banks' studies show quite clearly, have already achieved the size necessary
to achieve the kinds of economies of scale that could be useful in the
banking sector. Moving beyond that is not necessary. The mergers are not
helpful, because again, the empirical evidence doesn't support the contention
that mergers will increase efficiency and reduce cost to consumers, nor
will the mergers improve access to service.
Mr. Peter Bleyer (Executive Director, Council of Canadians)
Mergers should be judged in the context of tomorrow's expectations.
The world is an ever changing market-place where what could be perceived
today as contrary to the public good and the interest of the financial
services sector could be essential to tomorrow's success.
Mergers and acquisitions are not ordinary business transactions and
the financial services sector is not an ordinary industry. Mergers of large
financial institutions could have profound economic implications. They
can affect the overall safety and soundness of the Canadian financial sector
and can affect the access to capital for certain segments of the economy.
Consolidation can mean new entrepreneurial opportunities for some and lost
opportunities for others. In the long-run, it can mean better positioned
financial institutions, able to successfully face global competitors and
thus create jobs in Canada. On the other hand, they can also mean less
competition in the domestic market. It is important, therefore, that a
review process be in place to assess the effects that consolidation could
have on our economic well-being.
The other road is to say no to mergers, to say big shall not buy
big, to say our institutions are already big enough for Canada, and to
rule out our competing effectively in world markets. Canadian financial
institutions would also see their domestic shares dwindle, squaring off
against much larger foreign-owned competitors. That would be a valid choice
if your vision for Canada does not encompass excellence.
Mr. A. Charles Baillie (President and Chief Executive Officer,
Toronto Dominion Bank)
The Task Force Report recognizes that consolidation is a legitimate
business strategy. It recommended that mergers and acquisitions should
not be automatically barred. Indeed, a number of the measures included
in the Report are designed to promote and facilitate consolidation amongst
Recommendation 45 argues against the implicit "big shall not buy
big" policy that has been in place since 1990. The Committee agrees
that there should be no policy that automatically prevents large financial
institutions from entering into business consolidations with other large
institutions. Decisions to amalgamate or acquire should be viewed as legitimate
business decisions. Earlier in this Report, we referred to the evidence
that indicates rapid evolution in the sector. Financial service providers
will have no choice but to adapt. How institutions adapt is a decision
that they can best make. It is not up to governments to micro-manage financial
institutions. It is, however, essential that government give priority to
the protection the public interest. That interest is best protected by
a rigorous and objective analysis.
The role of the government should be to review the public policy aspects
of mergers and ensure that these restructuring initiatives are in the public
interest; not to apply across-the-board policies that prejudge mergers
and acquisition proposals. The "big shall not buy big" policy
can lead to bad public policy choices, hence the Committee strongly supports
If the government is concerned about excessive concentration resulting
from the bank mergers it should seek a structural remedy such as divestitures,
rather than seek to regulate prices and other terms of business. . .The
more conditions such as price reductions are imposed as part of the merger
approval process, the greater the investment of assets of the merging partners
must be, in order to even out the playing field.
Mr. Edmund Clark (President, Canada Trust)
The Task Force Report recommends (see recommendation 46 to 52) a multi-step
approval process for significant mergers. Such a process would include
investigations by the Competition Bureau and the Office of the Superintendent
of Financial Institutions.
The Competition Bureau is responsible for reviewing the impact on competition
of a merger or a acquisition under the Competition Act. It could
suggest remedies that would address any concerns that the Bureau has. The
Committee believes that this stage of the process should be co-operative
and allow merger proponents to respond to the Bureau's concerns.
The Superintendent of Financial Institutions will also evaluate significant
merger proposals, and report to the Minister of Finance any prudential
consequences that might arise. The safety and soundness of our financial
system is of the highest priority, and proposals should only be allowed
if they pass this test. One of the factors OSFI should address is whether
the "too big to fail" doctrine produces serious moral hazard
problems. As with the Competition Bureau examination, we believe the Superintendent
should be able to suggest remedies to alleviate his concerns and merger
proponents should be able to respond to these remedies in a timely fashion.
The Committee believes these two steps in the review process to be crucial
elements that will guide the Minister of Finance. Competition, and safety
and soundness are the most important elements in determining the public
We urge substantial additional due diligence by the government. As
the MacKay task force aptly observed, once a bank merger has been approved,
it cannot be unwound. An important element of the due diligence process
involves the task force recommendation that the Minister of Finance call
for a public interest impact assessment from each merger proponent. CRBSC
clearly urges that this step be taken.
Mr. Stephen Johns (President, Canadian Retail Building Supply
If there are no competition or safety concerns, mergers and acquisitions
should be approved unless demonstrated to be counter to the public good.
The Task Force recommends a new step in the approval process: a public
interest review. This third component would address broader public policy
interest considerations. As part of that public process, merger proponents
would be requested to produce a Public Interest Impact Assessment. Based
on the evidence collected and analyzed, and after stakeholders have had
an opportunity to make their representations, the Minister of Finance would
decide whether or not to permit or reject a proposal.
Under this process, the Minister would approve a merger proposal only
if he or she is of the opinion that competition in financial markets would
not be adversely affected, that there are no safety and soundness concerns
and that the transaction meets the broad public interest. The Task Force
envisages the Minister having the legislative authority to obtain enforcement
undertakings from merger proponents, including the power to impose sanctions
for non-compliance with those undertakings. (See recommendation 52)
As part of the public interest assessment, the Task Force recommends
that the Minister of Finance use a short list of criteria to assess the
cost and benefits to Canadians and the industry. These criteria would have
to be addressed in the Public Impact Assessment that proponents produce.
The Task Force recommends criteria such as the cost and benefits to consumers
and to SMEs, regional impacts, international competitiveness, the employment
impact, the adoption of innovative technologies, whether the transaction
creates a precedent and any other public interest considerations deemed
necessary by the Minister of Finance.
The Committee recommends one amendment to the criteria recommended by
the Task Force. The Committee believes that the examination of employment
effects should look at not just the short-term impact but also the long-term
effect on employment. Moreover, employment should be evaluated not just
in terms of the direct effect on the consolidating institutions but also
in terms of the indirect effects it would have elsewhere in the economy.
It is clearly in the public interest to consider the impact of a transaction
on employment in Canada. But is it in the public interest to require that
a merged institution have the same level of employment as the sum of the
separate entities prior to consolidation? What if a trend to reduced unemployment
is already in evidence? If the consolidation is expected to foster growth
and innovation in the economy, leading to more and better-paid jobs for
Canadians here and abroad, should it receive a failing mark because some
restructuring takes place? And should the review process give strong weight
to short-term effects, over longer-term effects?
The Committee believes that such an approach would be misguided. Indeed,
it would be inconsistent with the whole idea of competition that the Task
Force and the government endorse. Competition always leads to a certain
amount of adjustment, as resources move from those sectors that fail to
respond to consumer demands, to those that do. The transition of the Canadian
economy from one based on natural resources to one based on knowledge also
leads to a certain amount of dislocation. Free trade had the same result.
It is this process that allows labour and capital to move to more productive
The Committee agrees with the list of criteria recommended for the public
interest assessment, as amended above. In fact, no witness identified missing
criteria from the proposed short list, nor did any witness suggest that
a particular criterion should be dropped.
As we said earlier, large-scale consolidation of financial institutions
affects the public interest in a way that other consolidations do not.
Hence a public review process is appropriate. It is extremely important,
however, to clearly define the public interest.
At the start of this section we identified some of the motives that
are fostering the consolidation movement in financial institutions around
the world. The reader will likely disagree with several of them. Parliamentarians
will likely feel some are without merit as well. But these are business
decisions and it is up to the shareholders of financial institutions to
judge the merits of those decisions. The government should get involved
in the process when the public interest is at stake, with respect to competition,
safety and soundness and the broader public interest criteria. While the
line between business decisions and public policy concerns is sometimes
blurred, it is extremely important that we avoid crossing it.
So our one recommendation is to make sure that there is a public
impact statement that does not come, at best, from an institutional point
of view but begins to ask the questions the customers are asking, the business
customers are asking, the manufacturers and exporters, the retailers, other
business customers are asking about what the impact of these mergers would
be on their business.
Jayson Myers (Senior Vice-President and Chief Economist,
Alliance of Manufacturers and Exporters)
The Committee agrees with the recommended Public Interest Review Process.
This process should apply only in the case of large financial institutions
(i.e. where the merger involves institutions with more than $5 billion
in equity or creates an institution with more than $5 billion in equity)
or if otherwise considered necessary by the Minister of Finance. The Committee
agrees that smaller transactions that pose little risk to the public good
should be exempt from the review process. In addition, in the case of a
failing financial institution, the expeditious completion of a transaction
could safeguard the safety and soundness of our financial system. Hence,
the Committee agrees that the Minister should be empowered, following a
recommendation by OSFI, to rapidly approve a merger or acquisition proposal
and avoid the recommended review process.
As part of that review process, the Task Force recommends that merger
proponents submit a detailed Public Interest Impact Assessment outlining
their business plans and objectives, and identifying the public benefits
and costs of the proposed transaction. The proponents would also have to
indicate what steps they are prepared to undertake to mitigate undesirable
effects of the transactions (e.g. commitments to SMEs, rural areas, divestitures,
etc.). The Committee recommends that the government set out clearly what
is expected from financial institutions in terms of the information contained
in the impact assessments. The Public Interest Review Process should assess
mergers and acquisitions on a case by case basis.
To be successful, this process must be objective and co-operative. It
must include third-parties not directly involved in a proposed transaction.
Some have suggested that the public interest review process include public
hearings. The Task Force did not make any recommendations in this regard.
The merger review framework must be an efficient process. We believe
that the third step in this process should be required only after the first
two steps have been successfully passed. This sequential approach should
not delay the process. Once the Minister of Finance issues the appropriate
guidelines, merger proponents would likely prepare a Public Impact Assessment
as merger proposals are being developed. This sequential approach ensures
that a potentially costly third step not be undertaken unless it is needed.
In a business environment evolving rapidly, where consolidations take place
regularly, unreasonable delays in the public policy decision process could
mean lost opportunities. Hence the Committee recommends that the Bureau
of Competition and OSFI render their decisions in a timely fashion after
receiving an application. In Switzerland, for example, the Swiss Cartel
Commission sets a timetable of 120 days. The Public Interest Review Process
should also be undertaken expeditiously. Once the review process is completed,
the Minister would be expected to render a decision quickly. A fast, effective,
exhaustive, co-operative and transparent process will guarantee that the
financial services sector is able to adapt rapidly to new realities and
seize the best business opportunities. It will ensure that shareholders
have the right to a rapid approval or rejection of a consolidation proposal.
It will also provide Canadians with a mechanism to seek the best public
The Minister of Finance will need clear authority and powers to accept
and legally enforce, through the Governor in Council, undertakings from
merger proponents. If these commitments are not met, the Task Force recommends
sanctions be imposed for non-compliance with undertakings. The Committee
agrees. But while sanctions are important, the Committee also believes
that public disclosure by the Minister of any failure to comply, and the
expected public outrage that this would provoke, would act as an important
deterrent to non-compliance. As in many other situations, exposure to sunlight
is a potent antiseptic.
The Task Force made recommendations as to what the public interest assessment
should examine, but it did not recommend how that process should be conducted.
Will there be public hearings? Who will conduct them? Will it make use
of expert testimony and analysis? These are important questions that need
to be addressed and the Committee believes that a structured framework
should be developed, within which this review will be conducted.
The Committee's recommendations regarding the Task Force's Merger Review
Process are summarized below.
The Committee believes that mergers and acquisitions are a legitimate
business strategy in the financial services sector as long as they are
in the public interest.
The Committee recommends that there be a three-part merger review process
in order to determine if consolidation proposals are in the public interest.
- Step 1 would require that the Competition Bureau be satisfied that
any proposal does not violate the Competition Act and does not pose
a threat to competition.
- Step 2 would require that the Superintendent of Financial Institutions
be satisfied that any proposal poses no safety and soundness concerns.
The Committee recommends that remedial options be pursued actively and
co-operatively with the consolidation proponents. These proponents should
be able to respond in a timely fashion to any remedies put forward by the
Competition Bureau or the Superintendent of Financial Institutions. Upon
the successful completion of steps 1 and 2, the merger review process would
proceed to the final step.
- Step 3 would comprise a Public Interest Review Process, including a
Public Interest Impact Assessment. The Task Force recommended that the
following specific elements be included in this assessment:
- The costs and benefits to individual customers and SMEs.
- Regional impacts.
- International competitiveness.
- Employment, including both short run and long run effects as well as
direct and indirect effects.
- The adoption of innovative technologies.
- Precedential impact.
The Committee recommends that the Minister of Finance issue guidelines
that would describe how the review process is to work and make clear what
is expected of consolidation proponents. The process should satisfy the
following three criteria:
- It should be transparent so that the public can assess the benefits
and costs of consolidation proposals.
- It should be efficient so as not to delay the approval process
and impose undue costs and uncertainty on participants.
- It should be co-operative so that all parties work together
to ensure a solution to the benefit of all Canadians.
The Committee endorses the Task Force view as to when step 3 would be
required. Thus the Committee recommends that the Public Interest Review
Process be required for all proposals that involve, or would create, institutions
with more than $5 billion in equity. We further recommend that the Minister
of Finance should also have the option of requiring a Public Interest Review
Process for merger proposals involving smaller institutions. To ensure
that the three objectives noted above are satisfied, it is important that
the Minister issue guidelines so that financial institutions contemplating
consolidation know precisely what is expected of them.
The Task Force recommended elements that should be considered in such
a review but did not suggest how it should be conducted. The Committee
believes that it is important to specify the mechanics of this process.
CHAPTER 5: REGULATION
As in other aspects of the financial services industry, Canada enjoys
both advantages and disadvantages in the way its regulatory system has
been structured. We have a stability that the United States does not. We
have a history of reforms that have allowed the sector to develop in response
to consumer demands, again unlike the United States. And Canada has developed
a national financial services sector with a payments system that is the
envy of the world. The development of a national banking market has benefited
from the fact that banking is solely under federal jurisdiction.
Having worked for an American bank before and seeing regulators on
both sides of the border, we can be proud of the level of regulation and
the best practices adopted in this country.
Mr. John Cleghorn (Chairman and Chief Executive Officer,
Royal Bank of Canada)
On the other hand, we have not been as open as the United States to
new financial sector entrants and we suffer from a fragmented system of
regulation of the securities industry. This fragmentation is problematic.
Increasingly, the economy is turning directly to capital markets for the
financing of business needs. As well, consumers are increasingly turning
to those markets for savings opportunities. Here, the provinces are the
regulators and a national market is still far from a reality. And as international
co-operation becomes increasingly vital in a world of rapid globalization,
the regulatory framework in Canada may be at a disadvantage. Our decentralised
regulatory regime for investment securities makes our system expensive
and fragmented. One can simply look at the recent take-over of Fonorola
by Call-Net to understand how inefficient and conflicting securities regulations
Clearly, with ten separate securities regulators in Canada and, indeed
there are 12 if you count the securities regulators in the territories,
there is concern about the potential for regulatory fragmentation of what
is essentially one capital market.
Mr. David Brown (Chairman, Ontario Securities Commission)
For years there has been talk of a National Securities Commission, but
the provinces have never been able to reach an agreement. The Committee
was very pleased with the recent announcement of a new Canadian Securities
Service where issuers will be able to submit prospectus filings, registrations
of stockbrokers, insider trading reports and other documents that until
now had to be filed with each provincial regulator. If successful this
partnership initiative should benefit issuers and Canadian investors.
The primary reason for financial sector regulation has been the desire
to ensure a safe and sound financial sector, both at the level of individual
institutions and at the level of the sector as a whole. Increasingly, the
market conduct of institutions is also being regulated for the protection
of individual consumers. This is due to the growing complexity of financial
instruments and the need, therefore, to protect consumer interests.
Nevertheless, prudential regulation, i.e. that which is concerned with
safety and soundness, is still the most prevalent type of regulation. It
is designed to minimize systemic risk. Most consumers cannot adequately
assess the solvency of the financial institutions with which they deal.
Thus government plays a vital role as collective overseer of financial
institutions and the financial system.
The economic rationale for prudential regulation is based on the existence
of externalities in the financial services sector. If one institution suffers
financial difficulties, that difficulty could be transmitted to other sound
institutions via a general run from financial institutions. This is also
called systemic risk. The traditional function of deposit-taking institutions
has been to fund illiquid long-term assets (e.g. commercial loans) with
very liquid short-term liabilities (e.g. demand deposits). If the failure
of one institution leads depositors to withdraw funds from other institutions,
their illiquidity could lead to their insolvency. A single troubled institution,
especially if it is relatively large, could destabilize the entire sector,
threaten the savings of Canadians and severely hamper the ability of the
economy to function properly.
As this risk rests primarily with deposit-taking institutions, a system
of deposit insurance was instituted three decades ago. This, in itself,
is thought to assist in preventing systemic runs. But it has introduced
its own set of new risks to the financial sector, namely the moral hazard
that is created when depositors feel they have no need to be concerned
about the financial state of the institutions with which they deal and
when the management of those institutions try to exploit that situation
by engaging in excessively risky lending and investment activities. As
a result, regulatory authorities must engage in added prudential regulation
to counter the effects of that moral hazard.
OSFI is the primary supervisor of banks and other federally incorporated
financial institutions. It has responsibility for supervising all federally
incorporated financial institutions. In addition, CDIC plays an indirect
regulatory role through its standards of business conduct. CDIC is a Crown
corporation that insures deposits made by the public with banks and other
deposit-taking institutions, both federal and provincial.
All deposit-taking institutions that are members pay premiums to cover
CDIC's insurance obligations, although those obligations are guaranteed
by the Government of Canada. In addition, CDIC has the power to borrow,
if need arises, both from the Consolidated Revenue Fund (CRF) and from
the private sector; any such loans are ultimately repaid by the premiums
collected from member institutions.
The Canadian financial services sector was in the past characterized
by the four "pillars" - banks, securities dealers, insurance
companies and trust companies. Institutions carried on a limited range
of activities and regulation was focussed on institutions.
The four pillars started to crumble in 1987, when the federal government
allowed the financial institutions that it charters to own securities dealers.
Major deposit-taking institutions have all taken advantage of this opportunity,
and have done so in a very dramatic way.
That initial foray was followed by a profound and comprehensive change
in 1992 when every federal financial institution was given the opportunity
to own virtually any other kind of financial institution. In addition,
the in-house powers of institutions were enhanced. As a result, any financial
institution could offer the services of virtually any other institution,
either in-house or via a subsidiary. Increasingly, Canadian financial institutions
are conglomerates. The most extensive conglomerate groupings are those
formed by the Schedule I banks.
The Task Force argues that the two features that will characterize the
Canadian financial services sector in the future are accelerating convergence,
which will blur the distinction between institutional types and their products,
and the rapid evolution in technology which is allowing consumers to benefit
from completely new services, and allowing them to access new and traditional
services in completely new ways. This convergence is a world-wide phenomenon.
Consumers can now carry out banking, insurance and securities activities,
and wealth management with one institution or corporate group.
Technology allows new products to be offered and business decisions
to be made in better and more efficient ways. Telecommunications and computer
technology allows products to be delivered in innovative ways. ATMs, telephones
and the internet allow Canadians to undertake financial transactions 24
hours per day, 365 days per year, from any location in Canada and even
around the world. Some institutions don't even have branches in Canada.
Other institutions don't even operate, technically at least, within our
New financial conglomerates, offering new and complex products, delivered
electronically and instantaneously, are making it more difficult for regulators
to do their job. The Task Force Report offers certain measures which would
enhance the ability of OSFI to perform its duties more effectively in this
new financial environment.
Starting on April 30, 1999, CDIC will have in place a risk-related premium
regime. Some witnesses have argued against this new initiative because
of its likely impact on smaller institutions and new entrants. Gerard Soloway
of the Trust Companies Association of Canada said, "We believe that
instead of encouraging a strong second tier, it goes the other way. It
could harm the interest of smaller companies by making them less competitive.
We believe the proposed system will in fact operate to assign the smaller
institutions a higher risk rating."
Henri-Paul Rousseau of the Laurentian Bank used similar arguments. He
told the Committee, "the precise objective of CDIC is to make sure
if you're a newcomer or a small player, you bring competition. If. . .you
are imposing through the premium system a lot of obstacles to growth, then
you won't have the result you're looking for." This is a good thing.
It is important, however, that the government not set up regulatory regimes
that put one competitor at a disadvantage vis-à-vis another.
Just as the regulatory regime should not stifle competition, it should
also not distort it. With increasing convergence in the financial sector,
products and institutions are increasingly becoming direct rivals. The
CLHIA argued that fifty per cent of the annual premiums of Canada's life
and health insurers derive from wealth accumulation protected by CompCorp.
By contrast, banks and trusts companies now offer similar competing products
in the wealth accumulation market that are protected by CDIC, a federal
What we are most pleased with, is the fact that for the first time
in many, many moons, an institution which is associated with the federal
government, has recognized the competitive inequities that exist in the
financial services, including banks and insurance companies. . . These
competitive inequities deal with deposit insurance and access to the payment
M. Claude Garcia (président et directeur général,
Compagnie d'assurance Standard Life)
To the extent that regulation advantages one group of firms or products
over others, it creates protective barriers which could have the effect
of reducing the state of competition in the market. The Task Force believes
that such an imbalance now exists between the consumer compensation programs
that apply to customers of deposit-taking institutions and life insurance
companies. Recommendations 12, 117 and 118 call for the amalgamation of
CDIC and CompCorp. The Task Force does not specify which of the two options
it prefers, a private-sector model or a Crown corporation model.
The Task Force and witnesses from the insurance sector see the current
regime's imbalance stemming from the fact that consumers have more faith
in the CDIC because of the fact that it is a Crown corporation that has
access federal guarantees and the Consolidated Revenue Fund. The CLHIA
argued that there is no question that the current inequities in consumer
compensation arrangements create significant competitive disadvantages
for life and health insurers relative to banks and trusts. The CLHIA presented
a case study in their submission that summarized the decision by a trustee
of a large pension plan ($125 million) to transfer management away from
a large insurance company because CompCorp is backed only by the insurance
industry, and not by the government. Surveys have consistently shown that
consumers strongly prefer CDIC-backed products. The Committee heard testimony
that it lost contracts to deposit-takers for the provision of savings products,
only because the clients viewed the deposit-takers' products as protected
by a better guarantee.
The first issue I'd like to comment on is the question of the level
competitive playing field. CompCorp fully supports consumers receiving
the same level of government support in the event of an insolvency, regardless
of the type of financial institution that fails.
Mr. Gordon M. Dunning (Executive Vice-President, Canadian
Life and Health Insurance Compensation Corporation)
Savings products offered by deposit-taking institutions are perceived
by consumers to enjoy a government guarantee while savings vehicles subject
to CompCorp protection are not viewed this way. Since banks and life insurance
companies offer directly competing savings vehicles, the asymmetry can
have very real and unwarranted competitive effects.
The Task Force proposes [revising CDIC and CompCorp] in the interest
of two important public policy objectives: First, fairness between depositors
and policyholders; and second, enhanced competition and competitiveness.
Our industry strongly agrees with the task force. We therefore urge this
committee to recommend that the government move forward promptly to develop
and to adopt a specific approach for putting the plans on the same footing.
Mr. Chris McElvaine (Chairman, Canadian Life and Health Insurance
Association Inc., President and CEO, Empire Life)
The Committee also heard from CDIC that the products of insurance companies
and deposit-takers are still sufficiently different so as to make amalgamation
complex and possibly counter-productive. The Committee believes therefore
that the federal government should give serious consideration to simply
privatizing CDIC as a way of dealing with this concern. Gordon Dunning
of the Canadian Life and Health Insurance Compensation Corporation argued
that "While we do not advocate any particular level of government
support, consideration of models that reduced government support would
be entirely consistent with the direction of public and government attitudes".
At a higher level, I think we need to consider payment system recommendations
and CDIC recommendations with truly professional input. These are very
complex issues and have enormous impact upon safety and soundness of the
financial sector. I'm not arguing against them, I'm just saying they need
some really good detail look into by the practitioners.
Mr. Peter Godsoe (Chairman and CEO, Bank of Nova Scotia)
This is obviously a very complex issue. The Committee supports the principle
of the Task Force recommendations but believes that further study is needed.
Hence we recommend that the government examine the best way to resolve
this perceived inequity.
We urge the committee to recommend acceptance of the level playing
field proposal and further study of the most appropriate way to address
this and the related issues of institutional and product conversion and
consumer confusion. There are a number of models which could address these
issues and we at CompCorp are anxious to participate in any such future
discussions of the most appropriate solutions.
Mr. Alan E. Morson (President, Canadian Life and Health Insurance
The forces of change sweeping across the financial services industry
have more of an impact than just challenging the ability of government
policy to ensure a level regulatory playing field. It is having a profound
effect on regulators who are concerned with the maintenance of safety and
soundness in the financial sector. Financial institutions, both Canadian
and foreign-based, are increasingly becoming multi-business, multi-product,
internationally active financial conglomerates. It is hard for anyone but
a specialist to understand many of the products and transactions that are
part of an institution's menu. Only specialists can peer into the complex
corporate structure of a modern institution to establish the nature and
extent of risk. Canadian financial institutions are now global players,
earning half of their income abroad. Canadian banks not only manage global
risk, they must also manage the risks of their insurance, trust and securities
subsidiaries. Large-scale transactions can take place instantaneously.
All of this makes it increasingly difficult for regulators to judge
risk and threats to the solvency of an institution and the stability of
the financial system. There may well be a tendency in such a situation
to over-react by strict regulations that stifle entrepreneurial initiatives.
This should be strenuously resisted. Rather, as the Task Force argues,
"the challenge of modern prudential regulation is to find ways to
supervise more innovative, entrepreneurial institutions effectively, without
stifling the competition and dynamism that come from innovation."46
That sentiment is one that the Committee endorses. It is consistent with
our earlier recommendation that the "one size fits all" approach
to regulation be abandoned
It is proposed that [OSFI's] mandate would be modified to focus on
competition and innovation as well as safety and soundness. Our industry
has some concerns about this direction. The additional roles in promoting
competition and innovation and enforcement of consumer protection could
significantly divert OSFI's attention from the essential task of ensuring
safety and soundness. OSFI's mandate would become more difficult and subject
of greater ambiguity because of inherent tensions between safety and soundness
and promotion of innovation.
Mr. Chris McElvaine (Chairman, Canadian Life and Health Insurance
Association Inc., President and CEO, Empire Life)
The Committee does not agree with the way in which the Report extends
that sentiment by recommending that the mandate of OSFI be amended to explicitly
require the Office to balance off safety and soundness concerns with the
enhancement of competition, innovation, consumer protection and international
competitiveness. Instead, we agree that the existing mandate, with the
emphasis on safety and soundness, should remain, although its actions should
not constrain competition. OSFI ". . .is required to fulfil its role
with due regard to the effect on competition. . ." which helps to".
. .resist the temptation of excessive regulation,"47
according to John Palmer, the current Superintendent of Financial Institutions.
The task force is seeking to achieve some important policy objectives
including increased competition and enhanced consumer protection. However,
recommendations to achieve these objectives could have an adverse affect
of the government's ability to achieve other objectives including depositor
and policy holder protection and high level of public confidence in the
Mr. John Palmer (Superintendent, Office of the Superintendent
of Financial Institutions)
Mr. Palmer went on to express his opposition to these recommendations
(recommendation 10 and 112) when he said that ". . .competition and
innovation. . .are not matters within OSFI's control and may sometimes
conflict with matters of safety and soundness. The addition of a specific
responsibility for competition and innovation might put increased pressure
on OSFI to exercise regulatory forbearance, to back off, if you like, to
the detriment of early intervention and early resolution of problems."48
Mr. Palmer went further ". . .[C]ombining matters of competition and
innovation with OSFI's current mandate could make OSFI less independent
and more vulnerable to pressure based on non-regulatory concerns. . . .
If competition were a more important part of OSFI's mandate, OSFI might
be placed under pressure to accept less than desirable owners of financial
institutions." Michael Mackenzie, the former Superintendent of Financial
Institutions, also shared our concern about broadening OSFI's mandate in
OSFI's duty is to interfere as little as possible with competition.
We do not see this giving us the responsibility to actively facilitate
competition. Instead, OSFI's overriding objectives currently are to safeguard
depositors and policy holders from undue loss and to contribute to confidence
in the financial system.
Mr. John Palmer (Superintendent, Office of the Superintendent
of Financial Institutions)
Enhancing competition and promoting competitive domestic institutions
is a valid, and indeed important, goal of public policy. It should not
be a goal of the prudential regulator, however. Just as the Bank of Canada
has recognized that the pursuit of a single goal improves its functioning
and makes monetary policy more transparent and hence more accountable to
Canadians, so do we believe that OSFI should have a clear and non-contradictory
mandate, namely, to ensure the safety and soundness of the financial sector
and the institutions that comprise that sector.
In this way, any conflict between the two goals can be discussed and
debated in public. If, for example, there is a general feeling that one
goal is being excessively favoured at the expense of the other, that difference
of opinion would be out in the open. The Superintendent of Financial Institutions
and the Minister of Finance could appear before a Parliamentary Committee
to explain the conflict. Differences would be more transparent and such
transparency and public debate are unlikely to take place if the conflicting
goals are resolved within a single organization, whether structured as
it is at present or with a Board of Directors as proposed by the Task Force.
The MacKay Report proposes expanding the role of the Office of the
Superintendent of Financial Institutions by adding a consumer protection
component. I disagree with this recommendation as it would place OSFI in
a position of conflict. The primary mission of OSFI is to ensure the security
and soundness of the Canadian financial system.
Mr. Jean Roy (Professor of Finance, École des Hautes
Études Commerciales - appearing in an individual capacity)
Expanding the role of OSFI to take on an enhanced role in consumer protection
is also problematic. Again, the current and former Superintendents of Financial
Institutions argued that it is not within the mindset of regulators to
protect consumer interests and the potential for conflict also exists,
although not to the extent it would if OSFI also had to promote competition.
John Palmer argued the following: "Certainly, OSFI has a responsibility
to protect policyholders' interests, but how would OSFI best do so? By
maintaining adequate levels of safety and soundness in the institutions,
or by trying to advance particular consumer interests. It's unclear which
role takes precedent in the event of a conflict."
As a result, the Committee opposes recommendations 10 and 112 in the
Task Force Report. Instead, we recommend that a Consumer Protection Bureau
(CPB) be established. The Committee is recommending that the new Financial
Services Ombudsman be responsible for the CPB. The CPB would be responsible
for all of the legislated consumer protection measures that are found in
the MacKay Report. This is consistent with the Finance Committee's recommendation
in its October 1996 report, "1997 Review of Financial Sector Legislation:
Proposals for Change." The promotion of competition and innovation
should represent a principle that is the basis for the government's financial
sector policy in general.
With our recommendation for the creation of a Consumer Protection Bureau,
we are not suggesting a lack of concern for the burden of regulation. We
simply want all of the regulatory agencies to be assigned the appropriate
objectives and mandate.
There are a variety of ways in which the burden of regulation can be
reduced, to the benefit of consumers through enhanced competition, and
to the benefit of institutions, via lower costs and enhanced competitiveness.
We support the Task Force recommendations that streamline the approval
process for new entrants (recommendation 4(b)). CDIC, as an insurer of
deposits, has over time undertaken expanded regulatory duties. The Task
Force recommended that all regulatory and supervisory functions should
be centralized in OSFI and the Committee concurs. Grant Reuber of CDIC
does not support this recommendation. He argues ". . . [R]emoving
or reducing CDIC's role in reinforcing the safety and soundness of the
[financial] system, would be inconsistent with CDIC's present mandate to
minimize its risk of exposure for loss." The Committee believes that
the portion of the CDIC mandate that requires it to promote sound business
and financial standards for members overlaps with OSFI's rules. Thus CDIC's
role in setting standards for business and financial practices should migrate
to OSFI (recommendation 114). CDIC should be the insurer and undertake
all of the initiatives that are appropriate to that role. Close co-operation
between CDIC and OSFI is not only beneficial, it is expected. Again, if
that co-operation is lacking, it is likely to become public and subject
to Parliamentary scrutiny.
Recommendation 113 proposes to create a Board of Directors for OSFI
so as to improve its corporate governance. While the Superintendent expressed
his support in principle for the recommendation, he also noted a concern
that such a Board might undermine the powers of the Superintendent and
the Minister of Finance, and adversely affect the accountability channels
that run from Superintendent to the Minister and from the Minister to Parliament.
The Task Force report does not describe what the role of the board would
be. As expressed by Jean Roy: "In the case of OSFI it will be important
to be explicit about the respective roles of the Minister, the Superintendent
and the proposed board." The Committee has major concerns in this
respect and it recommends that the government not proceed with this recommendation
at this time.
The Committee supports the principle of recommendations 115 and 116,
that are intended to reduce regulatory overlap and streamline regulatory
procedures. As recommendation 115 deals with areas of jurisdictional authority,
the Committee suggests that the federal government and OSFI work closely
with their provincial counterparts to seek acceptable ways to resolve this
regulatory overlap. If successful, this recommendation will bring some
synergies and less duplication in the regulatory regimes. Yvon Charest
from L'Industrielle Alliance was very clear "Within our corporation,
L'Industrielle-Alliance, we have companies incorporated in Quebec and companies
incorporated under a federal charter . . . Even though the parent company
of the group is incorporated in Quebec, we must still provide financial
information to the federal regulatory body on a regular basis. If there
was a system based on respect for principal jurisdictions, we would not
have to deal with two separate oversight authorities."
It would be. . .important to harmonize regulations on an interprovincial
basis in order to reduce built-in administrative costs.
Mr. Jean-Guy Langelier, CEO of la Caisse centrale Desjardins,
Confédération des caisses populaires et d'économies
Desjardins du Québec)
The Task Force also dealt with a regulatory issue that will increasingly
pose difficulties for domestic regulators, namely how to deal with institutions
that offer services to Canadians without establishing a physical presence
in Canada. This is not a new issue. Large Canadian corporations have long
had dealings directly with foreign institutions. Some Canadian travellers
maintain banking relationships in Canada and abroad. Residents near the
American border deal with American banks in such cities as Buffalo, New
York. The entry of Wells Fargo into the Canadian market, however, represents
a completely new scope of access to the services of such institutions in
the future. And with the further development of internet transactions,
Canadians will, in a sense, be able to shop the world for financial services.
They will be attracted not just by mass mailings but by internet promotions.
Internet search engines will be like the Yellow Pages, directing consumers
to web sites such as www.cheapestmortgage.com or www.freechequing.com.
What kind of regulatory protection can they expect? What should they expect?
At present there is no coherent regulatory and legislative framework
that would apply to firms entering the Canadian market without a physical
presence. The provisions of the Bank Act apply only to financial institutions
operating in Canada with a physical presence. Those that do not, are subject
to no legislative or regulatory rules of the federal government. Indeed,
the Wells Fargo case involves one in which that financial institution went
out of its way to guarantee undertakings as required by the Superintendent
of Financial Institutions. As the Task Force noted, the undertakings responded
to no prudential concerns, nor did they make any business sense. They were
merely intended to promote the claim that the bank was not doing banking
business in Canada.
In such a world, what should we regulate and how can we effect that
regulation? The Task Force concludes that foreign, virtual entry into a
market can only be regulated satisfactorily by an international agreement
that would set common rules and assign enforcement to the home regulator.
In the meantime, it recommends a number of interim solutions such as a
certification system for foreign lenders who engage in mass solicitation,
and ways in which consumers can be kept informed about foreign providers.
This certification process, is a way of ensuring that foreign financial
companies dealing with Canadians respect Canadian market conduct regulation.
How effective it would be remains to be seen.
As the Task Force notes, foreign institutions without a physical presence
in Canada who take deposits from Canadians represent a much greater concern
for regulators and public policy makers. This is clearly not something
that can be resolved unilaterally, and the Task Force argues that Canada
should be active at the international level in encouraging a common approach
to this challenge. It suggests regulation by the home jurisdiction. The
Task Force recommended that, until the needed international arrangements
are in place, OSFI should step up its information disclosure operations
that are currently provided via the internet.
We do believe there are concrete initiatives that the government can
undertake now and that could address many of the concerns expressed in
the Report. The Committee recommends that the federal government enter
into negotiations, starting with the United States, to provide national
treatment to customers of financial institutions. Thus Canadian residents
who make deposits in American banks would have all the benefits of American
residents. Canadian resident borrowers would enjoy all the regulatory protections
of American resident borrowers. The same would apply to American residents
dealing with Canadian banks. If Citicorp decided to supply a full range
of financial services to Canadians over the internet, from a location in
the United States, Canadians would enjoy the same consumer and deposit
protections as American residents who deal with Citicorp.
CHAPTER 6: CONSUMER EMPOWERMENT
There are two ways one can protect consumers: enhancing competition
and legislating against undesirable anti-competitive behaviour.
Competition can be seen as the ultimate guarantor of consumer protection.
When in place, many of the Task Force's recommendations endorsed by this
Committee will provide greater choices to consumers. Competition amongst
many firms offers consumers the widest range of choice and the best products
at the lowest prices. And with more choice comes increased mobility so
consumers who feel badly served by a particular supplier can easily move
to another who will treat the consumer fairly and properly. If competitive
forces worked perfectly well there would be no need to legislate business
behaviour since consumers would simply move to another supplier.
[The Task Force report] makes it clear that financial institutions
will only serve all Canadians fairly and well if consumers are empowered,
if disclosure and transparency rules are strict and comprehensive, there
is a comprehensive accountability system enacted and it also makes it clear
that financial institutions, especially banks, must serve all stakeholders
fairly and well because they have benefited historically from regulatory
protections and they also provide essential services to Canadians.
Mr. Duff Conacher (Chair, Canadian Community Reinvestment
Coalition, and Co-ordinator, Democracy Watch)
But, we now live in a very complex business environment where competitive
forces are not always present. Consumers cannot always easily exercise
all their choices either because of dominant players and abusive commercial
practices or, more frequently, because of lack of information.
Consumer choices are more and more difficult to make because financial
products are complex and sometimes offer unique characteristics. These
characteristics make financial products difficult to compare. One just
has to look at the difficulty in comparing the wide variety of credit cards
offered to us to understand how sophisticated and innovative financial
products make our choices as consumers more difficult. This difficulty
is enhanced by new technology that translates into more choices. Many customers
will still shop around and select their financial products from more than
one financial institution. Many others however will take advantage of bundled
financial services. Financial institutions are increasingly aiming at building
a total customer relationship with their clients. This means that, not
only do deposit-taking institutions want to offer customers chequing and
savings accounts, they want to offer credit cards, RRSPs, life insurance,
brokerage and wealth management services. To do this, these financial institutions
use a wide assortment of incentives and compensation (lower fees, lower
interest rates on loans, higher return on savings products. . .). In these
circumstances, consumers' choices become difficult to assess and difficult
to act upon. Unless they get the information needed to make wise choices,
unless personal information is protected against abuse, unless there are
strict rules against coercive tied selling, unless they can freely move
from one institution to another, many consumers could eventually make wrong
The Competition Bureau has the task of examining the behaviour of firms,
in the financial services sector and other industries, to ensure that company
behaviour does not have an adverse impact on the state of competition in
the sector under question. Competition policy, however, is aimed at the
macro level. It cannot guarantee that individual customers will never face
abusive practices nor can it guarantee that such practices are rare occurrences.
Instead it attempts to ensure that restrictive trade practices such as
refusal to deal, tied selling, market restriction or abuse of dominant
position do not enable firms to exploit market power.
Canadians also appear to be concerned about the terms and conditions
of their financial contracts. A surprisingly high percentage of Canadians
(16 percent) reported feeling that their loan or mortgage might not have
been approved if they had not purchased another product from the same institution.
The limitation of the Competition Act was made apparent to the Committee
in the spring of 1998 when we were investigating tied selling - the Committee
ultimately recommended that section 459.1 of the Bank Act should be enacted
into law. The Competition Act, while an important tool, was clearly inadequate
for the purposes of protecting individual consumers from abusive practices.
This view was shared by the Task Force Report. Indeed, that Report went
even further, arguing that more than the Competition Act is needed to promote
an environment of competition in the modern financial marketplace.
As we discovered last Spring, and corroborated in the Task Force Report,
tied selling has become one of the more prominent concerns of financial
sector customers and financial services providers. Tied selling is the
process by which one product may be purchased only in combination with
There are instances in which tied selling may be beneficial and acceptable
to consumers. In some cases the link is due to the technological nature
of the products or because of consumer demand. In addition, there are instances
of beneficial cross selling or bundling, in which products may be purchased
individually or in packages, with the package price being less than the
sum of the individual prices. Because of the convergence taking place in
the financial services sector, institutions are increasingly bundling their
services. This type of packaging is usually beneficial to consumers.
[T]he most severe anti-tied selling regime in the world will have
limited impact if Canadian consumers continue to feel powerless sitting
across the desk from a bank loan officer.
Mr. David Thibaudeau (Canadian Association of Insurance and
As we learned during our earlier hearings, and as we are learning during
these current hearings, what concerns Canadians about this practice is
the potential coercive aspect. Coercion is about unequal power in financial
relationships and this must be mitigated against, especially if financial
institutions become more like conglomerates. Not only do such practices
abuse consumers, but they may well have the effect of diminishing competition.
Consumers cannot easily respond through the market to abusive practices.
It is not simple or costless to move financial business from one institution
to another. Realising this, financial conglomerates could use their leverage
to draw a wide variety of business to themselves.
The other realisation that has become apparent to the Committee is the
fact that tied selling is as much about perception as it is about reality.
To the extent that it consequently affects behaviour, leading to a lessening
of competition, it is clear that measures should be taken to address the
perception as well as the reality
The Task Force makes four recommendations in this regard. Section 459.1
of the Bank Act that was recently proclaimed into law on the advice of
this Committee should be expanded to apply to all federal financial institutions
and expanded to apply to a broader range of financial services that might
be tied together. This extension should be undertaken quickly, according
to the Task Force. In addition, consumers entering into an agreement covered
under the new provisions must be notified that any coercive behaviour of
the institution is against the law and they must be informed as to what
actions would constitute coercive tied selling. Finally, the Report recommends
the establishment of a redress mechanism with civil remedies.
The Committee supports recommendations 70 to 75 as a result.
In addition to forbidding certain behaviour, consumers must be given
the tools necessary to exercise and protect their rights. Empowered consumers
are an important prerequisite for competition. As noted earlier, competition
also helps to make financial institutions more competitive. Competition
is not just about the number of suppliers in a market, nor is it only about
concentration ratios. Competition is about behaviour. To have market competition
requires that all participants in a market behave in a way that is consistent
with competition, and in a way that fosters competition. A market works
well when participants have choices, for example, when consumers are willing
and able to walk away from bad suppliers. Thus policies that empower consumers
can have a wide-ranging impact on the look of the financial services sector
in Canada. In this regard, consumer empowerment measures, if designed properly
and if effective can greatly benefit the economy.
The Task Force recommends a series of measures designed to help consumers
have more choices and more power to exercise these choices.
Clear customer documentation must bridge the gap between the demise
of the tangible paper product and the cyber-world we live in.
Ms. Rozanne E. Reszel (President and CEO from the Canadian
Investor Protection Fund
As the Task Force reports, for consumers to properly play their role,
they must be able to discern a good product from a bad one and a good institution
from a bad one. This is a prerequisite but it is clearly not sufficient.
Indeed, it is quite a challenge given the nature of many financial products
and the way in which transactions are undertaken. They are complex services,
often purchased infrequently and subject to inertia on account of moving
costs. In such circumstances, financial institutions might perceive only
minimal costs as a result of bad customer treatment.
Sixty-four percent of Canadians think they are not receiving enough
information about the banking products they are purchasing. The number
is similar (68 percent) for products bought from insurance companies.
A smart consumer is an aware consumer. For that to be the case, the
consumer must understand the products that are being offered and the terms
at which those products are offered. In other words, transactions must
be characterised by transparency. Information must not only be disclosed,
it must be disclosed in a manner that consumers can readily understand.
While the complexity of prospectus disclosure for retail investors
is currently the subject of review specifically as it relates to mutual
funds, customers need clear and complete information to make informed decisions.
Certainly the recommendations in number 57 concerning clear and simple
English legal documentation is one we would whole-heartedly endorse.
Ms. Rozanne E. Reszel (President and CEO from the Canadian
Investor Protection Fund)
New disclosure and transparency rules would allow consumers to understand
what is offered to them and at what price and conditions. Plain language
is essential in this regard. One must avoid unreadable language and technical
jargon. One prerequisite of transparency is timely disclosure of the terms
of a financial contract. Financial services are nebulous products and it
is not until consumers know full well the terms and conditions of their
financial contracts that they know what they are actually buying. Anyone
who recently signed a mortgage contract understands what we are talking
about. Very few of us could explain the pre-payment penalties on a closed
mortgage if asked to.
The Committee endorses the recommendation 57 to 60 contained in the
Task Force Report in this regard.
The Committee does not believe OSFI should be responsible at the federal
level for enforcing transparency and disclosure requirements. In fact,
as discussed elsewhere in this Report, there could exist a clear conflict
with OSFI's main mandate of promoting safety and soundness of our financial
service sector if the Superintendent was also given the mandate to promote
innovation, consumer protection and competition as proposed in recommendation
112 b) of the Task Force. The Committee believes this responsibility should
be given to the new Consumer Protection Bureau under the responsibility
of the new Financial Services Ombudsman. Hence the Committee cannot endorse
recommendation 61 as presented.
The Committee also expresses caution with respect to recommendation
62, related to the disclosure of fees and commissions paid to employees
or third parties. A few witnesses argued against the Task Force's proposal.
For example, Mario Georgiev (Optimum réassurance) argued that ".
. .the Task Force goes too far in its recommendations especially with regard
to the disclosure of fees and commissions in respect of any financial services
transactions". The Committee believes that financial institutions
should only disclose the type of compensation, salary, bonus and fees given
to employees or agents. The Committee is of the opinion that to disclose
fees and compensation paid would not help consumers make better and informed
choices. In fact, has argued by the CLHIA, in their submission to the Committee:
"The best approach. . . is to ensure that the full cost of the product
is clearly disclosed in advance. It is useful for the consumer to know
whether the intermediary receives a fee, a commission, salary or bonus
. . . for the transaction. Moving beyond this to attempt to prescribe disclosing
how the distribution charges are allocated along a given distribution channel
can be literally impossible and has significant potential to mislead customers"
Finally, the committee rejects recommendation 63. If acted upon, the
statutory prohibition of unilateral amendment in consumer contracts could
be detrimental to consumers. First it is quite legitimate for firms to
review on a regular basis, their price structure and the range of services
that are offered. One cannot expect any business to freeze its prices unless
consumers consent to an increase. Secondly, unilateral amendments are not
necessarily negative. One could imagine new services (for example, smart
cards or PC banking) offered at no extra charge as part of an already agreed
to service package. What is important is not banning unilateral contract
amendments but making sure that the changes are fully disclosed and in
a timely manner. As recommended by the Task Force in recommendations 57
to 60, helping consumers to make the best decisions.
Canadians have strong concerns about privacy but are split on whether
their privacy rights are adequately protected.
Privacy is a unique issue because, as the Task Force notes, it almost
constitutes the status of a human right. But it also an economic right
in the sense that it defines the ability of individuals to determine what
type of relationship they want to have with a financial institution. The
financial services sector is evolving rapidly and becoming more and more
integrated. As new financial products are introduced, as information technology
becomes omnipresent, the risk of abuse of personal information is multiplied.
As the Task Force argues "[w]ith an increase in both opportunities
and incentive to abuse personal information by using it in ways the donor
did not intend, it will be important to have high standards of behaviour
to preserve the integrity of the relationship between customer and institution"50.
The Committee agrees with this observation.
Theoretically, you can create separate computer files and argue that
employees selling insurance will be physically separated from other employees
of the financial institution. You can erect all kinds of barriers. However,
in practice, in a bank branch, there may be 10 employees, two of whom sell
insurance and must meet sales targets. These employees have lunch and spend
eight hours of the day together. Despite the fact that theoretically, these
functions will be separate, there is no way of being certain that personal
information will really remain confidential.
M. Yvon Charest (vice-président exécutif, chef,
Exploitation, Industrielle Alliance)
Canada has a wide ranging privacy environment. The financial sector
has now established a variety of sector-specific privacy codes. Quebec
has now enacted privacy legislation that is very broad and extensive.
We believe that the basic minimum standards articulated are not onerous
and indeed protect the privacy rights of individual Canadians
Mr.Walter Robinson (Canadian Taxpayers' Federation)
The Committee strongly supports the government's initiative to legislate
standards for the collection, use and protection of personal information.
Bill C-54, entitled Personal Information Protection and Electronic Documents
Act, if enacted, will provide Canadians with right of privacy with
respect to their personal information that is collected, used or disclosed.
This legislation will initially apply to federally-regulated corporations.
The privacy provisions are based on the 10 principles of the CSA's Model
Code for the Protection of Personal Information. Bill C-54 should be expeditiously
adopted by Parliament. Hence the Committee endorses recommendation 64,
68 and 69.
[B]efore you give more powers to the bank, let's make sure that the
banks obey the laws of this country, respect the privacy of consumers and
respect the consumer by not forcing them to buy other products
M. Claude Garcia (président et directeur général,
Compagnie d'assurance Standard Life)
378. The Task Force recommends that the financial sector be required
to develop further binding sectoral codes that would be consistent with
the legislated standards, but that would go beyond them (see recommendations
65 to 67). The Committee endorses the thrust of these recommendations.
The Committee wishes to remind the government that OSFI should not be given
the mandate to certify the codes of conduct and ensure that compliance
is audited (as stated in recommendation 66). The new Consumer Protection
Bureau of the new Financial Services Ombudsman should be given this responsibility.
On privacy and consumer issues I personally concur with and strongly
support all the recommendations on empowering consumers. The banks are
in a tremendous position of power and influence over their customers, and
should be kept a strict accountability with how these use or abuse that
Mr. Christopher Moon (Barrister and Solicitor, Davis Webb
Schulze & Moon)
[O]ur submission strongly supports the need for a federal ombudsman
of financial services, somebody that would operate independently of the
current regime of bank ombudsman.
Mr. Stephen Johns (President, Canadian Retail Building Supply
In 1996, the Canadian chartered banks put in place a Canadian Banking
Ombudsman. Its power was expanded in 1997 to include personal banking customers.
Participation by the banks in the CBO is voluntary and at present 12 banks
are members. Bank appointed ombudsmen in each bank complement the CBO.
A customer's first recourse is to the ombudsman within the institution;
failing satisfaction, the customer may appeal to the CBO. The life insurance
industry has also put in place an ombudsman process similar to the banks'
[O]ur submission strongly supports the need for a federal ombudsman
of financial services, somebody that would operate independently of the
current regime of bank ombudsman.
Mr. Stephen Johns (President, Canadian Retail Building Supply
The Committee agrees with the Task Force and supports the recommendations
(see recommendations 76 to 80) that a Financial Sector Ombudsman be established
by legislation. It could act as a mediator and conciliator of consumer
grievances with any federal financial institution, not just the banks.
It would be independent of industry participants. If provinces agreed,
the Ombudsman could act for both federally and provincially regulated financial
institutions. It is believed this could substantially limit consumer confusion
and ease access to the redress mechanism. A consumer who purchased life
insurance from a trust's subsidiary and who wants to file a complaint should
not have to figure out which redress channel is the appropriate one. To
integrate all the complaint mechanisms under a single office for consumers
would be an important step in the right direction.
Secondly, the report suggests that the role of the Canadian Banking
Ombudsman be expanded to cover all financial services. I fully endorse
this recommendation. Furthermore, I believe that the role of the Ombudsman
should also be expanded to cover all consumer protection issues, and not
simply the resolution of individual problems. I recommend that the Ombudsman
be responsible for issues related to the transparency of contracts and
standards of access to financial services.
Mr. Jean Roy (Professor of Finance, École des Hautes
Études Commerciales) appearing in an individual capacity)
Jean Roy argued that "the role of the Ombudsman should also be
expanded to cover all consumer protection issues, and not simply the resolution
of individual problems." The Committee strongly agrees with this statement.
Hence, in respect of his/her mandate, the Committee recommends that the
new Ombudsman be given the responsibility of promoting consumer protection
issues and of auditing compliance. That office should also be responsible
for the newly-created Consumer Protection Bureau.
The Task Force recommends the establishment of a Financial Consumers
Organisation. It believes an advocacy group could help make consumers more
vigilant. The Committee believes this would be beneficial but we do not
believe it should be funded by the government. Instead, we believe that
Industry Canada should study the various models that are available to provide
funding for such organizations, including the distribution of information
related to consumer advocacy groups, through mailing inserts.
Finally, the Committee agrees with the Task Force recommendations related
to proficiency standards (recommendations 81 to 86). As the role of financial
intermediary evolves, the concept of a single regulator harmonising the
proficiency standards across all jurisdictions becomes more appealing.
The province of Quebec has already moved in that direction.
In conclusion the Committee wants to reiterate that one of the challenges
facing our government is how to empower consumers in a world of rapid evolution.
One has to be extremely careful to do so without overburdening the financial
services sector or stifling its ability to adapt to changing realities
when acting on recommendations 53 to 55. A delicate balance must be found
since constrictive regulation could diminish competition and competitiveness.
CHAPTER 7: CORPORATE CONDUCT AND CANADIANS EXPECTATIONS
Every day, customers of financial institutions undertake millions of
financial transactions: from renewing a small business line of credit to
depositing a cheque in an ATM, from paying a bill to making a night deposit,
from buying foreign currencies to making a direct payment at the grocery
Every day, millions of Canadians find themselves to be well served,
at reasonable prices, having access to a wide range of services. According
to data presented to the Task Force, 91% of bank users are satisfied and
2/3 of them had never switched financial institutions in the past 5 years.51
Average monthly fees are substantially below those imposed in the United
States or Sweden for example.52
Canadian consumers have comparatively lower interest rate spreads on personal
loans and mortgages.53
All these satisfactory results can be challenged using anecdotal evidence
or other data. The Committee has heard many times that many low-income
Canadians have difficulty in accessing basic financial services and that
many small and medium-sized entrepreneurs do not have ready access to financing.
In surveys produced for the Task Force, it has been shown that only 29%
thought that the quality of service provided by banks was very good to
Other data show that 44% of bank users think that service charges are unfair.55
Credit card spreads are higher in Canada than in the United States.56
There are, undoubtedly, areas in which corporate conduct is considered
failing and consumers' expectations are not met. This is why the Task Force
recommended measures to deal with the difficulties that many Canadians
face in their daily dealings with financial institutions. The Committee
believes the financial services sector should be subject to higher expectations
than are other sectors of the economy. It must meet the needs of small
businesses (including the very small) and of firms engaged in the risky,
knowledge-based technology sector. The Committee also believes it is important
for all Canadians to have access to a wide choice of quality financial
services, priced at reasonable levels.
These corporate obligations can be justified by the fact that financial
institutions play a special role in our economy. The financial services
sector is no ordinary industry and that has been recognized by government
policy measures over the years.57
The Committee wishes to make clear, however, that financial institutions
are not public utilities that should have a wide range of their business
activities regulated. They are not natural monopolies the way many public
utilities were in the past. They operate in an environment that subjects
them to competition. Furthermore it is the intent of this Committee, just
as it was the intent of the Task Force, to enhance competition in the marketplace.
Public utility regulation is completely inconsistent with such a focus
The Task Force makes several important recommendations regarding the
financing of small and medium-sized enterprises, the knowledge-based industry
and aboriginal businesses.
SMEs play an important role in our economy: 75% of Canadian businesses
have less than 5 employees and 97% of all businesses have fewer than 50
employees. It has been shown that very small firms have been the most consistent
source of job creation over the last 10 years. In 1996, 87% of new jobs
were attributed to this sector. SMEs represent more than half of private
sector employment and account for 43% of our GDP.
In 1933 and 1964 credit unions and caisses populaires had an insignificant
share of small business financing, and in 1996 accounted for almost 15
percent of SME business debt financing.
Banks hold 38% of total business credit. Of all business loans, banks
dominate the market with 84%.58
Of all the business banking services, small and medium commercial lending
is among the most profitable. It is estimated that in 1997, lending to
SMEs generated $1.3 billion in profit and a return on equity between 10
and 15 percent.
Specialized financing companies have recently experienced rapid growth
and now hold about 16 percent of the SME debt financing market, up from
just 9 percent in 1994.
Banks have tried, and are still trying, to address SME's concerns about
accessibility to capital. New initiatives aimed not only at SMEs but also
at knowledge-based industries have been put in place. The Bank of Montreal
offers $50,000 unsecured credit with 24-hour turnaround, CIBC : $15,000
to $100,000 loans at prime less 1%, TD Bank has 13 specialized knowledge-based
industry banking centres and offers an Advanced Technology Loan Program,
the Royal Bank has knowledge-based industry specialists and a Small Business
Venture Fund, Scotiabank has a $50 million Loan Program for Innovation
and Growth Sector. While the Committee agrees that important steps have
been taken, more should be done.
In fact, the Committee was told on numerous occasions that financial
institutions may not be serving SMEs properly. The main concern usually
relates to access to bank financing and access to capital in general, including
Evidence seems to indicate that there is a gap not properly filled by traditional
Canadian financial institutions. One can look at the myriad of federal
and provincial programs put in place to finance SMEs to realise the importance
of financing needs not filled by the private sector. At the federal level
alone, one can find a very long list of policy initiatives.60
The government and the financial services sector should be in a position
to better assess small business financial needs.
Recently, the arrival of Wells Fargo also signalled the fact that a
part of the market was not being adequately served. This San Francisco
based financial institution is able to offer quality and responsive services
to Canadian SMEs using a unique risk assessment model. Credit scoring allows
it to assess very short loan applications within 15 minutes. Using direct
marketing. Wells Fargo is presently offering pre-approved lines of credit
not exceeding $50,000.
Beside anecdotal evidence, there is no concrete proof that could be
used to properly assess the SMEs' difficulties in securing credit. There
is a consensus that SMEs are less likely than larger firms to apply for
financing, more likely to provide security for their loans, to pay higher
interest rates and to be turned down on loan applications more frequently,
but as the Task Force observed, there is a lack of adequate data to support
the establishment of solid policy initiatives. Hence the Committee supports
recommendations 101, 105 and 106 that are designed specifically to bridge
this information gap.
The relationships between SMEs and their banks are less than optimal.
As mentioned in the Task Force Report, loan officers are asked to administer
a large volume of borrowers and handle a large caseload of new loan applicants.
Because of the career path imposed by the banks' culture, loan officers
are often asked to move to other branches or other services. A recent survey
showed that 60% of SMEs had more than one account manager in the past 3
years. The Committee believes that this type of rapid turnover in account
managers results in the inability of SMEs to build a strong and personal
banking relationship. Thus Committee agrees with recommendation 102.
When appearing before the Committee, the Chairman and CEO of the Royal
Bank of Canada announced the establishment of a new bank subsidiary to
better served SMEs. The Committee can only support such initiatives that,
if successful, will foster stronger relationships between borrowers and
their financial institutions. It should also decentralise credit-granting
authority as recommended in recommendation 103 in the Task Force Report.
Most SME loans in Canada are priced between prime and prime plus
3 percent, with an average of prime plus 1.75 percent. In the United States,
this range is much broader, and loans can be priced anywhere from prime
to prime plus 8 percent, with an average of prime plus 3.25 percent. The
narrower range in Canada may imply that Canadian banks are not adequately
pricing for risk, which may have implications for SME accessibility.
In addition to the way in which the bank hierarchy operates, their attitude
towards risk also adversely affects access to capital by SMEs. Small businesses
are usually granted loans at 3% above prime. The problem was clearly summarised
by Terry Norman from the Metropolitan Halifax Chamber of Commerce: "If
the loan is considered higher risk it is declined rather than approving
it at a higher spread as is common practice in the United States".
This is why, small business owners are sometimes forced to use personal
credit cards or mortgage their principle residence to find the necessary
financing. Wells Fargo, on the other hand, is presently offering loans
at prime plus 8% and finding willing takers. Instead of denying credit
to those borrowers who would be willing to pay the appropriate risk premium,
Canadian financial institutions should be encouraged to serve this market
via appropriately priced loans. The Committee endorses recommendation 104
which promotes this.
MacKay [recommends] that lenders should be prepared to make available
more innovative financing packages with appropriate pricing for high risk
borrowers who may now be denied financing. In my experience this is a somewhat
naive statement. In most high risk cases there is no appropriate pricing
that will cover the loss ratio and cost of administration.
Mr. Christopher Moon (Barrister and Solicitor, Davis Webb
Schulze & Moon)
Rapid technological advances are changing the Canadian economy. We are
shifting from a resource-based economy to a brain-based economy where knowledge
will be the key to our success as a nation that provides a high-standard
of living. Skills, innovation, invention, technology, research and development
and entrepreneurship fuel the new economy. A knowledge-based industry does
not have physical assets; it has human assets. Financial institutions have
typically shied away from such firms for this reason, and because their
product development cycles are very long. Thus these firms rely more heavily
on equity than working capital. The knowledge-based industry faces unique
financing problems. Again, Terry Norman from the Metropolitan Halifax Chamber
of Commerce summarised very well the problem : "Much of the growth
in the SME market is being driven by KBIs, and they have non-traditional
financing needs, A big portion of the assets of the KBI go home every night
in the way of their personal. This requires the shift from assets-based
lending to cash-flow lending coupled with a thorough knowledge of the market.
In some cases it also requires pricing loans for risk which is contrary
to the common practice of the big six chartered banks". The Committee
supports recommendations 106 to 108.
The Task Force proposes specific recommendations that should facilitate
the provision of credit to aboriginal individuals and institutions, even
though some financial institutions have taken important initiatives relating
to aboriginal financing. For example, the Bank of Montreal established
an aboriginal banking program in 1992. It now operates 16 aboriginal communities
banking centres across Canada. It was announced earlier this year that,
in co-operation with Canada Post, it would further expand its service in
20 remote communities. The TD Bank has entered in a joint venture with
the Saskatchewan Indian Equity Foundation and created the First Nations
Bank. Some important and significant steps such as the one described above
have had a positive impact on the lives of aboriginal Canadians. The Committee
endorses recommendations 109 to 111.
Groups such as Option Consommateurs in Montreal clearly demonstrated
how many of the most vulnerable in our society have no access whatsoever
to basic financial services. They have difficulty opening bank accounts
or cashing welfare cheques for example. In 1997, 3 percent of adult Canadians
did not have a bank account and this number exceeded 5 percent in British
Columbia and the Maritimes. Eight percent of adults living in households
with annual income under $25,000 did not have basic accounts. This phenomenon
can be attributed to identification requirements and to the fact that creditors
can seize funds deposited in bank account. Thousands of Canadians rely
upon cheque discounters such as Money Mart every week.
As a first step toward gaining access to personal banking services,
one must have access to a bank, access to a bank account. The Task Force
concluded that there was a problem in this regard as 600,000 Canadians
- or 3% of the population, don't have a bank account.
Mr. Serge Cadieux (Syndicat Banque Laurentienne, Coalition
Québécoise pour le maintien des emplois et services bancaires
Those with a bank account see their deposits, including government cheques,
held for 5 to 7 days by deposit-taking institutions. Even though the major
chartered banks agreed with the federal government on a new regime to ease
access to account and cheque cashing services for low-income Canadians
in 1997, it seems very little progress has been achieved.
Ninety-four percent of Canadians feel that it is necessary for an
individual to have a savings or chequing account. Over half (51 percent)
feel this is "absolutely necessary."
The Task Force raises the argument that it is attitudinal and cultural
problems that prevent further progress. It is argued that low-income Canadians
are not perceived by deposit taking institutions to be profitable customers.
Even if profitability was the issue, Canadian financial institutions should
not deny Canadians, whatever their socio-economic conditions, the right
to have access to basic financial services at a reasonable price. Like
all the witnesses heard on this issue, the Committee supports recommendations
88 to 92. However, on the issue of making personal identification available
(recommendation 90(a)) the Committee recommends caution, considering the
potential abuses and fraud that such a measure could lead to. One just
has to look at the Auditor General's recent concerns related to social
insurance numbers. Further study is needed before starting to issue ID
cards to citizens.
We feel that access to basic banking services should be insured and
there should be a right for all Canadians. Unfortunately the task force
has said the banks should take a number of steps but we're going to give
them more time. Citizen groups, anti-poverty groups, consumer groups have
been pushing for over ten years with the banks trying to get them to provide
service fairly to all Canadians and at a fair price. There should be no
further delay. Require banks to give everyone a right to a bank account,
require banks to provide access to basic banking services.
Mr. Duff Conacher (Chair, Canadian Community Reinvestment
Coalition, and Co-ordinator, Democracy Watch)
Branch closures can have disproportionate impact on the elderly, smaller
rural communities, small businesses and low-income individuals. Bricks
and mortar that were so important just a few years ago are less crucial
today. For example, electronic banking such as ATM, telephone banking and
PC banking has revolutionised our relationship with financial institutions.
A few years from now we should be able to download money into our smart
cards using pay phones or a personal computer. There is no doubt that more
and more branches will close as the nature of banking evolves through the
use of alternative delivery channels that are less costly than the traditional
If people generally believe that most of the small businesses can
do their day-to-day banking electronically, then they are sorely mistaken.
. . Retailers also understand the growing possibilities offered by technology.
They also know technology is far from being a complete and adequate substitute
for services provided by local branches of competing financial institutions.
Ms. Diane Brisebois (President, Retail Council of Canada)
The Committee agrees that financial institutions should be obliged to
inform their communities in advance of their intention to close a branch.
Hence the Committee supports recommendation 93.
We're heartened therefore by the recommendation of the task force
that reinforces the need for financial institutions to be diligent in honouring
their commitments in terms of access to basic banking services.
Mr. Andrew Bolter (Director of Community Development Programs,
Life Spin - Women's Resource Centre)
For a number of years, the Calmeadow Foundation has pioneered techniques
for lending money to individuals who need small amounts to create their
own jobs. Micro lending can be viewed as a way of increasing self-employment
among various Canadians whose financial needs are too small to interest
traditional financial institutions. While the processing costs for such
loans might well exceed any possible return to them, such loans have enormous
potential in terms of community and individual development. The Committee
heard from groups such as the Montreal Community Loan Association. This
organisation argued that small lending needs relate to those wanting to
borrow from $2,000 to $20,000. "But there is 20% of the population
that can't get access to credit from mainline financial institutions. These
are people that are living in poverty, but they have good ideas, so how
do they get access to credit? Institutions like the Montreal Community
Loan Association are the way they get access to that". The Committee
believes such initiatives should be encouraged, thus we support recommendations
94 to 97.
[W]e're working on [micro credit] and hope to have a firm statement
and firm commitments with respect to a new approach to microlending in
the future and that isn't just a vague promise. We will commit to it and
address it in [our] public interest assessment document.
Mr. Matthew Barrett (President and Chief Executive Officer,
Bank of Montreal)
Financial institutions are active in the community. For example, the
largest five banks were the top five corporate givers in Canada in 1997,
donating more than $78 million to philanthropic causes across the country61.
On top of that, financial institutions with their employees donating their
time, play leadership roles in community activities. The Voluntary Sector
Roundtable identified a number of new opportunities that could help build
stronger and more caring communities that should be further explored by
the government and the financial services sector. Hence the Committee suggests
that the leaders of the financial institutions and of the voluntary sector
explore new partnerships as suggested in recommendation 98. If successful,
these new initiatives could significantly improve the condition of our
[S]uccessful micro-credit programming, in Canada, the United States,
and developing countries has proven to be successful but more successful
when linked to other forms of service such as small business management
training and technical counselling.
Mr. Peter Nares (Executive Director, Self Employment Development
Financial institutions are not likely to give without some encouragement
because there's a good risk that some businesses will not survive.
Mr. Roger Snelling (Member of the Board, Montreal Community
Like the MacKay Task Force, the Committee heard from the Canadian Community
Reinvestment Coalition that Canada should adopt a law similar to the Community
Reinvestment Act (CRA) that applies to banks in the United States.
The demand for community reinvestment began in the United States as
part of the civil rights movement in the late 1960's and early 1970's.
Many old, urban neighbourhoods were effectively declared off limits by
banks and S&Ls. Banks located in some cities would literally draw a
red line on a map around lower-income neighbourhoods - they would accept
deposits in these communities but consciously refused to lend money to
businesses or individuals located there, because of the perceived high-risk
and low return.
Hence, in 1975, Congress passed the Home Mortgage Disclosure Act (originally
known as the Financial Institutions Reporting Act). The industry was required
to publish information related to where it was making loans. This Act fuelled
the reinvestment movement. In 1977, the communities went further and pressed
not just for statistical disclosure but for an affirmative reinvestment
mandate. The CRA imposed a legal obligation on lenders to serve all the
residents and needs of their community.
The objectives of the CRA include the following: financial institutions
must demonstrate that the they are reaching out to all segments of the
local credit market and are meeting the credit needs of the entire community,
including low- and middle-income neighbourhoods, consistent with safe and
sound operations. It does not force financial institutions to lend money
to bad credit risks through quotas or mandated credit allocation. Four
federal agencies rate each financial institution on compliance with the
CRA. Lending institutions are graded every 18 to 24 months using criteria
such as geographic distribution of loans and investment and services in
the communities they serve. The federal government is required to take
into consideration CRA compliance when deciding whether or not to recommend
approval or denial of certain applications such as branch closures, acquisitions
and mergers or charter applications. The government relies on this reporting
system and data disclosure to encourage lending institutions to lend capital
in underserved areas. The risk of having an application denied for failure
to comply with the CRA is the principle tool of enforcement.
Inspired by the American experience, the Canadian Community Reinvestment
Coalition argues that Canadian financial institutions should become more
accountable so they can better serve the needs of their local communities.
This group recommends the adoption of a Canadian Act.
The Committee does not support this approach. In the first place, in
an industry that is continually evolving, the application of a Canadian
CRA would be extremely difficult and costly. The new corporate structures
of many financial institutions (e.g. financial holding companies) will
shift assets out of their traditional banking subsidiaries, thus reducing
the activities covered by a CRA. In tomorrow's financial sector, many banking
activities will not be undertaken by traditional banking institutions or
traditional product lines. One need only observe the billions of dollars
pouring into mutual funds and stocks every year by Canadians. Secondly,
the criteria for a satisfactory rating would be subjective and arbitrary
- with convergence taking place to varying degrees by financial groups,
such a rating system would treat competitors unequally. Thirdly, the primary
effect of the regulations is to increase the cost of operations, especially
for smaller financial institutions and for institutions operating in low-income
neighbourhoods. Fourth, the quest for a good rating might cause financial
institutions to adopt accommodating behaviour and chose inappropriate banking
practices. These sub-optimal investments could jeopardize the safety and
soundness of certain branches. The long-term consequences of these could
lead to the closure of branches in already poorly served areas. There is
no evidence that Canadian financial institutions are systematically denying
credit in poor neighbourhoods. No complaints of any significance have been
brought to regulators in Canada.
In addition, the banking sector and the social setting is very different
in Canada than in the United States. We have national institutions, they
have local ones. Canada does not have the inner city blight that characterizes
many American cities. Thus the Committee agrees with the Task Force that
there is no need for a CRA-like legislation in Canada.
This does not necessarily mean that financial institutions should not
become more accountable. The Task Force also recognizes the fact that Canadian
financial institutions must be more accountable to the communities they
serve. To achieve this the Task Force recommends (recommendation 99) that
federally regulated deposit-taking institutions and life insurance companies
be required by law to file Community Accountability Statements. These would
describe the financial institution's contributions to the community with
respect to relevant aspects such as philanthropy, investment in community
development, employment provided, taxes paid to all levels of government,
participation of employees in community service. The statements would be
filed annually with the Minister of Finance and also tabled with the House
of Commons Standing Committee on Finance.
The Committee does not agree with the legislated aspect of this recommendation.
First, a legislative requirement would add substantially to the regulatory
burden already faced by financial institutions. It would increase costs,
especially on smaller financial institutions and new entrants. Edmund Clark
from Canada Trust argued strongly against the accountability statement
by saying ". . . [R]egulation favours the large [financial institution]
against the small, and yet it's often the small that's providing the competition
that makes the consumer better off. . ." In its brief, the Canadian
Life and Health Insurance Association argued "[T]he industry is nonetheless
concerned that such a requirement could become a cumbersome and costly
regulatory compliance undertaking at a time when there is already a need
to streamline and to reduce the paper burden of the numerous reporting
requirements to which the industry is already subject." (see page
43 of the CLHIA submission)
Second, legislated requirements might limit accountability and involvement
in community. For example, Mr. Clark added in his presentation that legislating
accountability statement would remove the moral responsibility of the CEO
to his/her community. He argued that as a CEO he would owe to society nothing
more than what he is required to do. He said "Just tell us exactly
what we have to do to fulfil this requirement and that's what we will do".
Third, how would a "community" be defined (presence of a branch
in a neighbourhood, postal code, geographical distribution of clients.
. .)? Would a branch located in an industrial park have to table a community
accountability statement? How would a virtual bank such as ING Bank, Citizen's
Bank or Mbanx define their local community?
Fourth, as was said before, banking functions, as we knew them yesterday,
are already very different today and will continue to change. Should monoline
institutions operating from abroad such as Wells Fargo, or Countrywide
Credit be obliged to file an accountability statement? Why only force the
traditional banking sector to obey such community requirements? As stated
by Jean Roy from the Hautes Études Commerciales "However, it
must be clearly understood that there is potential for putting large Canadian
institutions in a difficult situation since on the one hand they would
be asked to play a social role and on the other hand the new financial
environment carries the risk of putting them into competition with various
types of financing institutions that do not have to fulfil such social
Finally, it is unclear what the House of Commons Finance Committee is
supposed to do with the tabled statements. With thousands of accountability
statements to look at, it is unlikely that the parliamentary public review
process suggested by the Task Force would be effective.
And finally, Canadian banks also need to respond to the increasing
expectations of Canadians that financial service firms should provide tangible
support for communities and pursue more community customer partnerships.
Mr. John Cleghorn (Chairman and Chief Executive Officer,
Royal Bank of Canada)
The Committee is opposed to recommendations 99 and 100. It believes
instead, that voluntary action should proceed, instead of another layer
of regulation. The Committee believes that it is in the best interests
of the financial services sector to be involved in the community, and to
do so in a way that meets the needs of that community. In such a case,
the institutions would obviously wish to disclose their activities. It
is good business practice for institutions to do so and they do not need
a Parliamentary Committee to suggest good business practices to them.
this particular development is relatively recent, it did not require federal
legislative changes to implement it.
the amounts invested in mutual funds do not exceed total bank deposits,
they now exceed total personal deposits in the banks.
Consulting Group, Financial Services at the Crossroads, January
derivatives allow individual investors to take on new types of risk, they
do pay for this through slightly lower rates of return than they could
earn via direct investments.
Force on the Future of the Canadian Financial Services Sector, Discussion
Paper, June 1997, p.5.
& Company, "The Changing Landscape for Canadian Financial Services
- New Forces, New Competitors, New Choices," Task Force on the Future
of the Canadian Financial Services Sector, Exhibit 7-10.
& Co. The Changing Landscape for Canadian Financial Services, Research
paper prepared for the Task Force, September 1998, Exhibit 5.13
Competitiveness and the Public Interest, Background paper no.1, p.15
This figure is an estimate for 1998. See: CIBC, Why Customer Choice and
Canadian Ownership Matter, October 1997. The Task Force Research Report
prepared by McKinsey & Company (The Changing Landscape for Canadian
Financial Services) estimates a 21% share for branch transactions.
By looking at the slide entitled "The redistribution of transactions
from the branches to alternative channels will continue in Canada"
in Ernst & Young, Canadian Financial Institutions and their Adoption
of New Technologies, Research Paper prepared for the Task Force, September
1998, one could argue that it is already yesterday's alternative.
Electronic Funds Transfer at Point of Sale.
Users typically do not save much by using ATMs or telephone banking instead
of using a bank branch. They do, however, benefit from the fact that these
channels are far more convenient. See McKinsey & Company, Exhibit 6-29.
Households have only partial control over the allocation of their financial
assets - they tend to have no control over institutional pension-related
assets. Households now hold 45% of their discretionary assets in long-term
form. This is expected to grow to over 60% in the next ten years, suggesting
a further move away from deposits.
It is conceivable that, through Internet banking for example, Canadian
consumers would be able to access the services of foreign financial institutions
which offer the products we want, (deposits, loans, insurance and mutual
funds) all at one location. If Canadian institutions are not allowed to
do the same, they would not be competitive even though consumers would
still enjoy the benefits of competition. The converse could also be true.
Some countries support a policy of creating "national champions,"
that is, national financial institutions that are also large global players.
This is achieved via mergers that have the effect of creating a highly
concentrated domestic market. If barriers exist in the domestic market
that prevent it from being contestable, this high concentration could lead
to a reduction in domestic competition. Some countries pursue policies
that trade off domestic competition for the enhanced international competitiveness
of domestic financial institutions.
* Compound annual growth rate.
At $18 per month for a typical package, the Canadian cost for SMEs' banking
services are about half way between the lowest rates found in Europe and
the rates found in the United States. (Background Paper #1, p. 74)
House of Commons Standing Committee on Finance, Evidence, September 29,
1998, Issue 116, p. 27.
"Report of the Technical Committee on Business Taxation," Submitted
to the Minister of Finance December 1997, p.6.25.
Organizational Flexibility for Financial Institutions: A Framework to Enhance
Competition, Background Paper #2, p. 68-73.
Ibid. p. 96.
E.P. Neufeld and H. Hassanwalia, "Challenges for the Further Restructuring
of the Financial Services Industry in Canada," in G. M. von Furstenberg,
The Banking and Financial Structure in the NAFTA Countries and Chile, Kluwer
Academic, Boston, 1997, chart 12.
Ibid. Chart 13
Commissions, expressed as a proportion of trading volumes on the TSE and
MSE, have fallen from 1.6% in 1987 to less than 1% in 1995. It is over
this period of time that the banks came to dominate the securities sector.
(Royal Bank Financial Group, Three C's of Canadian Banking: Conduct, Competition,
Concentration, February 1996.)
Coopers & Lybrand, "The Property/Casualty Insurance Industry,"
Research Paper prepared for the Task Force on the Future of the Canadian
Financial Services Sector, p. 31.
DesRosiers Automotive Consultants Inc., Background Report on Extending
Bank Powers to Include Light Vehicle Leasing, p.15.
Bank loans now account for 34% of corporate debt, whereas they accounted
for 44% of debt 10 years ago. (Report p. 49)
In 1991, bank personal deposits, at $216.5 billion, were 4.3 times as large
as mutual funds. In 1997, those same deposits, at $290.3 billion, were
only 1.02 times as large as mutual funds.
GE Credit, for example, has a AAA credit rating which is higher than that
of any Canadian bank.
I. J. Horstmann, G.F. Mathewson and N.C. Quigley, "Ensuring Competition:
Bank Distribution of Insurance Products" C.D. Howe Institute, May
1996, p. 86.
C. Freedman and C. Goodlet, "The Financial Services Sector: Past Changes
and Future Prospects," Bank of Canada, Technical Report No. 82, March
1998, p. 21.
Canada Trust violates the Task Force proposals because its 35% public float
is not made up of shares with voting rights.
Competition, Competitiveness and the Public Interest, Background Paper
#1, p. 172.
Change Challenge Opportunity, Report of the Task Force on the Future
of the Canadian financial Services Sector, September 1998, p. 104-105.
"Organizational Flexibility for Financial Institutions: A Framework
to Enhance Competition," Background Paper #2.
Ibid, p. 113.
Report of the Technical Committee on Business Taxation, December
1997, p. 4.2.
Task Force Report, Competition, Competitiveness and the Public Interest,
Background paper no. 1. page101.
McKinsey and Company, The Changing Landscape for Canadian Financial
Services, Research Paper prepared for the Task Force on the Future
of the Canadian Financial Services Sector, September 1998, Exhibit 4-4.
Euromoney, Euro-gigantism, February 1998.
Charles Freedman, Clyde Goodlet, The Financial Services Sector: Past Changes
and Future Prospects, Bank of Canada, technical report 82, p. 25
In January 1998, the Royal Bank of Canada and the Bank of Montreal announced
their intention to merge. In April 1998, CIBC and TD Bank announced their
own merger. As of October 31, 1997, the merged Royal Bank/Bank of Montreal,
would have had assets exceeding $450 billion and shareholders equity reaching
almost $20 billion. The TD/CIBC would have had assets totalling more than
$410 billion with shareholders equity in excess of $17 billion.
Charles Freedman, Clyde Goodlet, The Financial Services Sector: Past Changes
and Future Prospects, Bank of Canada, technical report 82, p. 21
Task Force Report on the Future of the Canadian Financial Services Sector,
Competition, Competitiveness and the Public Interest, Background
paper no. 1, p. 128.
House of Commons Standing Committee on Finance, Proceedings, 27 October,
Issue 144, 20:15.
Donald G. McFetridge, "Competition Policy Issues", p. 89.
"Improving the Regulatory Framework" Background Paper #5, p.
House of Commons Standing Committee on Finance, Evidence and Proceedings,
Issue 147, 29 October, 1998, 1835.
At present, deposit insurance is typically limited to deposit accounts
denominated in local currency. Thus American dollar accounts in Canadian
banks do not enjoy a CDIC guarantee and Canadian dollar accounts in American
banks do not enjoy FDIC guarantees.
Task Force Report. p. 130
See McKinsey and Company, The Changing Landscape for Canadian Financial
Services, September 1998, Exhibits 6.33, 6.34.
Ibid, Exhibit 6.25
Ibid, Exhibit 6.20, 6.21
Ibid, Exhibit 6.32
Ibid, Exhibit 6.23
Ibid, Exhibit 6.22
It has been argued that measures such as restrictive foreign bank entry
policies, deposit insurance, access to liquidity support from the Bank
of Canada, wide-ownership policy have meant special privileges granted
to the banking industry.
Ibid, Exhibit 2.27
Beside access to credit, the other concerns relate to account manager turnover
and pricing of financial services: 60% of respondents in a recent CFIB
study reported that they have had more than one account manager in the
past 3 years.
Small Business Loans Act, Business Development Bank of Canada, Financing
support through the Regional Economic Development Agencies (ACOA, WEDC,
Canada Economic Development for Quebec) and the Federal Economic Development
Initiative for Northern Ontario, Community Futures Development Corporations,
Canada Community Investment Plan, Source of Financing, Farm Credit Corporation,
Financing Assistance for Canadian Cultural Organisations, Aboriginal Business
Canada, Community Economic Development Program, Commercial Development
Program, Resources Access Negotiations Program, First Nations and Youth
Business Program and generous tax incentives such as SRED tax credit and
See Exhibit 2.43