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Committee proceeding on the possibility of the merger of Canadian Banks
Banking, Trade and Commerce
Tuesday, September 29, 1998 (p.m.)
Browse the committee transcript for this Meeting on the official committee web site
Senator Joyal: The last time we met, as you pointed out in your presentation, the development of the financial world was unforeseen and, to a point, unforeseeable. What happened in Asia and Russia and partly in South America in the last months of the summer led us to reflect a second time about the implications of globalization. Globalization requires a more open market, a better range of services, more effectiveness in terms of displaying the panoply of what customers can have as financial products. However, at the same time, there are risks. When there is a collapse, waves can be felt throughout the world.
In its opening remarks, the report says that financial conglomerates, often operating in many countries around the world, are becoming more widespread and regulators of such organizations effectively will require new regulatory techniques and approaches based on greater understanding of risk management and greater reliance on effective internal governance processes.
In view of your experience, which is wide and certainly compelling, what do you suggest to us as criteria for the kinds of new regulations and policies we should devise to protect the interests of Canadians generally, in view of the emergence of those financial conglomerates? That, of course, brings Canadians to the point of thinking twice in the context of the reorganization of the financial service market in Canada.
Mr. Cleghorn: You can look at what is here today and at what Canadians are using and perhaps extrapolate a bit. Institutions that are not banks are now providing financial services to Canadians, be it mutual funds, credit cards, or commercial finance. In some cases, regulators can deal with them, as they have with the monoline card companies, because they have established a bank licence. ING is a major multinational bank insurance company out of Holland that is coming in with a direct banking approach. They are using the banking regulations.
The fact that we have a regulator already combined here with insurance and banking helps, because in many cases there may be bank-assurance groups coming in which know what they are doing in insurance as well as in banking.
Again, knowing who these players are is very important. Our regulators are not just sitting north of the 49th parallel. They have a world view and are knowledgeable about what is going on around the world. They have a healthy exchange with regulators in the key trading countries for Canada. We have a much better understanding through the BIS. We have central bankers. We have regulators, such as the Superintendent of Financial Institutions, who get together on a regular basis with their counterparts.
Hedge funds in the United States are not regulated because the people dealing with them have tended to be sophisticated, wealthy individuals, so there was a feeling that perhaps that should not be regulated. I think we should consider how Canadian regulators will react to that. Our experience in recent weeks shows that the private sector has literally came together. I do not know all the details because we are not involved in that floatation process, and I do not know exactly the role of the New York Fed in that. However, as I said, some of the players that are active today have not gone through a full cycle.
As managers of risk, we must take that into account in dealing with them as counterparts. We are a leading player in foreign exchange for our clients and also in trade finance, so to that extent we must have relationships with both banks and financial conglomerates around the world to be able to do that business. We must ensure that it is balanced risk, that it is contained within our own capacity, and that we do not take material risks, because we do not want it to jeopardize the 75 per cent of our business that deals with individuals and small- and medium-sized businesses through the whole process, whether they are investment management, administration or traditional banking. The corporate investment banking side for us is 25 per cent.
We want to ensure that it can serve our businesses, but we do not want to put the rest of our operation at risk. I think that regulators must be able to look through all of us, whether at some point we are permitted to have a holding company structure or continue to have the structure we have today. They must be able to look through it and understand it.
I think Canadian regulators are a good example for others to follow; we need to ensure that our regulators are strong and are able to hire and keep the talent they need in order to stay current with events. If the Japanese authorities had adopted Canadian practice, they would not be having the problems they are facing today.
Senator Joyal: Do you believe that we have an institutional base in our country that is sufficient to address the issues at this point, or should we look beyond that, taking into account the new context in which we are operating?
Mr. Cleghorn: In terms of safety and soundness, I believe we have a strong position to build on. It is much better than it was when we had the LDC crisis and the energy crisis in the 1980s. We learned from that. The improvements have been highlighted here, but it is important to ensure that the talent and the scope of the Office of the Superintendent of Financial Institutions is sufficient to enable it to do the role that is spelled out for it here, meaning a broader role as a financial regulator over more than just the group that is being viewed today.
Senator Joyal: In your comments on the report you did not mention its extensive recommendations on tied selling and the protection of the privacy of customers. Do you agree with the recommendations of the report on those matters?
Mr. Cleghorn: Yes. An important issue for us, both strategically and going forward in terms of building and keeping our customers, is the area of credibility. Clearly, our industry has had a problem with credibility, both in recent years and going back a long way. I do not think the Canadian perception is that much different from the public perception of banks in the United States.
Clearly, if there is to be lots of competition and people will be doing similar business to us and our expectation is that we can broaden our product offering, then there must be clear rules and the consumer must have the confidence that commitments made will be met and that there is some form of independent review of the processes.
We think we have had a good history of meeting the concerns of consumers, but clearly credibility has not kept pace with what we think are leading standards, so it is probably a good idea to adopt the process here so that accusations of tied selling can be put out in the public domain in a transparent way and so that all competitors must meet the same test as banks.
Senator Joyal: Of course, if we were to adopt a set of regulations for financial institutions, it would be for all those under the framework of the objective of the legislation. There is no doubt in our mind on that.
Mr. Cleghorn: On that point, there are 500,000 Canadians directly working in the financial services industry. Of those, 220,000 work in banks. Therefore, 280,000 are working in other areas, be it insurance, brokerage, mutual funds, or whatever. The 220,000 who are working in banks seem to get isolated for some of these issues. It is a customer service issue. It is also a morale issue among employees. Therefore, we would prefer, where possible, to see the other 280,000 employees put on the same reporting basis as the people who work in banks.
It is interesting to note that the 44 per cent breakdown of employees to the total population directly involved in financial services is about the same breakdown of financial assets that banks have in Canada as well, if you include the whole service industry.
Tuesday, September 29, 1998 (p.m.)
Senator Joyal: We have been told by representatives of the Royal Bank and other banks who are in favour of the merger that one of the reasons why they support that option is the appearance on the Canadian market of a form of outside competition that challenges their ability to maintain control over the Canadian market and, in particular, in the case of small business, the example of Wells Fargo is often cited. How can two financial institutions that have access to such experienced economists have such opposite readings of the threat that foreign competition poses here in Canada? How can the consumer or taxpayer determine which is right? You represent a smaller company compared to the four other banks asking the government to approve their merger. How can they tell us that this competition is not terminal? It is there but we can work around it. We can handle it. There is no reason to make fundamental changes to the way financial services are currently provided here in Canada. How can the Canadian Bankers Association reconcile its views with that interpretation of current market conditions?
Mr. Courville: Well, economists are not the best people to answer that kind of question. We hired one of my former students who told us, after reading the documents, that what you are saying makes a lot of sense.
Ms Vachon: At first glance, it is not so much the reading that is different but the solutions that are called for. I think we all have the same reading of the situation. Competition is clearly on the rise in Canada. This increased competition is in very specific market segments, whether we are talking about Wells Fargo or MBNA. They are operating in very specific, very effective market segments because they are very big players who benefit from economies of scale. If there were reduced competition in Canada as a result of bank mergers, would the Canadian banks be big enough to hold their own against even bigger players? Well, what is important is how you respond to that competition.
It is also important to remember that mergers could be a positive step forward whereas a loss of competition would mean more regulation or different strategies. The response is different. It is possible to be both a universal bank, and a bank that operates in certain niche markets outside. The size argument is not something we see as a credible strategy for dealing effectively with competition.
Mr. Courville: In fact, if you listen to what those proposing the mergers are actually saying, it is important to remember that you do not know what their ultimate strategy is. All you hear is that they have some concerns, that there is a threat there and that their survival is not guaranteed. But it is not a matter of survival. It might be more accurate to say that their profitability is not guaranteed. I do not think their survival is threatened. The Royal Bank remains a major bank and the Bank of Montreal, even though it may be small, is still the 25th largest bank in North America, whereas we represent only one-fortieth of the overall market. You do not know what their strategy is. They have another purpose in doing this.
Senator Joyal: Your interpretation of the situation is that foreign competition will continue to be a fact of life and will affect specific niche markets or products. You mention, Mr. Courville, that the Hongkong Bank of Canada -- or any other ING, for that matter -- is not going to set up a branch banking operation tomorrow morning that would place it in direct competition with the National Bank either in Quebec or elsewhere in Canada. I don't think that is what the market is heading towards. The way compartmentalization is occurring now suggests that foreign offerings are related to specific services and aimed at specific market segments.
Ms Vachon: Yes.
Senator Joyal: So, if we are interested in looking at how we should redefine the rules with respect to competition, do we not have to come down in favour of consolidating Canadian capacity vis-Ó-vis specific products, rather than trying to open up the market as much as possible to all foreign competition?
Ms Vachon: I am not sure I understand your question. The point is that if we are looking at all the areas where Canadian institutions are currently operating, the MacKay report clearly recognizes the fact that there will have to be more uniform regulations before institutions will be able to compete on an equal footing.
As has already been mentioned a number of times, because of their history, because of the regulatory system in Canada and because of the reality of Canadian universality, banks in Canada are universal. This has not come about just because institutions developed a strategy to become a universal bank. The fact is that the banks are universal, because of the fact that a regulatory system was implemented here far more quickly than it was in the U.S. and that geographical regulation never took hold here in Canada. What counts most for the banks is to see that regulations apply uniformly to all the players in each of their areas of operation.
Senator Joyal: Do you recognize that there are some financial product lines where Canadian institutions will not be very competitive? People are always setting the example of the credit card contract given to American Express, rather than Visa or Master Card.
Even assuming a consolidation of the entire banking system within an individual bank, it still would not be competitive compared to the product American Express offers. Do you not think that Canadian banks will have to accept that some products, although they may not be available through them, will be available on the international market?
Mr. Courville: In Canada, we have what are called "scope economies," which means that by working with the same client in a number of different ways, we are able to compensate for the economies of scale that others may enjoy. There is no doubt the two will always clash, but I do not think one will prevail over the other. We benefit from scope economies by selling several products to the same clients. Institutions that sell only one product benefit from economies of scale, but not from scope economies. It is one against the other. Having a single bank in Canada does not mean we will have a universal bank capable of being all things to all people or being good at everything. That just is not possible.
Senator Joyal: Supposing the government were to go along with the merger. What does the MacKay report say about the kind of institution that would allow you to maintain your market positioning, given that the ground rules would be fundamentally changed?
Mr. Courville: First of all, there will be a relaxation of certain conditions, particularly with respect to powers, which we will receive more quickly than the other banks. We are being told that banks with sales of less than $5 billion will have an immediate extension, as soon as the time setting has been decided, of their insurance and leasing powers. We will also be in a position to change our corporate structure more easily. Finally, we will even be able to become associated with other financial institutions and form alliances whereby someone else will be able to have a 65 per cent interest in our operation, provided that this arrangement has received approval from the board of directors, the shareholders' meeting and the minister. So, we are being given the flexibility to counter the effects of this merger.
Senator Joyal: Are you currently looking at those options?
Mr. Courville: We are not considering an alliance at this time. When the report was released, even a little before that, we made the board of directors of the bank aware of the issues we were facing. Although it opens up new opportunities, it also raises a number of important existential questions. Indeed, the MacKay report itself poses the question. It will not be possible to avoid these mergers.
There is still room on the ice for players like us. Is the MacKay report satisfactory or sufficient? I do not know. I am just telling you what the MacKay report has done. It will be up to us to decide whether that is adequate or not, and to make the appropriate representations if we feel it is not.
Senator Joyal: What kind of alliance would you be looking at?
Mr. Courville: I am not in a position to answer that question now. It was put to us not so long ago. We are aware of it and we will be working on this further to determine whether it is sufficient and if we feel it is not, we will make the appropriate representations. After that, we will start to think about strategies.