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A BLUEPRINT FOR CHANGE

RESPONSE TO THE REPORT OF THE TASK FORCE ON THE FUTURE OF THE CANADIAN FINANCIAL  SERVICES SECTOR

Report of the Standing Senate Committee on Banking, Trade and Commerce

Chairman : The Honourable Michael Kirby

Deputy Chairman : The Honourable David Tkachuk

December 1998


MEMBERSHIP

 

The Honourable Michael Kirby, Chairman

The Honourable David Tkachuk, Deputy Chairman

 

and

 

The Honourable Senators:

 

Angus, W. David Kenny, Colin
Austin, Jack, P.C. Kolber, E. Leo
Callbeck, Catherine S. *Lynch-Staunton, John (or Kinsella, N., acting)
*Graham, Alasdair B., P.C. (or Carstairs, Sharon) Meighen, Michael Arthur
Hervieux-Payette, Céline, P.C. Oliver, Donald H.
Kelleher, James F., P.C. Stewart, John B.

 

 

*Ex Officio Members

 

Note: The Honourable Senators Carney, P.C., Di Nino, Joyal, P.C., Kinsella, Kroft, Perrault, P.C., Poy, St. Germain, P.C. and Spivak were members or present at meetings at various stages during the course of this study.

 

Staff from the Parliamentary Research Branch, Library of Parliament:

Dr. Gerald Goldstein, Director, Economics Division; Ms. Margaret Smith, Research Officer, Law and Government Division and Mr. Dan Shaw, Research Officer, Economics Division.

 

Staff from the Committees and Private Legislation Directorate:

Ms. Lise Bouchard, Administrative Assistant and Mr. Till Heyde, Legislative Clerk.

 

Gary Levy
Clerk of the Committee


ORDER OF REFERENCE

 Extract from the Journals of the Senate, Wednesday, October 22, 1997:

"The Honourable Senator Carstairs for the Honourable Senator Kirby moved, seconded by the Honourable Senator Callbeck:

THAT, the Standing Senate Committee on Banking, Trade and Commerce be authorized to examine and report upon the present state of the financial system in Canada;

THAT the Committee have the power to permit coverage by electronic media of its public proceedings with the least possible disruption of its hearings; and

THAT the Committee submit its final report no later than December 10, 1998.

The question being put on the motion, it was adopted."

 

Paul Bélisle
Clerk of the Senate


TABLE OF CONTENTS

CHAPTER ONE:

Restructuring the Financial Services Sector — Six Years Later

CHAPTER TWO: The Special Role of Financial Institutions (and Deposit-Taking Institutions in Particular)

CHAPTER THREE: The Proposed Bank Mergers

CHAPTER FOUR: Objectives of Financial Institutions Public Policies

CHAPTER FIVE: The Principal Thrust of the Task Force Report

CHAPTER SIX: The Committee's Vision of the Financial Services Sector of the Future
A. Business Environment Overview
B. Objective: To Foster Canadian Control of the Key Institutions in the Financial Services Sector
C. Objective: To Provide a Framework for Healthy Competition in the Financial Services Sector
D. Objective: To Ensure the Safety, Soundness and Integrity of the Canadian Financial System
E. Objective: To Enable Consumers to Make Well-Informed Decisions and to Protect Consumers from Improper Business Practices:
F. Objective: To Fulfill the Stewardship Responsibilities of Financial Services Institutions

CHAPTER SEVEN: Concluding Observations

APPENDIX

LIST OF WITNESSES

LIST OF ORGANIZATIONS AND INDIVIDUALS THAT SENT BRIEFS BUT DID NOT APPEAR

CHAPTER ONE

Restructuring the Financial Services Sector — Six Years Later

  1. On June 1, 1992, the federal government proclaimed its new legislative framework for federally regulated financial institutions: banks, trust companies, insurance companies, and the national organization of the credit union movement.

  2. The new legislation dramatically changed the landscape within which federally regulated financial institutions operate. They were given a broad range of new powers, their ownership regime was changed, and new prudential safeguards were introduced.

  3. In August 1995, the Committee published its Interim Report on the 1992 Financial Institutions Legislation. In it, it was noted that:

  4. The Department [of Finance's] perception is that the new legislation is working reasonably well in practice, and is perhaps working very well if one takes into account the extent of the revisions that were made. The Department has been generally satisfied with the direction taken in 1992 and does not expect that there will be a need for major revisions to the statutes in 1997. (Interim Report on the 1992 Financial Institutions Legislation, August 1995, p. 3)

  5. The pace of events over the past few years has, however, forced policymakers to rethink that position. With the deregulation of the financial services sector across market economies, and the breathtaking pace of technological change in communications and data processing, international financial markets have become inextricably linked to each other. Financial service providers have grown into powerful multinational competitors, with many of these organizations operating as unregulated entities. Consequently, the Canadian financial services sector is facing challenges that have forced policymakers to face some very fundamental questions concerning the future of the sector.

  6. On December 19, 1996, the Minister of Finance announced the mandate and makeup of the Task Force on the Future of the Canadian Financial Services Sector. The Task Force was asked to advise the government on what needs to be done to ensure that the Canadian financial system remains strong and dynamic in the years to come.

  7. The Task Force released its final Report on September 14, 1998. The Standing Senate Committee on Banking, Trade and Commerce then proceeded to hold public hearings across the country on the Report.

  8. During those hearings, the Committee heard from a wide range of witnesses — providers of financial services (regulated and unregulated), consumers of financial services, regulators, academic experts, and policymakers. Concurrent with this public discussion, there has also been ongoing debate on the proposed mergers of four large chartered banks: the Royal Bank with the Bank of Montreal, and the Canadian Imperial Bank of Commerce with the Toronto-Dominion Bank.

  9. The Task Force did not directly address the specific mergers. Rather, the Competition Bureau is charged with the responsibility of reviewing these mergers. In addition, the Office of the Superintendent of Financial Institutions has been asked to give an opinion on the impact of the mergers on the overall stability of the financial system. Finally, the Minister of Finance must decide whether or not to approve the mergers.

  10. While the Committee does not directly address the mergers in this Report, it did receive extensive testimony on them. It has provided a representative sample of this evidence without comment in Chapter three of this Report.

  11. Chapter two of this Report addresses the special role of financial institutions, and deposit-taking institutions in particular, in the Canadian economy, and in Canadian society overall. It makes a case that these institutions have a unique set of characteristics and obligations, and the Committee argues that future public policies must reflect the special responsibilities these characteristics impose on the sector.

  12. Chapter three, as noted above, presents a representative set of quotations on the specific proposed bank mergers, without comment from the Committee.

  13. Chapter four contains a discussion of the public policy objectives that the Committee believes should be reflected in legislation and regulation affecting financial services providers in Canada. These include the promotion of safety and soundness in the sector, of healthy competition in the sector, of Canadian control of key financial institutions, the importance of enabling consumers to make informed decisions, and achieving the widest possible accessibility to financial services in Canada.

  14. Chapter five examines the principal thrust of the Report of the Task Force, namely the creation of increased competition across the full range of financial services, but particularly in banking services. It disagrees with the Task Force on a number of its recommendations with respect to how the objective of increased competition should be achieved. In particular, the Committee is concerned that the time required to generate more real competition in the sector will be substantial.

  15. Finally, in chapter six, the Committee presents its vision for the financial services sector of the future. This "vision chapter" takes each of the five objectives outlined in chapter four and shows how they would be impacted by the Committee's recommendations. Thus, this chapter provides the logic behind the Committee's recommendations. Underlying these positions is the testimony the Committee received, past reports and studies by the Committee, as well as the arguments in the Task Force Report.

  16. Chapter seven contains comments on the need for a balanced package of reforms, and the need for these reforms to be implemented quickly.

  17. The appendix to this Report analyses each of the recommendations in the Task Force Report. It does so in the light of testimony given at the Committee's hearings. Chapter five also gives the Committee's response to these Task Force recommendations.

  18. The Committee is fully cognizant of the complexity of the financial services sector in Canada. Any changes to the legislative or regulatory framework will generate both gains and losses to participants. The Committee heard repeatedly in its hearings, however, that the status quo is not an option. Further, despite the fact that the financial services sector operating outside of Canada is beyond our control, we cannot, and should not, isolate ourselves from developments abroad. The task, then, is to get on with reform and to establish a framework that will serve Canada well in the coming years. The Committee hopes that this Report makes a significant contribution towards that goal.


CHAPTER TWO:

The Special Role of Financial Institutions (and Deposit-Taking Institutions in Particular)

  1. Financial institutions are critical to a smooth functioning economy. Firstly, financial institutions (but more precisely deposit-taking institutions (DTIs), credit-card providers and debit-card providers) process payments and settlements, without which the undertaking of commercial transactions would be extremely difficult. Secondly, financial institutions act as intermediaries channeling funds from those who are seeking a return on those funds, to those who seek to employ those funds. Without such intermediaries, the costs to many potential lenders and borrowers (particularly the small ones) of finding an acceptable match would be extremely high. Finally, financial institutions manage risk across the economy, evaluating the riskiness of loan requests, pricing the risk accordingly and diversifying the risk across the economy. Thus, the importance of financial institutions in the day-to-day life of consumers and firms is considerable.

  2. The characteristics of financial institutions described above are so important to the functioning of national economies that all countries impose conditions on those who wish to operate a major financial institution, and a DTI, in particular. These conditions include capital requirements, regulations on operations and ownership, and more.

  3. At the core of this government oversight is the desire to maintain the stability of, and public confidence in, the financial system. Such stability and public confidence are preconditions to a thriving economy.

  4. For decades, Canadian governments have believed that an integral element of maintaining stability of the financial system, and of helping to ensure that financial institutions were responsive to the needs of Canadian consumers and businesses, was the requirement that the key financial institutions operating in Canada be controlled by Canadians. This consideration led to policies which originally restricted total foreign ownership in major financial institutions to 25 per cent and, in the 1960's, to the encouragement of major Canadian life insurance companies to become mutual companies, so that they would not be subject to takeover by foreign insurance companies. Today, in the post-NAFTA era, "national treatment" requires that Americans cannot be distinguished from Canadians with respect to ownership policies. Hence, this concern about major financial institutions being Canadian controlled is reflected in the widely held ownership rule — the 10 per cent rule — which applies to Canadian banks. There are conflict of interest reasons as well for the 10 per cent rule.

  5. Further, the Canadian regulatory system has been designed to protect individual consumers, as well as the safety and soundness of the financial services sector as a whole. There are three aspects to consumer protection: (1) prudential regulation; that is, the protection of individual depositors and insurance policy holders through regulation that addresses the soundness of a financial institution, and thus the safety of funds entrusted to that institution, (2) conduct of business regulation; that is, regulation which addresses issues such as full disclosure of relevant information to a depositor or borrower, and regulation to ensure the absence of coercive tied selling techniques, privacy regulations, and protection of a client’s personal information held by a financial institution, and (3) deposit insurance; that is, insurance which guarantees the security of the first sixty thousand dollars of a depositor’s money in any deposit-taking institution.

  6. This regulatory system does not mean, as a few witnesses suggested, that financial institutions, particularly banks, should be treated as a public utility. This is clearly not Canadian policy. Canadian policy recognizes that financial institutions are profit-seeking firms dedicated to enhancing shareholder value which operate in a competitive business environment. They need to make profits in order to have access to capital, which is essential to the health of any financial institution. They must therefore be allowed to make whatever business decisions they believe to be in the best interests of their firm, provided that those decisions do not result in the firm failing to meet its larger public policy responsibilities as outlined above, or in undue concentration of market power.

  7. While deposit-taking financial institutions are regulated, the regulatory structure is designed to enable them to compete aggressively, as long as they meet the legislative and regulatory requirements with respect to financial stability, consumer protection, and Canadian ownership.

  8. The Committee recognizes the unique characteristics of deposit-taking institutions outlined above, and believes that future public policies must reflect the special responsibilities which these characteristics impose on the sector.


CHAPTER THREE:

The Proposed Bank Mergers

  1. The Committee would like to make it clear that it does not intend to make any comment or advance any specific recommendations concerning the Royal Bank/Bank of Montreal and CIBC/TD Bank merger proposals. Until the Competition Bureau and OSFI have completed their analyses of these proposals, and the Committee knows their results, any comments the Committee might make on the merger proposals would be premature since they would not be grounded on a solid base of facts.

  2. However, as the Committee’s hearings became a platform for interested stakeholders to voice their opinions on these two mergers, we have chosen to present a balanced selection of arguments made on either side of this debate.

  3. One witness, quoting from a detailed impact analysis study, informed the Committee that the proposed Royal Bank/Bank of Montreal and CIBC/TD Bank mergers entail economic efficiencies and savings to the sector in the order of:

  4. ...anywhere between 20 per cent and 30 per cent of non-interest costs can be saved through rationalisation. Those numbers translate into an overwhelming savings per Canadian. Those would be savings between $1,000 and $3,000 over the next 10 years. Those types of efficiency gains in the aggregate numbers are $29.5 billion to $88.5 billion depending upon which range of savings you would accept. … We are talking about a material amount of savings that could be generated through the mergers. (Jason Clemens, October 28, 1998)

  5. This view was supported by others who believed these savings provided net economic benefits that would eventually find their way to Canadian consumers. For example:

  6. We believe in a free market environment and want to ensure that our clients prosper in that environment. Our firm, as well as many others, are the result of mergers to better serve the clients and the partners and the owners or stakeholders in the firm. We see the positive results of the proposed mergers within the Canadian banking industry as outweighing any potential negative consequences. (Glen C. Agro, November 4, 1998)

  7. and

  8. [T]hese mergers can be a valid business strategy to develop banks into world class competitors … My investors, my customers are First Nations people. Their economy is still local. Their issues are local. They have local service needs. They have domestic investment and cross-investment requirements across the First Nations in Canada. … Having said this, my opinion of the mergers is that it will not be a detriment to the development of our institution. First, our interests lie in lowering the operating costs of our partner bank, and we see that being accomplished through the mergers. Our customers and our bank will benefit from the lower costs of the merged banks, whether achieved through increased application of technology or the economies of scale that we believe they will achieve through the mergers. (Keith Martell, October 27, 1998)

  9. However, some witnesses concluded just the opposite, arguing that there was confusion over what was an efficiency gain versus what was simply a cost-cutting exercise. They further questioned whether or not consumers would be better served as a result of the mergers. A typical example of this position follows:

  10. Usually what we tend to see from bank mergers in other countries is that there was a confusion between efficiency and cost-cutting. Generally what banks referred to as efficiency was merely cost-cutting. … Usually it meant closing banks, laying off people and increasing service charges and having less service available to people. (Marjorie Griffin Cohen, October 28, 1998)

  11. and

  12. [W]e would lose 3,000 direct jobs in British Columbia. There is a concern for job loss. Secondly, … 75 per cent of B.C. communities are vulnerable to branch closure as a result of the proposed mergers. Of these B.C. communities, 199 are served by three or fewer financial institutions. This group has the most to lose and more than half of them are at risk of a branch closure due to the proposed bank mergers. (Ian Waddell, October 28, 1998)

  13. This assessment was supported by others with general and specific comments to make on the expected impact that the mergers would have on Canadian consumers. That is:

  14. The task force said that greater competition would benefit consumers, and observed that there was already too much concentration in core banking. It surprises me that it then went ahead and provided an orange light to bank mergers. … We think mergers would be bad for us, as corporate consumers of banking services, we think they would be bad for individuals as consumers, and we think that it would be bad for the economy as a whole. Having competitive banking is very important for all the different sectors’ effectiveness as competitors. (William A. Black, October 21, 1998)

  15. Another interesting perspective of the debate centred on the ability of other financial institutions to fill in the competitive vacuum left by the merging parties. Arguing in favour, the Committee heard:

  16. Unless you are in the shoes of whoever is making the decisions, you cannot make as good a decision. If the banks want to merge and blow their brains out, let them. There will be people who will come in and fill the vacuum. It may be from a different perspective and done differently, but the public will be served. The free marketplace dictates that where there is an opportunity, somebody will build a mousetrap, and that is the way it works. One of the things already happening with the mergers, as I mentioned, is that we have syndicate positions. As these firms merge, we get bigger syndicate positions. This is not only good for us, but also good for the country. By and large, we are dealing with the smaller client. Whereas the guys in Toronto want to write the $50 million or $25 million ticket, we are happy to write the $1 [million] and $2 [million]. (Lonsdale Holland, October 20, 1998)

  17. and

  18. We see a niche for ourselves in Atlantic Canada. We are all for letting the major banks merge, if, in their opinion, that will allow them to be more competitive and more profitable. They probably know better than someone who is not in the business how their businesses should be run. However, I suggest that there is probably room for a lot more banks in the Canadian banking scene. We should open up the doors. Everyone will find a niche. In this way, the public will be well served. (Lonsdale Holland, October 20, 1998)

  19. Arguing to the contrary, the Committee heard:

  20. Although some have argued that mergers should go ahead immediately so that smaller players can come in and pick up branch outlets or people that are divested by the merging banks, we wonder about that. We imagine that any large bank trying to consolidate will want to hold on to its best locations and its best human and physical assets. As a result, we would wonder how efficient and effective these potential competitors or smaller institutions may be with the cast-offs of the major banks. Despite our concerns over how quickly or effectively real competitive alternatives to the big five may set up, we are certainly pro competition. We think that true competition is the only way to go and the only way that we will ever see a well-served small business market, not to mention other segments of the market. … We oppose further concentration and mergers until we see actual competition taking place. (Catherine S. Swift, November 5, 1998)

  21. and

  22. I want to give you a little bit of the flavour of the hearings. … In Peachland, British Columbia, in the Okanagan, there was an example of a bank branch that had closed. There were no banks in the town and the residents had to travel 12 kilometres to Westbank. What they told the task force was we lost something in our community. It hurt us directly and people go and shop in the other community; it took away business from our community. … A fellow from Dawson Creek said to the task force that he tried to get a loan. He went into a bank and was turned down. He said that he can go to the bank next door. He went to three banks and he finally got a loan and got a small business going. If there is only have one branch, you will not to be able to do that. (Ian Waddell, October 28, 1998)

  23. One witness argued that the response of second-tier financial institutions would depend on the remaining barriers to entry into the sector and their possible removal. For example:

  24. Something that we did not focus on in the paper but that I would include in the presentation is the fact that even through the rationalisation process and the closure of branches that leaves an opportunity for niche players to get into those particular markets. In a particular cluster, if we see all five of the major banks with a branch, if two of those branches are closed that clearly gives an opportunity for people like VanCity, Schedule 2 banks, mutual fund providers, niche players, regional players, to come into that market and contest it if the barriers are removed. (Jason Clemens, October 28, 1998)

  25. Yet there were more neutral positions taken as well. One witness argued that it was not the number of remaining large chartered banks that mattered, but it was the concentration of the marketplace that was the disturbing fact.

  26. The issue of chartered banks in Canada is an issue where there is already huge concentration. That is to say, a concentration economic power and reach, and an increasingly enlarged segment of the whole service approach. The trust industry was a competitor that has now disappeared. Investment dealers were unique, but they also disappeared. They are all part of the banking system now. We have not had anything to say about the proposed bank mergers and I do not think we will have anything to say about it. That concerns the shareholders of the bank and the Minister of Finance, who must consider all the issues that affect all Canadians. There is a higher degree of concentration already than there is in any western world country. The banks have enormous power. If you have that kind of concentration, apart from the prudential aspect of it, does it make a lot of difference whether there are six or four? The issue is not whether there are six or four or 10, the issue is concentration. (Jim Burns, November 5, 1998)

  27. Picking up on the issue of market concentration, one witness advanced a cautionary perspective on the present state of the credit card business and the dilemma therein posed by one of the proposed mergers.

  28. Duality is when one bank operated two competing credit cards, for example, VISA and MasterCard. So they would be under one roof, versus the situation we have today where Royal Bank has a VISA and Bank of Montreal has the MasterCard, for example. … [ W] hen retailers accept credit cards in their stores they also pay a merchant fee to the bank that operates the card. In today’s environment, MasterCard is a more competitively-priced card than VISA. The biggest concern our members have is that, indeed, if those two cards end up being under one bank that there certainly is not an indication that the merchant rate for VISA would be dropping but, indeed, we believe that the merchant rate for MasterCard would increase to match the rate that now exists with VISA. As an example, our members are paying through the Retail Council program approximately 1.45 as a MasterCard merchant rate and approximately 1.8 as a VISA merchant rate. They do not believe that if those two cards were under one roof that indeed the VISA rate would go down to 1.45, but that the contrary would occur. There is also a question of market concentration … (Diane Brisebois, October 27, 1998)

  29. The Committee also heard evidence casting these mergers in a different light. Arguing from a public interest perspective, one witness claimed Canada's national interst would be advanced by strong Canadian financial institutions in a post-merger environment.

  30. Will we end up with a regime that does preserve choice and competition? Where we may differ with some people is that we believe there are forces of consolidation that are definitely sweeping this industry. We believe that some consolidation is probably inevitable in Canada and is probably in the public interest if you want to preserve strong Canadian institutions. We have taken a position that we have no objection, in principle, to Canadian firms participating in that consolidation trend, provided, and this is obviously an important proviso, that the mergers do not significantly reduce domestic competition. We believe that conditions could be imposed on the merger proposals that would allow the proponents to pursue their chosen strategies while at the same time preserving adequate levels of competition and choice in Canada. (Ed Clark, October 7, 1998)

  31. However, an equally convincing argument putting forward the opposing position was also made:

  32. Clearly the mergers are not necessary or useful. The mergers, in fact, are downright dangerous. The extent of concentration in the banking industry is a serious matter, not only because it leads to increased market power for a few corporations, but also because it can and often does lead to undue political power. … We have seen analysts doubting whether the federal government has the capacity to stop the mergers. … We have most recently seen bank chairmen making very thinly-veiled threats about what will happen if we do not allow the mergers to go through. … The Finance Minister must be urged to close the file on the mergers … (Peter Bleyer, November 5, 1998)

  33. From an international competitiveness perspective, some witnesses argued in favour of the proposed mergers. A typical example of this was:

  34. If there is a no, I think you lose control of the process. … If you have a qualified yes; yes, you can merge, but you cannot close more than X branches a year, you can put in a number of controls. If you just say no, then you will see the branches close and you will see consolidation anyway. You cannot stop the clock. It is happening all over the world. We have talked about size in banking. … You get into the big banks in the world, the Royal Bank is a peanut and even the Bank of Montreal and the Royal Bank together are still small, but it allows you to get into bigger loan syndications and lead deals where the fees are larger. Usually the lead bank takes the lion’s share of the fees and they are always down the food-chain and they are finding that in the world in the big deals and we find it on the street every day in Canada. I do not think you will support the upcoming of new financial institutions by trying to retain the status quo and the old system. They have the lion’s share of the market now. They will retain it. If they are allowed to merge they might focus more on global business and wealth management, some of the other areas and allow the traditional intermediary business to be absorbed by others. (Larry Pollock, October 28, 1998)

  35. An equally compelling rebuttal was also made. For example:

  36. [W]e tried to see if the argument that there was contestability of markets locally, and also whether or not it would be essential for banks to merge in order to have access to international markets. Essentially what we could discover through our research was that the size of the bank was not crucial to profitability in international markets. Certainly, the Bank of Nova Scotia has put forward this idea that they have performed very well in international markets without being the largest. So that seemed to be not an essential argument, certainly not one that was really convincing to use around a need to merge. … The Royal Bank indicated to us that it intended to have 40 per cent of its assets in international markets as a result of the merger. … We heard a lot of people tell us that they found that very dangerous, that this would put Canada in a precarious position if its largest bank in fact was so connected to international markets in that sense. (Marjorie Griffin Cohen, October 28, 1998)

  37. Still more cautious positions were taken on this issue. For example, the Committee heard from one witness:

  38. I would rather the banks did not merge in the short run, but I do not know in the long run whether that is the right answer for Canada, because I think ultimately, we are in a global era and technology is increasing it, and I attend a lot of meetings outside of Canada where I meet some of these big players and I know what they are doing. At the moment, we have been very fortunate in Canada to have a very strong domestic industry, but as the pieces get pieced off, it is not clear to me that we can expect to maintain that kind of advantage indefinitely in the future, and that is the challenge I think from a public policy point of view. (David A. Nield, November 2, 1998)


CHAPTER FOUR:

Objectives of Financial Institutions Public Policies

  1. The Committee believes that legislation and regulation affecting financial service providers in Canada should reflect the following set of public policy objectives:

  2.     •to ensure the safety, soundness and integrity of the Canadian financial system;

  3.     •to provide a framework for healthy competition in the financial services sector;

  4.     •to foster Canadian control of the key institutions in the financial services sector;

  5.     •to enable consumers to make well-informed decisions and to protect them from improper business practices; and

  6.     •to fulfill the stewardship responsibilities of the sector, including achieving the widest possible accessibility to financial  services across all regions and income groups.

  7. The above set of objectives are not listed in any order of priority. They are all important. As a set, they constitute a multi-facetted objective which public policies affecting financial institutions should try to meet.

  8. How to achieve these objectives has been the subject of intense political debate in Canada for years. Moreover, the means used to achieve these objectives have been different at different points in time. Thus, the means to achieve these objectives are not static, but evolutionary in nature.

  9. At one end of the spectrum are those who believe that these objectives can be achieved only through heavy-handed regulation of all the business practices of financial institutions, essentially treating these institutions as a public utility. At the other end of the spectrum are those who argue that market forces should be the primary — some say the only — regulator of financial service firms, that is, treating financial institutions as if they did not have the special characteristics described in section 2.

  10. The Committee rejects both these extreme positions. The former fails to recognize that financial service firms are publicly owned businesses in a competitive market place and have an obligation to their shareholders to enhance shareholder value. The latter fails to recognize that unconstrained market forces may well lead to outcomes which violate some of the public policy objectives listed above, such as safety and soundness, consumer protection, or Canadian control.

  11. As stated in chapter 2, the Committee regards a financial services firm as being a regulated firm lying somewhere between the two extremes of a public utility and a completely unfettered and free market-driven firm. The Committee recognizes, however, that the culture of the financial services industry must be one of vigorous competition. Therefore, the design of the regulatory system should interfere with this culture as little as possible and provide necessary flexibility.

  12. The Committee also considered the approach to bank policy taken by some European countries, such as the Netherlands and Switzerland. This approach treats banking as a strategic industry and seeks to establish a small number of a nation's major banks as global leaders in the banking industry. This policy works in these countries, without violating objective two (the healthy competition objective), because, in the Netherlands and Switzerland, consumers have widespread access to smaller, so-called, tier two deposit-taking and credit-granting institutions. Tier two institutions provide real competition for their nations' global banks in domestic financial markets.

  13. The strategic industry approach to banking cannot be used in Canada without violating objective two. With the exception of the caisses populaires in Quebec and credit unions in Western Canada, particularly in Saskatchewan and British Columbia, there is no strong second tier in Canada. In particular, the second tier is woefully weak in the country’s most populous province, Ontario. Thus, the essential condition of the strategic industry model does not exist in Canada.

  14. The Committee believes, therefore, that the means to achieving the five public policy objectives presented above requires a balance between government regulation and the use of market forces as a regulator. This balance is reflected in the recommendations which follow.

  15. These recommendations also reflect the fact that, during the past decade, all the major industrialized countries, including Canada with its 1992 amendments to various pieces of financial institution legislation, have moved on the spectrum in the direction of less reliance on government regulation to more reliance on increased transparency and competitive market forces.


CHAPTER FIVE:

The Principal Thrust of the Task Force Report

  1. The industry structure and business powers recommendations in the Task Force Report, when viewed in their entirety, have as their primary thrust the promotion of healthy competition across the full range of financial services, but particularly in banking services.

  2. The Committee supports this principal thrust of the Task Force Report. However, as detailed in the sections which follow, and as a result of evidence heard by the Committee, the Committee disagrees with the Task Force on a number of its recommendations with respect to how the objective of healthy competition should be achieved.

  3. Of critical importance with respect to increased competition, is the question of how long it will take, from the time public policy changes are made to encourage more competition, until the new competition actually materializes in the marketplace. This issue was not addressed directly in the Task Force Report. However, the unequivocal conclusion the Committee draws from the Report is that the Task Force expected this increased competition to materialize quickly.

  4. On the basis of evidence presented during the Committee hearings, however, it is abundantly clear that it will take several years — at least three years and more likely five years — from the time public policies, legislation, and regulations are changed before new competition is active and vibrant in the marketplace.

  5. Witnesses from the credit union movement, for example, said it would take three to five years before its national community bank would be fully operational.

  6. As well, evidence presented at the hearings showed that the set of policies that is required to encourage the development of new, small, community-oriented deposit-taking institutions will take in the range of five years from the time the new policies are in place before they result in new, meaningful competitors for the major banks.

  7. The proposed foreign bank branching policy, first outlined in the 1996 report of the Standing Senate Committee on Banking, Trade and Commerce, and supported in the Task Force recommendations, will not lead to increased competition in retail banking. Neither will it lead to increased competition in wholesale banking overnight. Thus, opening Canada’s borders to foreign banks, while highly desirable as a public policy, is not a panacea. The Committee does not believe it will lead to the immediate creation of a multitude of new second tier consumer-oriented deposit-taking institutions.

  8. However, increased competition could occur quickly if existing second tier deposit-taking institutions (e.g. Canada Trust, Canadian Western Bank, Laurentian Bank, Hongkong Bank) were to have the opportunity to buy blocks of branches from existing deposit-takers.

  9. It was also strongly urged on the Committee by the Hongkong Bank of Canada that there be an immediate move to full functionality of automatic banking machine networks. If that recommendation were acted upon, it would mean customers, rather than being limited to only those machines operated by their own bank, could both deposit, as well as withdraw funds, through the vast majority of such machines. Full functionality would provide each new deposit-taking institution with an instant 19,000 new locations through which to offer their services, thereby ensuring that other players, however large, would continue to face intense competitive pressure in all regions of Canada.

  10. In light of this evidence, the Committee urges the government to be realistic in assessing the length of time it will take for new, competition-oriented policies to have an impact. It will clearly take some time after the new policies become law before new, effective competition materializes in the marketplace.


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