Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 30 - Evidence - October 8, 1998
OTTAWA, Thursday, October 8, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 9:00 a.m. to examine the present state of the financial system in Canada (Task Force on the Future of the Canadian Financial Services Sector).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: We are here for our last day of hearings in Ottawa prior to beginning our hearings across the country on the MacKay Task Force Report on the Future of the Canadian Financial Services Sector.
We have two sets of witnesses this morning: the first comes from the Credit Union Central of Canada and the second from the Bank of Montreal.
With us this morning is Bill Knight, CEO of Credit Union Central, Bob Quart, president and CEO of VanCity Savings, the largest credit union in the country, and Jonathon Guss, CEO of Ontario Credit Union Central. Mr. Knight, please begin.
Mr. William Knight, President and Chief Executive Officer, Credit Union Central of Canada: I wish to express the regrets of our chairman, Mr. McVeigh. He came down with the flu last night and felt it was best not to spread it around this morning.
I thank the committee for the opportunity to be here in these times when we are dealing with major public policy issues as presented in the MacKay task force report.
The credit union system is diverse and complicated. It comprises over 850 independent financial Co-operatives operating in more than 1800 locations across the country outside the province of Quebec. In over 300 communities in rural Canada, we are the only financial institution providing services. Collectively, the credit union system has combined assets of over $48 billion, which represent about 7 per cent of the financial services market in Canada. We are especially strong in the residential mortgage and personal loan markets.
Credit unions operate on the basis of "one-member, one-vote" and value their democratic governance and commitment to the communities in which they operate. We have over 4.5 million members in the credit union system. If we add to this number the 5.6 million members who belong to the Caisses populaires Desjardins, our counterpart in French-speaking Canada, we come up with nearly 10 million Canadians who are members of financial service co-operatives.
By responding to their members' needs, credit unions have established a tradition of innovation in the financial services sector. We were the first to offer daily interest savings accounts, weekly payment mortgages, consolidated member statements, and financial planning services. The credit union system was also first to provide a publicly accessible ATM.
As an organization, the credit union system has three levels. The local level, where individual credit unions serve their members, is the primary and most important level within our system. The second level is the nine provincial centrals that provide local credit unions with services in such areas as technology, training, and asset and liability management. The third level, the Credit Union Central of Canada, is a national finance facility and trade association.
The Canadian central is the direct clearer of the Canadian Payments Association for the credit union system, a member of the Interac Association, an equity partner in Mondex, and a provider of services through full brokerage, for example, with Credential Securities. We have our own proprietary family of funds called Ethical Funds. You may have seen the commercials. Along with a majority of the provincial centrals, Canadian Central is regulated federally under the Co-operative Credit Associations Act.
Mr. Chairman, as the MacKay report has documented and all Canadians know, the financial services industry has been going through tremendous changes, particularly in the last 10 to 15 years. Indeed, this will continue in the next 10 years. The reforms of the early 1990s crumbled the four pillars of financial regulation, allowing for an intermingling of businesses and renewed dynamism in the financial services sector. It has also resulted in greater consolidation and concentration.
Mr. MacKay's response -- and he is to be lauded for this -- is to make the enhancement of competition the number one public policy objective. MacKay goes on to propose many different ways of achieving this policy objective: encouraging new domestic entrants; opening up to foreign banks; allowing institutions to broaden the range of their offerings; and engineering public policy outcomes through regulatory intervention.
We are here to speak to you about an alternative that is competitive, that has been around for 100 years, and that has a proven track record in serving the personal, small business and community financial needs of Canadians.
I will now refer to the MacKay report and some of the areas that are important to us.
Chapter 5 of Background Paper No. 2 of the report, which I commend to your attention, recognizes the credit union alternative. It presents a clear description of the financial co-operative sector in Canada. It recognizes the strategic position that we occupy. As the bricks and mortar of financial institutions are used less to house traditional transaction functions and are more for relationship-based functions, the credit union alternative, based on personal trust, is poised to take advantage of these changes.
The MacKay report has set out two legislative vehicles to help us move forward in the new environment and thus provide us greater competition in the financial services sector.
First, the report endorses our submission last year to the task force, in which we propose desirable changes to the Co-operative Credit Associations Act. At present, if centrals wish to provide wholesale services to other financial entities or retail services to their own members, they must do it through a subsidiary which they must own, for example, Co-operative Trust, Agri-Finance, leasing companies, and credit union corporations that provide credit services. This is immensely costly. In addition, the Co-operative Credit Associations Act restricts the ability of centrals to enter into financial joint ventures among themselves and with credit unions to provide an efficient and harmonized delivery of financial services. In summary, such legislative changes would enchance the centrals' capacity to provide a broad range of support services within the credit union system. These changes, it should be mentioned, would only be enabling changes. They would still require OSFI's approval in each particular case.
A second legislative option outlined in the MacKay report would consist of the creation of one or more co-operative banks under the Bank Act. Under this option, a credit union, or a group of credit unions, would apply for continuance as a federally chartered co-operative bank. As well, credit union centrals could become co-operative banks, whose only business would be to provide services to local credit unions which otherwise might not be able to afford the necessary investment in systems. At the moment, a number of credit unions are working out the business, legislative, and regulatory implications of migrating to the Bank Act.
With your permission, Mr. Chairman, I will leave with the clerk some documents outlining our Bank Act proposals.
We are also pleased with recommendation number 36 of the report, which states that, "Businesses organized in the cooperative or mutual form of ownership should be deemed to comply with the widely-held rules by definition and without the need for special exemption, whatever their size." In this recommendation, the "widely-held" will allow us greater flexibility in terms of our system responding at the national level and federal jurisdiction in order to operate across the country.
Finally, the credit union system is pleased that the MacKay report took a phased-in approach to the acquisition of expanded business powers. Subject to appropriate privacy and tied-selling regimes, it makes sense to let those financial institutions with less than $5 billion in shareholders' equity retail insurance and lease light vehicles before letting the bigger players into the market.
Some credit unions already enjoy these powers. This is true in British Columbia and in Quebec, with our first cousins, Desjardins. Both consumers and the financial institutions involved have benefited from the more liberal legislation.
In summary, I wish to outline to the committee what we believe is the essence and the importance to us of the MacKay report. In the next five to 10 years, the financial services business will be highly competitive. An excellent research paper, the Mackenzie report, was submitted to the MacKay task force. It outlines five viable strategies for Canadian players, and I invite the senators and the committee to examine them.
There will be players in the Canadian market who strive to provide ultimate service in strictly one product. We see those new entrants in the card business this very day in this very city.
There are other players with a wide distribution network, like the credit union system, who have the opportunity, with the new entrant strategy of the MacKay report, to take that access to that wide distribution and membership base and relationship banking that we have in local communities, and build on that to be the advice givers for our member customers. As we do that, our strategy in these changing markets must be to have full financial services; an array of products; and a menu of those products from insurance, to mutual funds, to services, to small and medium-sized business across the piece. We must do this in order to take advantage of the enormous network that we have.
What is exciting to us about the MacKay report is that the new entrance strategy allows greater flexibility, which will enable the credit union system as a whole to move to provide those kinds of services coast to coast.
We will share with you today a map of the restructuring models that we are looking at in order to provide those full services across the piece. In parallel with the MacKay report, the Senate Banking Committee hearings and the announcement of potential mergers in the spring, we have an opportunity to reinvent ourselves to a large degree, creating a national service entity and taking advantage of permissive legislation to allow us to look at the co-operative bank model.
We invite your questions.
The Chairman: I would like to ask you to enlarge on one point. In point 2 on pages 7 and 8 of your brief, you outline two models for the future advancement of the credit union movement. One seems to be the credit union centrals combining to provide common services and thereby efficiencies in back-office services across a wide range. The second is captured in one sentence where you say that a number of our credit unions are working out the implications of migrating to the Bank Act.
Would you explain whether those are two ideas or in fact only one? If they are two ideas, are they complementary or are they in competition with each other, and could you explain where each of them stands?
Mr. Knight: We have one national initiative and we have complementary models to work together. Because of the national service entity, as you can see on the chart that I gave you, we have an opportunity to primarily consolidate the wholesale services into one national service entity to back up our credit unions, which range in size and structure across the country. We will be able to provide them with common products.
Because of the new entrant strategy related to the MacKay report, we then have a model where a number of our credit unions from across the country would look at consolidating themselves into a national co-operative bank but still have those connections with the national service entity. So, you have a new entrant into the competitive market, but we believe that with that, plus the changes we are making with the national service entity, we will be able to make the business grow and provide full services across the country. We will share a number of services, such as in the areas of wealth management and back-office reporting.
Mr. Bob Quart, President and CEO, VanCity Savings Credit Union: Given that there are over 850 credit unions in this country, and that they vary in size from assets of approximately $300,000 to over $6 billion, and that some of them are community-bond credit unions and others are employee-bond credit unions, it is not possible to come up with a one-model-fits-all solution for these organizations.
We on this national task force have attempted to provide options for credit unions -- and there are three options here -- depending on their position today. Of the approximately 800 credit unions, there are several that, because of the nature of their business, are quite happy to continue to maintain their operations as they are today in a totally autonomous environment. We provide for that because they need services that they cannot provide for themselves. By and large, these are very small organizations and they cannot afford all the back-room services required for them to succeed.
There are others that want to maintain a significant amount of local autonomy as well but see the advantage of being affiliated with other credit unions across the country. Through our national service entity, and by providing certain minimum standards, a number of credit unions may feel very comfortable in becoming part of that group.
There is yet another group, of which my credit union happens to be one, which feels that we need a lot of change and we need it quickly. We feel that we need it quickly because we compete head-on with the banks in this country on the retail and small business sides. Our industry, as you all know, is going through incredible amounts of change. We believe that we need change now.
As a result of that, this group of credit unions has developed a third option, which requires us to receive legislative accommodation from the federal government to enable us to operate interprovincially.
Some comments have been made about growth in our industry. One of the restraints to growth that credit unions face is that, while Canadians are very mobile people and they move around this country significantly, when one of my members moves from Vancouver to elsewhere in Canada, they become either a dormant account or, hopefully, we manage to transfer them to another credit union, although this is not always the case. Our bank competitors simply transfer their account to the bank branch in the city where the individual is relocating.
We face the same problem with employees. As our services become more and more sophisticated, it is necessary for us to train and train and train people so that we can provide valued service to our members.
Frequently, our staff must move to other cities because their partners have been transferred, and we lose the talent that we have developed in our local environments. Therefore, this group of credit unions that I have referred to is anxious to explore fully how we can become more of a national organization delivering a similar set of financial services from coast to coast. We want to structure this in such a way that we do not lose that which is our significant competitive advantage, namely, our community connection and what we do within the communities in which we currently operate.
We have a two-fold vision. The first is to be able to provide continuous service from coast to coast to the people who have chosen us as their primary financial institution. The second, as a result of the first, is to actually increase the amount of money that we spend in local community development in those communities in which we were born.
Senator Tkachuk: The credit union movement in Saskatchewan is a very powerful force. In our province, we have been fortunate to have a strong credit union organization, especially as it relates to their commitment to agriculture, in good times and in bad.
One of the things that many of us talk about when we discuss the question of competition is the fact that, although the credit union movement does have significant operations in British Columbia, Saskatchewan, Manitoba, and Quebec, once you leave those four provinces, the services are not as available.
In your opinion, why do we not have a strong credit union movement in Ontario and Atlantic Canada?
Mr. Jonathan Guss, CEO, Credit Union Central of Ontario: Thank you for the question. I think you must look at Ontario as two separate markets. There is Toronto and then there is the rest of Ontario. If you take a step back and see it as two segments, that will help. If you look at any city outside of Toronto, credit unions are there and quite visible and have a reasonable market share, in some cases on the order of what you see in the western cities that you have mentioned.
Toronto is a market unto itself, and we are all aware of that. It is the home of the banks. It is the founding place of every mutual fund, save one or two, of every brokerage company, save one or two, of all the insurance companies, save a couple, and, basically, it is an extraordinarily competitive and fragmented market. It is a much more difficult market in which to make an impact.
Anyone coming into that market has a hard time. If you talk to insurance companies that started banks or trust companies, you can see that they started in Toronto and backed off. They probably realized that they made a mistake starting there and that if they had started anywhere else, they probably would have been more successful.
If you separate the markets, we are doing fine in Ontario outside of Toronto.
We do have some geographic gaps and skill gaps. It is a major challenge and we must admit that. There are some things that we could do together better to fill those gaps. We also believe that there should be a stronger national organization to fill those gaps, especially in the small-business lending area.
I do not want to leave you with the impression that I do not want change. We definitely need change to attack the Ontario market, but you must look at it in the context of the two segments.
Senator Tkachuk: You obviously support the recommendations of the MacKay report. What is stopping you now from having a national organization?
Mr. Knight: We have a national organization. Historically, we have defined services wholesale-wise in a limited manner, in terms of our own system, not being able to pick up other business in order to cut costs for credit unions. Second, we have not been in a position to respond in terms of retail powers, to almost use it like a unit bank in terms of the central. Third, we have three tiers. We have an opportunity here with the proposed changes, which is very significant. All of us know the nature of Canada, whether it is government, business or whatever. We have an opportunity here, through the national initiative, to put before our membership the concept to reposition for the next 10 years in the marketplace, not to have 9, 10 or 11 centrals but one national service entity to back up that system. That is the significant change here.
Senator Tkachuk: The banks that have come before us and before the MacKay task force have mentioned the taxation differences as a competitive advantage to the credit union movement compared to the banks. I do not understand the taxation of high finance like the Royal Bank of Canada, but perhaps you could explain if you are treated differently from the banks as far as taxation is concerned. Do you think their statements are true and that it gives you a bit of an advantage?
Mr. Guss: First, we are treated differently. I think you are aware of that. That is under section 137 of the Income Tax Act. However, it should be very clear that we also have different access to the financial or capital markets. The way our taxation was designed in 1972, after the Carter commission, was specifically to take account of the fact that we do not have access to the major public capital markets. All of our capital comes from our members or from internal earnings. In order to ensure that we can build up sufficient capital to meet regulatory requirements, they tax our capital but they tax us differently as we build that capital. When our capital reaches a certain level -- called the maximum cumulative reserve -- then we are taxed like the banks. Basically, it was designed for us to build capital more quickly.
Senator Tkachuk: The Wheat Pool and the United Grain Growers (UGG) have moved from being a co-operative to being a public company. Has there been any talk among the credit union movement about that happening, which would give you that access to capital? You would actually be able to go to the capital markets. Or can it be done with all the independent, different credit unions across the country?
Mr. Knight: Through the Co-op Credit Association Act, we could do a public issue now.
The Chairman: Am I not right that Surrey Credit Union has already done that?
Mr. Knight: Yes, but, by and large, most credit unions raise their capital in terms of preferred shares or build it internally from retained earnings.
The two models of UGG and the Wheat Pool are quite different on the governance control mechanisms of the two entities. The Saskatchewan Wheat Pool would make the case that the member-owners control the service.
I should like Bob Quart to respond to this. One of our real strengths in the marketplace, if I can call it this, is our relationship banking. Our member-owners are driven in terms of service to them. We are on the hook every day of the week that they come in there, in terms of relating to them. Moving to the equity markets would have serious implications.
Mr. Quart: The democratic principles under which the credit union system exists continue to be important to us, regardless of which of the three options a credit union wishes to choose. For as long as possible, we should like to preserve the fact that our members own the place. That really means something.
When a member is in one of our branches getting service from one of our service providers, that person is talking to the owner. That is a different relationship than simply talking to the customer and having an owner who has other needs and requirements. That works in another environment, but I do not think that it would work well in ours.
To give you an example, at the present time, my executives are not concerned about the value of their stock options. I expect that is true in most of corporate Canada today. Discussions around that issue take up a lot of their time.
Senator Tkachuk: Or why they are not worth anything right now.
Mr. Quart: Right.
The way we are structured, we are there to serve our owners, who happen to be our customers. We want to maintain that as we move forward with whichever of the three new options we are looking at. That keeps us much closer to the people we serve.
Senator Callbeck: Mr. Quart, I want to follow up on your response to the question about why credit unions are so strong in Manitoba, Saskatchewan and British Columbia, but not so strong in other parts of Canada. I come from Atlantic Canada. In New Brunswick, they are much stronger than in the other Atlantic provinces.
You mentioned Ontario, which has basically two markets -- Toronto and outside of Toronto. Can I assume that the reasons you gave as to why credit unions are not strong outside Toronto are the same reasons that would apply to Atlantic Canada?
Mr. Quart: One of the reasons credit unions in Saskatchewan and British Columbia have done as well as they have is because they have had favourable enabling legislation from successive governments in those provinces. That has allowed them to provide the four pillars of financial services to their members in a way that has not been experienced to the same degree in other provinces. In some ways, that has hindered the development and growth of credit unions in other provinces that have not had such a generous environment in which to operate.
Senator Callbeck: Perhaps you could give me some examples of that, some of the deterrents in Atlantic Canada.
Mr. Quart: In British Columbia, we have been selling insurance to our members for a long time. Some of our credit unions are also in the automobile leasing business. These are things that have been going on in our environment for a considerable period of time, subject to the tied-selling rules and other things that ensure privacy and safety, as far as our members are concerned.
There are two examples of precisely where we have done very well. Some of our credit unions in British Columbia do extremely well on the insurance side. The result from a competitive perspective has been that consumers are getting more attractive offerings in the form of different types of insurance packages available to them through these outlets.
Senator Callbeck: In Saskatchewan, can credit unions sell insurance and lease cars?
Mr. Knight: No, but credit unions have had other flexibility within their legislation and have built their capital and started operating subsidiaries that are in a number of those businesses. It has been a different model.
Prince Edward Island credit unions are very successful and their business has grown. I need to say that on behalf of our colleagues there. Outside of that, Quebec, Saskatchewan, Alberta and B.C. have traditionally made moves legislatively that are enabling. Traditionally, others have followed the federal lead. That is why it is exciting for us to see the new entrance strategy, as outlined by the MacKay task force.
Senator Callbeck: If the task force recommendations are implemented concerning credit unions, do you see the credit union movement in Atlantic Canada becoming as strong as the movement in western Canada?
Mr. Knight: Yes. As long as we are comparing it to the asset population base in comparative terms, I believe that would be the case. We do have successful caisses populaires or credit unions across Canada, so they will grow.
Senator Callbeck: The report also said that, in some areas, credit unions are finding it difficult to attract young members. Is that because of the services? In a lot of areas, you do not offer as many services as other financial institutions. Is it because of the make-up of the credit union, the structure? What is it?
Mr. Knight: There is a variation between those signing up with banks or ourselves. It relates sometimes to the full-service package, quite frankly. We are into Internet banking, home banking, and all of those things, but we are fragmented in rolling them out. We are looking at opportunities to make our business grow and to do it in a manner where those services would be consistent. Plus, we desire the consistency of being able to deposit and interact between those credit unions across the country. With those moves following the MacKay report, we could help close that gap. That is the main reason.
Mr. Quart, and Mr. Guss in Ontario, have a lot of experience on the retail side, and they may wish to comment.
Mr. Quart: I think the comment Mr. Knight made is correct. Our experience at VanCity -- and I do not want to focus entirely on it -- is that over the recent years we have spent a significant amount on technology. We were the first to introduce interactive home-banking technology. We used the technology to create a virtual bank, the Citizens Bank of Canada.
We are seeing a number of your people using our services. We are seeing a significant portion of our member base using our technology. Once again, however, the cost to maintain and to be leading edge in this kind of environment is an extremely difficult issue. It is one of the reasons that we feel we need to consolidate our efforts as a system and ensure that the dollars we spend on technology are being spent correctly, wisely, and that we are able to implement that technology as quickly as possible.
Mr. Guss: I wish to pick up also on the background of the credit unions. Every credit union has a tradition or different roots. They are not so much geographic. In the west, credit unions have community bonds or roots; in the east, they tend to have industrial or parish roots. As industries age, so does the population using the credit unions. We must make extra efforts to attract younger people. Where we have community roots, regardless of the province, we tend to have the same cross-section as the banks. That goes back to some of your questions about the Atlantic region.
One of the distinctions in the East is that the banks have been based in the east, not just Toronto. I am thinking of the Bank of Nova Scotia.
My mother is 90. If I called her today and said, "What should we invest in?" she would say, "Buy shares in the Bank of Nova Scotia." That is her credit union. She is in New Brunswick.
In Toronto, 250,000 people work for the banks. Everyone has a mother, father, brother, sister, or child who works for a bank. In the west, there is much more emotional distance from the banks, and as we have learned, there is a major emotional element in the financial markets.
Senator Callbeck: You mentioned community bonds. I understand that they are very successful in Saskatchewan. Is that area continuing to grow?
Mr. Guss: It is very strong in B.C. as well, and it is starting to grow in Ontario. I am sure it is starting to grow in the Atlantic region as well. That reinforces what Mr. Knight was saying.
Senator Kelleher: When our committee travelled to the United States earlier this year, we thought we learned quite a bit about the community banking system down there. It has provided a second-tier system in the U.S. that we do not seem to have at the present time in Canada. How would you compare your present, open scope of operations and the services you provide with the community banks in the U.S.?
Second, assuming that the comparison is less at the present time, if the MacKay report recommendations were implemented, would this bring you up to par or up to speed with the powers and scope of the community banking system in the U.S.?
Mr. Knight: First, there is a strong and active credit union across the United States, as well. In terms of their markets, I will not get into how they function versus us, and the similarities and differences. There is a credit union system across the United States that we do relate to and confer with.
Second, the community banks and their second tier in the United States have gained more flexibility in terms of new entrants and being able to serve particular markets. But I believe that those community banks also vary a great deal in terms of where their strategic focus is, almost by community.
If the MacKay report went through, if I understand the range of the community banks within the U.S., we would be very much in a position to be one of the players to assist in filling that void in Canada. That is what is exciting to us.
Senator Kelleher: When Mr. Clark appeared before us, the CEO of Canada Trust, he expressed some concerns about the lack of competition that would exist in Canada in the banking system if in fact these mergers went through. He said, notwithstanding that MacKay is recommending increased power for foreign banks, notwithstanding that MacKay is recommending increased power for credit unions and converting to near banks or banks, that he remained concerned that it would take quite a while for this new competition to get up and running.
Could you take a look at your crystal ball, and assuming that the MacKay recommendations with respect to credit unions were in fact approved, how long do you think it would be before you could get into some kind of meaningful operation?
Mr. Knight: I will let Mr. Quart respond in a moment here, but in terms of going from three tiers to two tiers, looking at what we could do in full services, we are looking strategically at over a three-to-five-year period with some initial, fairly dramatic moves. Frankly, we would need to see legislative action quickly, once the public policy debate is discussed, and determine how we would respond. Later this fall, we could be in a position. Our processes are unique to our system: we are held accountable to our primary first tier in terms of buy-in, but with that buy-in we could begin to make significant moves and take advantage of this opportunity very soon, meaning early in 1999.
Mr. Quart: As far as the 12 organizations that are doing the work on this third option, we see ourselves moving quickly, after the year 2000. We do not wish to start converting systems late in 1999. We want to get past the year 2000. Assuming that we have the legislation in place, we can quickly put together this group of 12. That would represent roughly 140 branches across the country, plus the capabilities of the Citizens Bank of Canada on the virtual banking side: 800,000 customers and members and assets of approximately $12 billion.
I do not believe that there are many other entrants, foreign or others, that could come in and produce bricks and mortar from coast to coast in that period of time, or even that would have the intestinal fortitude to build them.
Senator Kelleher: Given the existing banking system that we have now, in your opinion, do you think that this would provide meaningful competition for the Schedule I banks?
Mr. Quart: It would only be a beginning. Again, I must refer back to the community I know best, which is my own. In that community, we have some successful credit unions operating side by side. One person in eight in the Greater Vancouver area use my own credit union as their primary financial services delivery outlet for retail banking services. Where we have not done as well as we want to do is in the small- and medium-sized business area. There, by pooling our group together, we can hire the expertise that is necessary to do that and we can enter that business in a way that we have not been able to, to date.
We start up many small businesses, many ma-and-pa operations. The successful ones that we create get to a point where they get too big for us to keep on our own, so we end up losing them to the banking system. If we had more capacity to lend higher levels and to provide additional services, which they require as their businesses grow and prosper, and as their businesses become more national or international, we need the tools to ensure that we keep those members with us. Many have come to me in the years that I have been CEO and have said that they love our service but that we do not have all the services needed today and they must go elsewhere.
If we had this ability nationally, we could provide competition in an area where there is a void. Canadian small business is crying out all the time that they are not properly served. Let us give them more competition and choices.
Senator Kelleher: Would a protected start-up period be helpful for you if the MacKay recommendations were approved?
Mr. Quart: I could never say no to a question like that.
Senator Kelleher: I did not expect you to say no.
Mr. Quart: It would take us a little while to structure certain things. We have significant expenditures that we would need to absorb in order to bring these organizations onto one platform for technology. It means significant costs in the short term in order to get us into a position where we can actually act as one and be seen as one by our members. If a member goes into a branch in Halifax or in Grand Forks, B.C., they get the same service and the same statement, et cetera. That will require significant capital investment. Any kind of break that we can get to help us through would be helpful.
Mr. Knight: I wish to add some comments to that question.
Many of you, like myself, went through the major public policy debate of the 1990 reforms. We allowed, in essence, capital to move between the barriers and the pillars. We were looking at enhancing and seeking competition. My view is that the MacKay report allows new entrants to be first out of the post, if you like, to deal with some of those product lines, to have some provisions around either capital taxes or our taxes. By allowing that flexibility for the new entrants versus very large and quite dominant players, maybe we have a route here to get past all of the industry debates that have occurred about who should handle insurance and who should not. They will not be able to shift that marketplace that significantly in the first three years, but you will have an experiment to measure from a public policy point of view.
As you know, here in Ottawa, as soon as a report comes down, all kinds of positions are taken and hardened by industry in the financial services about who can do what and who cannot, after all of the research has been done and the study completed. It may well be that the new entrant strategy will provide a route of public policy and allow people into those marketplaces.
For example, on the insurance issue and related to deposit-taking, that allows you to see what we have experienced in B.C. Brokers and credit unions can co-exist. Customers and industry benefit. Most important, the citizens of B.C. have enough of a range and a competitive market that they get very good pricing and service related to those products.
The Chairman: I am sure, Mr. Knight, that you will not be surprised to learn that Canada Trust and Banque Nationale have also volunteered to be the part of the pilot project with the expanded powers.
Mr. Knight: Yes, and I promise that I was not reading the transcript.
Senator Joyal: Mr. Knight, I was looking at your chart. As you well stated, the MacKay report recommended that there be a strengthening of the second-tier banking service in Canada. While I was looking at the figures on page 2 of your brief, it reminded me of the strength of your cousin in Quebec. If we are drafting the map of a second tier, would it not be preferable to have one co-operative bank in Canada? In that case, you would join forces with the caisses Desjardins.
On the principle of corporate ability, which you have mentioned, you would have access to the same services wherever you are in Canada. We must take into account that the economy is less regional and more national, continental and global.
This would add a significant element in terms of capital and flexibility in the system. It would position you in a better seat in the second tier, especially after our chairman has said that Banque Nationale and Canada Trust and others at that level would want to compete with you.
Setting everything aside, this seems to be a logical development if we are really to reshape the second tier in Canada.
Mr. Knight: You may well be meeting with Desjardins in the coming weeks as you go across the country. I do not want to speak for them, but we are in fact in conversation with each other to compare our business cases, to compare where we believe the industry is going and to see where we can work together. We work with Desjardins today in a number of areas. Mr. Quart could comment on that for you. There is another area in Saskatchewan. We work with Desjardins Life in terms of our QCorp, which is a commercial lending company. We are looking at each others' channels of distribution in terms of exchanging our mutual fund families or portions thereof. Those discussions, particularly on business, are under way.
As this marketplace is changing, we are finding between Desjardins and ourselves the opportunity to discuss some of the back-office operations. In terms of electronic switching in the back offices, we discovered that we both go separately to the same, very good supplier. We thought that, next time, we would team up and go together. All of that is under way.
I understand that Desjardins is interested. We are waiting to hear the direction that it will take in terms of their planning, in terms of the federal legislation and the MacKay report as it relates to co-operative banking and perhaps international business. This involves not only Desjardins but RaboBank. We are in discussions and meetings with Desjardins to see where we can work together.
[Translation]
Mr. Quart: We recently came to an agreement with Desjardins Visa and VanCity Visa that enables us to offer their card across the country. Such an agreement is interesting for us because of the volumes Desjardins already has. If we take the volume of the two organizations, we can see that there are financial advantages and advantages in terms of the products we can offer since they have a lot of experience. If we recognize that the culture is different in each region of Canada, there are other situations where we could do things together for the good of all organizations.
Senator Joyal: Regarding mergers, even with banks that perform better and are capable of competing with the superbanks, how can we get better results, when a more flexible system that has allowed foreign banks to come, in the last years, has not yielded the expected results, especially in the distribution system.
Like Desjardins, you have a network of branches. You are there where the service has to be accessible. Before accepting or recommending the merger, we should be convinced that a strong and competitive second tier of banking will happen soon.
We perceive the tradition of the cooperative movement as more individualistic. Each bank is its own master in its area even if there is a sharing of services, but the very tradition of the institution is not a quick and global opening.
One of the key factors is the speed with which you must respond to the terms set for accepting the merger. To what extend do you have the human and financial ability to take over immediately?
Mr. Quart: If the federal government is giving us the needed legislation and tools, whether it be Desjardins, RaboBank or other entrants at the cooperative level, there will be many reasons for the organizations to look together at the advantage they can muster. But first of all, the needed changes at the federal level are so onerous that they will force us to do something together.
Discussions are underway and they are not just assumptions. When we know the route we will have to follow and when we know where it will take us, I am sure that we will find the needed partners whether it be Desjardins or others. This is inevitable at the national level. I feel positive about it and I am sure that when you meet them in Montreal, you will get the same answers.
[English]
Senator Meighen: In terms of the MacKay report itself, some are arguing for a speedy implementation of its recommendations and some are preaching the wisdom of a much more measured approach, perhaps with some self-interest on either side. Who knows? Then there is the school of thought that says that the worst thing we could do would be to implement it piecemeal and that it should be implemented as a whole package. Where do you people come down on those two approaches?
Mr. Guss: First, you heard from Bill Knight that we think it is a positive report. In general, we find it carefully balanced and calibrated. While it is massive and, I would say, a masterful piece of work, the balance between competing interests was found. From our perspective, we are on the side of saying that it should be done as a whole because of all the balancing that they have done.
Senator Meighen: What about the speed of adoption?
Mr. Guss: From our perspective -- and perhaps this is self-interest -- there are pieces of it that we need. I am here as living evidence that our centrals are prepared to amalgamate; we want to de-layer our system.
As you know, provincial centrals are hybrids. We are provincially incorporated but federally regulated. We cannot, today, amalgamate ourselves easily; and these changes would allow us to amalgamate. It is important, for simple, practical reasons, to get the whole package through.
The Chairman: Recognizing the desirability of doing everything as a whole, but also recognizing the complexity of doing everything as a whole and hoping to make some progress, can you give us an answer, either now or by way of a letter, to the following question: What are the two, three or five recommendations that are critical to the credit union movement that would enable the you to do the things that you have talked about? In other words, what are the legislative or regulatory barriers that must be removed or changed in order for you to be able to achieve your objectives? In effect, if progress on some other fronts is slower, one could at least proceed with the things that one would like to have done.
Mr. Knight: First, in the material that you have been handed are a number of the policy areas -- and Mr. Quart may wish to comment on that.
We will outline them in a letter, which we will provide to the committee.
Mr. Quart: Our handouts outline the powers that we seek. Those powers are powers that we enjoy presently at the provincial level. Therefore, we would find it difficult to tell our membership that, although we are moving into a national arena, we cannot do this, this, or that any more. We do not think that will sell.
The Chairman: In a province like British Columbia, where you are allowed to sell insurance, you do not want to give up that power as you move into what you call the third option, the bigger national institution.
Mr. Quart: We want to go further than that. If we say we are a seamless organization from coast to coast, what you do in Vancouver you should be able to do in Halifax. We are asking for these powers. The same goes for leasing and security sales, and so on.
There are also some tax considerations. As we move these organizations together into one, we obviously do not want to trigger capital gains, because that kills the business case.
Senator Meighen: In your submissions to the MacKay task force, you talked about Crown financial agencies. Unless I missed it, I have not seen anything in MacKay dealing with the role of Crown financial agencies, the Farm Credit Corporation or the Business Development Bank. Do you consider them to be competitors of yours?
It is fair to say that they are certainly players in the financial services industry in Canada. If I am not mistaken, the Business Development Bank has just issued its own Visa card. Where do you see them fitting? Do you see them assuming a role that goes beyond what they should be doing?
Mr. Knight: Like yourself, senator, I did not see any comments about that in the report.
We have a good working relationship with the Business Development Bank in parts of the country. We would like that to continue; indeed, to enhance it.
In the last year or so, we have been in less conflict with the Farm Credit Corporation; in fact, we are looking for opportunities to partner in projects. I believe there is one partnership in Ontario, and there is work going on in the Prairies.
Senator Meighen: Is it a case of "if you can't beat 'em, join 'em"?
Mr. Knight: They may have responded that way, but we have always had a very good working relationship -- excellent, in fact -- with the Business Development Bank, and in significant parts of the country.
From time to time, we have had real challenges related to the Farm Credit Corporation. However, to be quite candid with you, the new president and CEO and the board of that Crown corporation have been making significant moves to cooperate and work with us.
The Chairman: When you say "work with us," do you mean work with you in terms of the new ideas you are developing or just work with you in terms of the existing structure? Members of this committee were subjected to considerable abuse a few years ago for suggesting that these various Crown corporations be merged into one -- something that we thought was a good business decision.
When I look specifically at the Farm Credit Corporation and the Business Development Bank in comparison with your organization, it seems to be a natural fit, in that they are only in commercial lending and you are not in commercial lending to any notable extent. The vast majority of credit union loans are in personal loans and personal mortgages. You have a vast distribution system, which they do not, and they have the expertise in business and commercial lending, which you do not. On the surface, it looks like a good fit. I say that without asking the next question, which is: Why do they need to remain Crown corporations at all?
Is your relationship with them friendly, as one often has with people in the same business, or is it moving further in light of the kinds of structural changes that you are talking about?
Mr. Knight: It is moving further, to the point where we can align and partner in terms of enhancing our networks of full service around commercial lending.
The Chairman: With reasonable support and with some enthusiasm on their part?
Mr. Knight: With some enthusiasm and taking the notion seriously of their institutions and ours being compatible in terms of possible joint ventures, that is correct.
Senator Kroft: As a Manitoban, I am aware of the presence and the strength of the branch operations of the credit unions. It is particularly on the subject of branches that I would like to ask you a question.
There is a certain conventional wisdom in some areas that the development of technology and the accessibility to banking services that that technology offers is, in many ways, making traditional branch-type operations of financial institutions no longer necessary. Mixed in with that is, perhaps, the suggestion that they are not cost-effective.
On the other hand, others, such as Mr. Clark from Canada Trust, who was before this committee yesterday, have said that the branch is the heart and soul of any financial institution and that that is where the business is done, and the more the better.
Can you tell me, as people whose institution is built on branches and on the concept of being there for the customer -- and I think that is something that you would like to say when the banks are not -- what do you see as the future of the branch operation and its relationship to technology?
Mr. Quart: The nature of the branch has changed dramatically and will continue to do so. Fewer and fewer transactions are being done in the branch today as technology makes it easier for consumers to do it more conveniently and at a time of their choice.
Having said that, it is also true that the financial needs of Canadians are changing. We have an ageing population, one whose needs are centred around savings, investment, tax advice, retirement advice and estate planning. This is becoming more and more so, as every day goes by.
We need to redesign -- and have begun to do this -- how those branches operate as value-added centres, and not necessarily a place where you go to withdraw $20 or to pay a telephone bill. By value-added centres, I mean somewhere one can go to get a financial check-up, to get some value-added ideas about how to simplify one's financial life, through the various financial life cycles one goes through, from birth to the grave.
The branches that are in the credit union system today by and large will move to that kind of environment, some more quickly than others. Many kinds of specialized personnel will be required, in order to do this and to do it right. That is taking place and will continue to do so.
Insofar as branch closures are concerned, I will speak to the third option, which is the National Co-operative Bank. The National Co-operative Bank would be owned by what was formerly credit unions and are now co-operatives in different communities across this country.
Credit unions will create a national option. Local communities will decide whether branches stay open or not.
Mr. Knight: I would like to provide the committee with some information on Manitoba. The Manitoba credit union system in the rural areas, in a number of instances where there has been a pull-out by the banks and there is no financial institution, has moved into those communities and provided those services, either as satellite services or directly to that community.
The trick in terms of our model is that there needs to be buy-in from the community as well to use the service. The services are changing, and we have some experience, particularly in rural areas, of being able to out-manoeuvre some of the other players in terms of moving into a vacuum. Manitoba is in the lead in that. I would be happy to discuss that and outline to you how they do it and what kind of services that means to them.
Senator Kroft: Your case, then, in some part at least, is that there are elements intrinsic in the co-op movement that give strength and opportunity to the branch movement that perhaps are not offered by what I may call a more crass commercial operation. Is that correct?
Mr. Knight: Yes.
We are still very commercial. I want to be clear that if there is not a community buy-in, we will not go to that community. There is a trade-off, and then the commercial business takes place. However, in Manitoban communities where there is significant interest to use that entity, we have been successful.
Mr. Guss: I want to drive home the point that Mr. Quart made about governance. We not only have user governance, which was mentioned earlier today, but community governance.
Community governance ensures that if a company can make more money somewhere else, they will take their capital and move it elsewhere. If the economy is weak in Thunder Bay and strong in Calgary, most companies will move from Thunder Bay to Calgary.
A credit union will say, "We are based in the community; governance comes from the community." That is Mr. Quart's point. We will accept a 6 per cent return on capital instead of moving it to where we can get 18 per cent. We have seen that in Manitoba.
Senator Kroft: If your governance leads you to a 6 per cent solution, will that allow you the kind of return that will be needed for reinvestment in your operation to be competitive under your third option?
Mr. Guss: Yes. It makes it tougher, but we can definitely do it.
Senator Angus: In the Manitoba example, regarding what you said about the sharing of functions with the BDC, did you have any alliances or arrangements with the main chartered banks, the Schedule A banks, in terms of back-office functions or sharing any aspects of the payment system -- payment system access or any of those things?
Mr. Knight: First, we are very much players in the payment system. We are members of CPA and Interac. We do group clearing through Canadian Central. In terms of, let us call it the bank utilities, I will let Mr. Guss respond.
Mr. Guss: Based in Toronto, we look at the bank volumes. We look at the Royal and the Bank of Montreal proposing to get together to create a larger entity. We said, "Surely we can piggyback on those volumes." We have made an alliance with them, and they do our backroom cheques processing. We still have the link to the Bank of Canada, and we still do the financial settlement ourselves, but they do the processing of our cheques.
We are prepared to do that in any field to get the volumes and drive down the cost for our credit unions. That is the name of the game.
Senator Angus: When we were in the U.K., we heard, for the first time, from banks that were emphasizing contact with the consumer, details about the opening of outlets in supermarkets. It became clear that the banks themselves were doing all the back-office stuff and the retail outlet was providing another service, the direct contact with the customer.
It occurred to me while you were talking about the Manitoba operation that there is half a loaf, perhaps, available for you, and then you are able to piggyback on some of the other things. I wondered if there were others in the checklist.
Mr. Quart: In addition to commercial arrangements that we can make with banks, there are also other organizations with which we can make beneficial arrangements. For example, the "telcos," because we rely on communications to a great extent. Another example might be computer companies and post offices.
In this new age, there are many ways where you do not have to do it by yourself. We clearly want to control the relationship between our members and our organization. That is the bottom line.
Senator Stewart: Earlier, mention was made of the difficulty of approving new members. That prompts me to ask about student loans. I do not know whether student loans are a good way of recruiting new members or not, but let us assume that they are. Am I correct in thinking that the credit unions are not in this business? If they are, what is your experience as to customer loyalty?
Mr. Knight: If you are referring to the Canada Student Loan program, we are in it. We have a contract with the Government of Canada. We provide that service to credit unions who choose to join in that program. It is particularly used in the prairie basin. Beyond that, it is spotty, quite frankly.
I must tell you quite candidly that, as it relates to the 5 per cent premium and all the changes over the last five to 10 years, we do not think that the program is functioning very well at this time. It is my understanding that there is work under way to completely review that program and how it is functioning. It is very difficult to sustain.
Quite frankly, students are facing an awful load these days. When you try to assist financially, you are not doing well on those loans or the number of bankruptcies.
A number of credit unions, such as Sherwood Credit Union in Saskatchewan and a number of others in Alberta, have their own unique programs aimed at students, separate from the student loan program. They are meeting with some success in financing and providing those provisions.
Since the latest budget, we are as well providing, through the system, RESP services to a greater extent than we did before.
Senator Stewart: Am I correct in concluding from what you just said that, insofar as the Canada Student Loan Act is concerned, your members do a fair business in the parts of the country in which the credit union is strong, relative to the general population as distinct from students?
Mr. Knight: Interestingly enough, the Prairies and parts of Atlantic Canada have used the program extensively. Speaking of alliances, we have them within our own organizations. There are a number of areas in Atlantic Canada that deal with the Acadian movement and handle the back-office work on the student loan program in that part of the country. Saskatoon Credit Union has provided that service in the west. In terms of that particular program, that is where their experience is, but it is a challenge.
Senator Stewart: I wanted to open up that topic. We may have to explore it later.
The Chairman: Absolutely. I sense an element of inconsistency in some of the things you have said. On the one hand, you position yourselves very much as a commercial enterprise. On the other, Mr. Quart comments with some pride on how difficult it would be to close a branch. I am puzzled by the inconsistency of one saying that, while we are a business, we will take a 6 per cent return when we could get 18 per cent elsewhere. That analogy does not strike me as a classic, commercially driven model. That, in turn, leads me back to Senator Kroft's point. In light of the fact that you are sort of commercially driven, what makes you confident that you will be able to succeed as the marketplace becomes increasingly competitive and things like margins really start to matter?
Mr. Knight: First, yes, the value structure makes us unique. Second, we are commercial. Yes, we must be three times as nimble as some of our competitors. They can slop over losses that we could not take. In that sense, we are very much there, but we have an enormous network of distribution and an enormous base from which to grow. If 28 per cent of our people use us as their primary institution, and we move that to 35 per cent, it has an enormous impact on our cost base.
Second, we work on the principle that if we create a national service entity, as an example, or the national community bank, through the principle of pooling our capital we are able to redirect it to the emerging enterprises very effectively.
So yes, we are a mix of the commercial with the community. There is no question about that.
In terms of our trend lines, credit unions of varying sizes have merged in order to become more effective and to provide a full range of services within regions or communities. Over approximately a decade, we have gone from 1,200 or 1,300 credit unions to about 844. If that trend continues, I could foresee 300 or 400 full-service credit unions of some nature across the country, plus the national community bank.
Mr. Quart: It is important to recognize that we are a commercial enterprise and we do look at things commercially. However, at the same time, we are driven by what is best for our owners, who happen to be our customers. That is a fundamental difference between us and our competition. Yet, on a day-to-day basis, we compete head-on with banks, trust companies, mutual fund operations, specialty companies, et cetera, in order to win the business of our members.
Our members do not deal with us because it costs more money for them to do so. They do not want to pay more for the service we provide them, but they expect more service and they get it. Recent quality studies show that credit unions are ranked third by Canadians among 20 different service industries. Canadian banks ranked seventeenth in that study. That shows that we do invest more money in service to our membership on a pro rata basis.
Also, profitability by itself is not the sole driver of a credit union. The purpose of profitability is to generate the capital through the retained earnings that we need to grow. I am proud of the growth that we have experienced. My own organization is an example, but it is only one of many. We have grown from 600 employees six years ago to 1,500 today. Our assets have grown to $6.2 billion. They have almost doubled in the last six years, and we are profitable. We are not as profitable as Canadian banks are today, but we are profitable and have been for a long time.
The way we deploy our profits is different. We are proud of the way we do that and we think that more Canadians would benefit if there were more of us around doing it in all parts of the country.
The Chairman: Your argument is interesting. It is almost exactly the same argument the committee heard for why community banks in various parts of the U.S. have been successful.
Gentlemen, thank you for appearing here this morning. Please send us that note on legislative requirements.
Mr. Knight: We will.
The Chairman: Our final group of witnesses this morning is from the Bank of Montreal.
Mr. Barrett has an opening statement with which I will ask him to proceed, and then we will turn to questions.
Mr. Matthew Barrett, Chairman and Chief Executive Officer, Bank of Montreal: Good morning, senators. It is indeed an honour to have the opportunity to address you this morning.
In my opening statement, and with your permission, I will offer some brief comments on the report of the MacKay task force. I will then move to present a Bank of Montreal perspective on the future of the financial services sector in this country, and our hopes for the new bank we hope to forge.
In taking a bird's-eye view in my opening remarks, I do not want to signal to you any unwillingness on my part to deal with any of the bread-and-butter issues. I will be happy to respond, of course, to any questions you have. Since the ground has been well-tilled on many of those more detailed subjects, either by previous witnesses or by your own research, I thought that a broader perspective from me at the outset might be a helpful addition to your deliberations. That, of course, will be for you to judge.
To help me provide that perspective, I am joined this morning by Al McNally, Chairman and CEO of Harris Bank, who heads up the Bank of Montreal's U.S. operations, and Tim O'Neill, our chief economist.
My first reaction to the MacKay report was one of appreciation for its comprehensiveness and thoroughness. It is an impressive body of work. By commissioning the task force, the Minister of Finance has vested it with significance. In the process, he has elevated the debate beyond the parochial concerns of rivals in the industry to a discussion of issues of national importance.
As might be expected, the result of the MacKay task force's study on such a complex subject was a fairly hefty report, which includes 124 separate recommendations, and which, taken as a whole, is a lot to digest. Nevertheless, as I immersed myself in the report, I was struck by what I believe is its central and most compelling theme; namely that change, driven by globalization, by advances in technology and by profound demographic shifts, is already here.
The word "change" is much overused today, so much so that it risks being debased. Let me illustrate by example the truly fantastic nature of the change with which we all must contend.
Science is pushing back the frontiers of the unknown at an astonishing rate. At the same time, the practical applications of scientific discovery are transforming modern life and a remarkable shift has taken place. Rather than focusing on the raw power of the application, its speed or memory, design engineers have now turned their attention to making the applications more accessible and more user-friendly. In fact, the day is not far off when computing power that would have been unimaginable a decade ago will be in the hands of users whose only required operating skill will be the ability to speak.
In the words of Don Tapscott, distinguished author of Rise of the Digital Economy, we are in "the early turbulent days of a technological revolution that may prove to surpass all previous revolutions -- the printing press, the telephone, the computer -- in its impact on our economic and social life." The heart of this revolution, the microprocessor, is now penetrating every aspect of our lives.
Let me give you an example. The family car has been become a mobile information centre with ten times the computing power of the Apollo space craft that took man to the moon and back.
Banking, too, of course, has been transformed by this revolution. That transformation was made possible in part by an enormous investment of more than $2 billion here in Canada to build the Interac network, which is the banking system's electronic payments network. Despite this huge investment, by the year 2000, ATMs will be rivalled by a new access channel, the Internet. According to Mr. Tapscott, in less than two years, 20 per cent of families in Canada and the United States will do their banking on the Net. A virtually brand-new delivery system will account for one-fifth of all retail banking transactions.
This revolution has created extraordinary opportunities for Canadian financial institutions and, at the same time, extraordinary challenges. The investment in technology needed just to stay current with industry-best practices is staggering. Add to this the cost of maintaining a nationwide branch system and our task becomes even more daunting.
If this were not enough, a whole new set of challenges confronts Canada's banks. Foreign competitors are now able to use technology to transcend national borders and, as I speak, they are setting up operations in our major cities. Large monoline specialists like the credit card giant MBNA are using their size and technological focus to become market category killers.
The spectre of new competition also emanates from less obvious sources than you typically hear debated. I like to call them stealth competitors. Internet aggregators, including Microsoft, have developed the capability to place themselves between the financial institution and the customer. By taking on the function of screening financial services and products for customers, they threaten to reduce the role of Canadian financial institutions to that of a commodity provider. The financial services industry needs to take stock of their presence and act decisively for the future.
As described in the Minister of Finance's Purple Book, the Canadian economy has consistently lagged behind the American economy in productivity growth for a quarter century, and each year the gap grows wider. Canada's major banks have not escaped this problem. Our productivity consistently trails the best U.S. banks -- the ones most likely to come here -- by an average of about 15 per cent.
Even without the revolution in information technology, we have a serious productivity problem. Consider how much more serious that problem is now that, in order to stay competitive, we must invest in a broad range of new technologies, including Internet banking, telebanking, electronic commerce and the so-called smart technologies.
As I noted, the MacKay report's recommendations for industry and regulatory reform comprise a coherent, integrated vision for the future of the Canadian financial services sector, and for that the task force is to be commended. However, I welcome the report's arrival for another reason.
For the past eight months, prior to the release of the report, public debate has focused on just two trees and not on the forest. Now, thanks to the work of the task force, the debate has shifted and we can all spend more time looking at the forest -- in other words, at the elements needed to foster and maintain excellence in Canadian financial services in the next century. If the task force advice is heeded, that discussion will be conducted in the spirit of cooperation and collaboration.
The Bank of Montreal has its own vision for the future of the Canadian financial services sector. We see an intensely competitive marketplace, with individual markets being served by both Canadian and foreign institutions that offer consumers a wider choice of products, service levels and competitive price. Like the MacKay task force, we see included in this mix not only large national financial institutions such as our own, but also a tier of smaller national and regional Canadian institutions to serve the market. We see greater choice for customers in the channels they use to access financial services, from the traditional retail branch to the latest electronic and virtual delivery systems. Finally, we see a future in which Canada's premier financial institutions can compete effectively, first at home and then abroad, with the best in the world.
Because our vision preserves a strong Canadian-controlled, Canadian-based presence in the market, I believe it is the one that will best serve Canada's national interest. It promises more jobs in Canada, more decisions taken in Canada, more access for Canadians in remote regions of the country, and more foreign earnings flowing into Canada.
Where does my own bank, the Bank of Montreal, fit into this picture? Of course, we want to be an active and profitable participant in it, maintaining and enhancing our place among Canada's premier financial institutions. To achieve that goal, we have to successfully meet four challenges simultaneously.
As we move from a transaction-based business to one based on professional relationships and professional advice for customers, we must upgrade the skills of thousands and thousands of our people.
As we move from a business that was once almost entirely centred on the branch to one that offers a wide choice of delivery channels, including the traditional branch, we must upgrade and transform even our existing delivery system.
As information technology continues to transform the way we do business, we must continue to make the enormous investments necessary to upgrade our technology.
Finally, as we move from a business that was once only domestic to one that is truly global, we must be able to successfully enter foreign markets and return a healthy stream of profits to our home base in Canada.
By successfully meeting these challenges, we will be able to fulfil our vision for the new bank that we hope to create. The new bank will harness the latest technology to help solve problems that have plagued our industry for 200 years. It will create customer segments of one. It will democratize sophisticated financial services such as wealth management and "anywhere, anytime, anyhow banking," which until now have been the exclusive purview of the privileged and the affluent.
For the Bank of Montreal and the Royal Bank, the best and I believe only way to achieve this vision is through growth, and for us, the best way to sustain growth is through a merger. This, in turn, will enable us to fulfil our role as a full-service bank with both electronic and domestic access and branches nationwide. It will enable us to be a Canadian-based, Canadian-controlled, globally competitive bank; one that creates well-paid Canadian jobs and orders for Canadian suppliers; and one that makes management decisions made in Canada for Canadian purposes. It will allow us to be a bank with the resources to reinvent the range and quality of customer service at a level beyond anything experienced before.
If there is one point of consensus that has so far emerged from the debate, it is that the status quo is not an option. The hard reality is that, one way or another, Canadian banks must become more competitive and more productive. If we are not allowed to merge, then we must find other ways to achieve efficiencies. Those other ways mean greater focus and selectivity in lines of business, the customers we serve and the products we offer. In such a scenario, the Bank of Montreal would emerge as a smaller entity and no longer a national full-service bank.
That is why it is imperative that the proposed merits of the merger be weighed thoroughly, fairly and in context, not judged against some idealized past or unsustainable present.
In closing, Mr. Chairman, let me say that in a time of great change and uncertainty, a compelling vision can serve both as a beacon and a compass. This morning I have outlined the Bank of Montreal's vision for the future of the Canadian financial services landscape. The Bank of Montreal hopes to play a leading role in the fulfilment of that vision. I believe that the choice we have made to fulfil that role is the one that will best serve all our stakeholder interests and the nation's interests.
As a financial institution, the Bank of Montreal is aware of the role we play and the responsibilities we bear in the Canadian economy, and we accept both willingly. At the same time, however, we are also a private sector organization, with the responsibility to conduct our affairs properly.
As the merits of our proposed merger are weighed, let me ask you, with respect, to bear some facts in mind. We are not asking the government for protection. We are not asking the government for subsidies. We are not asking the government to help us win new business around the world. We are simply asking for the freedom to manage our affairs, to compete effectively, and to organize ourselves in the most efficient way available to us.
If our plan meets the regulator's provisions for safety and soundness, and it sustains or promotes a competitive marketplace, should we not be allowed to implement it? Once approved, should we not let the consumer judge whether the strategy that has been adopted is the correct one? If it produces greater value for them, they will accept it; if it does not, they will reject it and give their business to our competitors.
As I have said in the past, from a consumer perspective, it does not really matter if our merger is approved. Customers will win either way by getting the products and services they want, even if they have to source them from outside the country. The larger question is, will Canada win? That is what you must help decide.
Senator Kolber: Welcome, Mr. Barrett and associates. Thank you for being with us. I commend you on your opening remarks, which partially answer some of the questions that will be put to you.
I should like to concentrate my line of questioning on the costs and benefits of the merger and on what would appear to be contradictory evidence. Although contradictory, there may be some ways you could explain it.
In your speech to the Canadian Club of Toronto this week, you noted that productivity in major Canadian banks, which is measured by calculating the ratio of non-interest expense to revenues " is consistently worse than the best United States and international financial institutions. Canadian banks spend about 65 cents of every dollar earned on non-interest expenses. For the best U.S. banks, the figure is 53 to 55 cents in some cases."
According to the MacKay task force report -- and this is found in the table on page 115 of Background Paper 1 -- in 1996, the Canadian banks ranked second out of the seven countries compared. That is to say, Canadian banks represent the second-lowest ratio. The ratio for the five largest Canadian banks was 62.9 per cent, and for the U.S. it was 63.5 per cent. The Bank of Montreal and Royal Bank had the worst performance amongst the top five in Canada. However, the trend in productivity in Canadian banks has worsened in recent years, which leads me to my questions.
First, why does the performance of the Bank of Montreal and the Royal Bank appear to be poor? What prevented you from achieving the levels of the Bank of Nova Scotia, which ranked first in Canada? The Bank of Nova Scotia would have ranked second in the U.S., just behind Nations Bank. Furthermore, the Bank of Nova Scotia's ratio for 1996 is better than the Canadian average for 1992.
Second, how is it that the Canadian bank productivity is not further ahead of the U.S. banks than it already is? The U.S. banking system has been dominated by unit banks -- that is, mostly local small banks -- while the Canadian system has been dominated by large national banks. With that structure, productivity in Canadian banks should have been far ahead of U.S. banks, not just a little ahead.
Finally, I wish to speak of the productivity in the two mega-banks in the Netherlands. At present, the average for UBS and SBC in Switzerland and the Deutsche Bank in Germany is much worse than in Canada. The UBS and SBC have already announced staff cuts, cutting overlap by some 20 per cent to improve productivity. Please tell us how the Bank of Montreal and the Royal Bank will perform in the future if the new merger is allowed, given experience around the world. Alternatively, is it possible that the range of products that we supply in Canada, as opposed to those available in the United States, is so vastly different as to explain the differences?
Mr. Barrett: That is a very broad topic.
Part of productivity is a function of what the appetite of individual rivals or individual players is for investment. We have significantly outspent some of our competitors in Canada on investment in new technologies. We have also significantly outspent some of our competitors in transforming the workforce and in building the Institute for Learning so that we would not render people obsolete and then have them thrown out in the cruel world.
That is one element where you might find differences between domestic players. It is a question of strategy. If you believe that you should have the minimal investment in technology, then you can show a short-term gain in your productivity versus the other guy. However, you sacrifice the future.
When you go vis-à-vis the United States, it gets more complicated. The United States has several structural advantages. It is not that they are necessarily smarter than we are, but they do have advantages. First, the merged banks who are emerging as the best in class-productivity players were able to get the productivity gains from in-market mergers. Second, the United States has a taxation system that is 12 per cent less than the taxation paid by Canadian banks and that figures in the cost line on productivity. Third, on the revenue side of that equation -- because it is both a cost and a revenue ratio -- service charges in the United States are approximately double what they are here. Furthermore, the margins -- that is, the difference between what we pay Canadians on deposits and charge them for loans -- is much narrower here than the United States.
The willingness of the Americans to pay higher service charges, have wider margins and a lower taxation burden are structural advantages that we must overcome. There is no point in saying that we can import the American advantages here. We must be that much better to overcome those advantages, and we think we can. For example, we believe that, through the combination of efficiencies that the Royal Bank and ourselves would get over a three- to five-year period, we would be about 10 per cent.
Senator Kolber: According to the report, our numbers show that the productivity of the top five Canadian banks compared to the top five American banks is better today.
Mr. Barrett: You have to watch averages. I do not watch averages, but rather I concern myself with who is the best in class. We do not compare ourselves to the average.
The best in class bank is Lloyd's Bank in the U.K., which has 50 per cent. Several of the major banks are emerging with 50 to 53 per cent in the United States. Those are the ones I worry about. Looking at broad averages can blind you to the fact that, nestled within the average, are banks that have already achieved very high productivity and, as a result of that productivity, are banks that may well have a price advantage against you.
Senator Kolber: In 1996, Lloyd's Bank was at 59 per cent.
Mr. Tim O'Neill, Executive Vice-President and Chief Economist, Bank of Montreal : It has been going down.
Senator Kolber: I only have what the task force gives me. Please continue.
Mr. Al McNally, Chairman and Chief Executive Officer, Harris Bankcorp Inc., Chicago, Bank of Montreal: The mergers that have taken place are creating huge opportunities for productivity gains. As Mr. Barrett stated, in a merger situation, it takes time for these benefits to work through the system. Clearly, you are seeing those gains as one of the real prizes resulting from the mergers. The productivity of the merged banks decreases as they implement their benefits from the mergers.
Senator Kolber: U.S. research indicates that the gains have not yet appeared, but they might.
Mr. Barrett: They have appeared in some cases.
Mr. McNally: There are banks returning 53, 54 and 55 per cent. I do not know which ones you are looking at there.
Senator Kolber: We are looking at the top five.
Mr. McNally: The cost efficiencies from the mergers take some time to occur, but they do take place.
Senator Kolber: Are they cost efficiencies or just the elimination of overlap?
Mr. Barrett: It is pretty much the same. There is the synergy flip on top of that. By combining the strengths and core competencies of the two organizations, you hope to improve your revenue base and get a double flip from the combination.
Mr. McNally: Some of these banks are taking the productivity gains from the merger and reinvesting them in information technology to create those revenue opportunities for going forward. That is occurring simultaneously.
Senator Kolber: Do you agree with the consumer protection provisions contained in the task force report?
Mr. Barrett: Yes, I do. I give a lot of thought to that. Any businessman's knee-jerk reaction to suggestions for increased regulation and oversight is to scream. I come at it as much from an emotional response as from a business response. I have been going hoarse for approximately 36 years trying to debunk the mythology surrounding Canadian banking. If it takes a third party sanctioned by the government to convince people of the facts, then it is well worth the price. I am in favour of the public interest assessment, the community assessment, whatever you pick, because, as an industry, we stand to gain from third-party involvement.
When I say something, people will say, "Why would he not say that? He is the bank chairman." However, if someone from Ottawa says it and it is based on fact, not on anecdote or mythology, then we will benefit from it. I would argue that it is a small price to pay if we end bank-bashing as a perennial national hobby.
Senator Kolber: You do not mind having another layer of government intrusiveness?
Mr. Barrett: Yes, but it is a cost benefit analysis. If it solves the other problem, it is well worth it.
Senator Angus: Mr. Barrett, I was interested and pleased that you addressed the future and articulated for us, in a summary form, a vision of our financial services sector in the future.
The MacKay task force report, which we are trying to understand and perhaps contradict, talks about the status quo not being an option.
You said yourself that there is some urgency. You talked about all this change. I did not feel that the report set out a road map for us. You said in your remarks that the task force articulated a coherent, integrated vision for the future of the sector. I do not quite see that vision there. I am glad you have decided to put out your own vision for the future. I must admit that the sense I had was that it was more your vision of the future of your new bank, which is fine. I will ask you some questions about that.
First, could you perhaps elaborate on how you see the future of our financial services sector? Do you see more regulation or less? Do you see foreign domination, more foreign players, or less, or the same? Do you see larger retail banking outlets, or more of them? Do you see more alliances of the type you are forging with Safeway; more examples like the ones provided by Loblaws, Walmart, and Marks and Spencer?
Mr. Barrett: First of all, I do believe that the MacKay task force did incorporate a vision by dint of the themes. The themes which run through the report are that there should be a liberalization of entry of competition because the interplay of rivalry inevitably leads to a better deal for the customer.
By the way, I fully agree with that, that it should liberalize and allow competition. Frankly, we might as well agree with it because we have no choice. We are signatories to NAFTA, and trying to protect the Canadian financial services industry would create a backlash that would hit many other Canadian industries that depend on the export side.
I do see entry. I am hoping that Canadian providers will be so good and provide such value that it will be difficult for those entrants to make much of an inroad. I am a businessman. What I am most concerned about is sitting back navel gazing while someone comes in and steals my business. I believe, therefore, that it is inescapable that there will be more competition in Canada.
I believe that the MacKay task force report raises the legitimate point of encouraging the formation of second-tier financial institutions in the country. We have quite a bit now with caisses populaires, credit unions, et cetera. Anything that is helpful to promoting those types of boutique or local community banking type players is a plus. I would applaud that. I would ease up the rules surrounding the creation of domestic institutions. I would allow some of these smaller players into the payments system.
I would like to see the regulatory regime become flexible and adaptable. I do not think I will get very far with this one, but the Bank of Montreal's submission to the task force said that one of our problems is the fact that we have historically looked at regulation through the prism of four pillars, and those pillars are blurring completely. If you could disaggregate legislation and regulation down into functions like deposit-taking, lending, and risk insurance, and then let the market form whatever combinations and permutations it likes within the regulatory framework, it would make it easier for regulators. Rather than trying to turn this battleship of institutional regulation every 10 years, you would be able to adopt smaller chunks of legislation that govern each element of it like a flotilla of small ships. Each is more manoeuvrable.
The counter-argument to that is that functions do not fail; people do. There is a regulatory oversight issue that must be grappled with. I should like to see some way that we would not need to go through 10 years of Socratic debate every time we wish to change a specific piece of legislation. I should like to see legislation see through institutitions, which are, after all, only commercial organizations, and regulate across the function.
Senator Angus: We have had a great deal of evidence -- both hard evidence and anecdotal -- in our travels and our comparative study about the uniqueness of the Canadian banking system. Clearly, it is one of the most, if not the most, concentrated in the world. It is quite complex when viewed in the context of our demographics and our geography in the nation.
We are hearing many cautionary remarks about not tinkering with it too much until you are sure of what you are doing. We have also heard that a great deal of change is taking place, and that, while certain players feel that there is an element of urgency to it, others would prefer to go slower. How do you feel about that?
Mr. Barrett: You must proceed. I am not an expert in public policy issues in the political process, so I will defer to anyone here. In business, you are always torn between the pace of change and the organization's capacity to absorb that change. There is also the fact that if you get into analysis paralysis, and you wait until you have perfect information, you never get anything done. Somewhere between the two is what makes one company successful over another. Perhaps that is also true of nations.
When the task force report said that to delay is to deny opportunity, they were signalling that, in many respects, this transformation and revolution I am talking about, this major discontinuity, took place in the last 10 years. I should like to have seen the MacKay task force in 1994. In some respects we are already five years late in getting at the fundamental transformations we need in Canada. Therefore, I would not want us to delay further so that our backs are to the wall and we have lost the opportunity by the time we actually make the necessary changes. Eventually, we will make them one way or the other. Why not make them in a timely fashion and in a pre-emptive way that is good for the country rather than wait until the evidence is so overwhelming that we are on our backs? Everyone agrees that we need to do something.
I would rather pre-empt withering on the vine or a justification for change based on the fact that we are now weak. Let us do it while we are strong and still have a shot.
Senator Angus: In your own vision for your operation, you talk about your belief that growth is key and bigger is better. I know I am oversimplifying that. Bigger is better in terms of what you would like to accomplish in setting your place in the future of the Canadian financial services sector. Yet, Mr. Godsoe had the temerity to come before us yesterday and say there is not one scintilla of evidence to substantiate that view; that in fact it is an extremely dangerous prospect, and that we are already big enough and perhaps too big. This puts it squarely on the table in front of us.
We also hear that Belgium, for example, said no to big banks. A few years later it ended up with no ownership of key institutions. I would like your comments on that. You read the papers this morning, I am told. Mr. Godsoe said that he did not pull any punches.
Mr. Barrett: I always find it awkward and difficult when I am drawn into conversations about a competitor. Mr. Godsoe has a point of view. Some people believe the earth is flat. Some people believe Elvis is still alive. There are many points of views out there and one must respect them. How much credence you give to them must be decided on the evidence.
I have had extensive discussions with Mr. Godsoe over the years, and I have never once heard a philosophical aversion to mergers mentioned, either by him or by his predecessor. His submission to the MacKay task force of a year ago expressly asked that the policy options permit mergers. I am not quite sure what happened since January 23 to cause this change in ideology. One could speculate, but it would be unwise of me to do so.
Senator Angus: I asked him a direct question on that yesterday. I asked "Why did you change your tune, or have you changed your tune?" It depends on what side your bread is buttered. Today you are preaching for this parish but tomorrow you may be over in the next county.
As I understood it, he came fairly clean and said that he is a professional CEO who does what is best for his shareholders at any particular time of day.
Mr. Barrett: That is a very telling comment. He is right and I respect him for that. Let us extend that. Supposing I am CEO and I see competitors doing something in the marketplace. If I think it is dumb, I applaud it. If I see a competitor doing something bad for their customers, I encourage them. Then I try to slit their throats at night and take their customers away.
I cannot get Mr. Godsoe to answer this question and I have challenged him for several months on this. There are only two possibilities. Either he thinks that the merged bank will be do a better job for the customer or he thinks it will do a worse job. If it is a worse job, then he has a tremendous competitive opportunity and it would be irresponsible of him to try to stop it as a CEO, for his shareholders and employees, et cetera. If, however, he thinks that they would do a better job than he is doing, then his arguments fall apart. I cannot get an answer to that question. Perhaps you would let me off the hook because I am uncomfortable discussing this.
Senator Angus: What about the "bigness" issue; the argument that bigger is better and the Belgian example, among others? Without oversimplifying, what are you telling us about opening up to transactions, such as the one you are proposing? Perhaps it does need to be changed. I have not seen all the details. It is not our job, frankly. So far we have not been asked to analyze it.
Is it your general testimony that if we do not allow transactions of this nature, we will miss the boat and the price we pay will follow the Belgium example -- that is, there will be no major Canadian players in the banking business?
Mr. Barrett: I absolutely believe that. This is not a recent thing. I have been on record publicly on that since 1994. I passionately believe that this is an issue for Canada. It is in the Canadian national interest. It is a proxy for a challenge faced by most of our industries.
I know this committee has travelled the world to study banking systems, so some of this will resonate with you. I would ask you to keep in mind that we benefit hugely from being cheek by jowl with the most powerful nation on earth. NAFTA was a very smart move and it is been great for Canada. Seventy per cent of the population now agree.
Senator Angus: That was a fine initiative from the great Mulroney government.
Mr. Barrett: Do not draw me into that. The Liberal government also signed NAFTA, the MAI and WTA and all those trade agreements. We have usually benefited as a nation from multilateralism.
On the other hand, you are one hour north of a country that houses the most powerful organizations on earth, right across the board. They decided 10 years ago that their banking system would have hegemony in the world. That is why they promoted public policy to create consolidation.
Someone might say that competition is not a big deal and that they will not come. One hour south of us, the Americans are forming some of the most massive and best-in-class financial institutions in the world. Their aspirations are tri-polar, in Asia, Europe and the United States. It is unbelievably dangerous naivety to think that they will ignore the North. Walmart did not. Home Depot did not. Then there is a bogeyman thrown up by some critics about over-concentration. This debate in some respects is no longer a debate about just the banks. The MacKay task force report and the Competition Bureau, which has yet to rule, have said that this must be examined and that the right way to look at it is not the share of banks. If that were true, you would break up Canada Trust, which has 100 per cent of the trust market.
It would be ludicrous to suggest something like that. When you look through it, the only thing that matters is what degrees of concentration exist and what product lines exist. If you take deposit-taking, lending, mortgages, et cetera, the Bank of Montreal today has about 9 or 10 per cent of the market in most product lines. The Royal is a bit bigger. Between the two of us, we have 20 to 25 per cent. I have never read a concentration theory in the world that would find 20 to 25 per cent of any market to be egregious.
I do not know yet. I am not presuming how the Competition Bureau will rule. Why not wait for them? These debates are being held on "too big to fail" and "safety and soundness" while our government agency, called OSFI, which is one of the most respected in the world, will tear that apart and opine on it for us all. We have a Competition Bureau, which again is a government agency that will opine on concentration. So why are we having these debates pre-emptive of a process that is already laid out for us, and which will produce the answers one way or the other?
Senator Angus: Our role, as the chairman will underline, is not to project that debate on the mergers but rather on the vision, which you started.
Mr. Barrett: My vision would be to let the market economy operate, provided that the national interest is paramount and provided that there is nothing about it that could be abusive to customers. I see nothing but a brighter future for customers. However, whether we are a winner or loser in it, it will be better for customers.
Senator Kenny: I was intrigued by your comment that when you see a competitor doing something foolish, you applaud them.
Mr. Barrett: I was being humorous.
The Chairman: In our business, we do exactly the same thing.
Senator Kenny: Since you put Mr. Godsoe in with the Flat Earth Society and visiting Graceland, does this mean that at night you secretly think he is right?
Mr. Barrett: I do not understand the question.
Senator Kenny: I will go at it again slowly. You told us that when you see a competitor doing something which you think is foolish, you publicly applaud him. You are not applauding Mr. Godsoe. You are attacking Mr. Godsoe.
Mr. Barrett: No, I am not at all. Let us turn that around. That is an unfair characterization. I thought we were having a little bit of fun.
Let me say this. We have gone before every committee and every hearing with a positive vision of what we want to do. We have not gone forward with a vision of what someone else should not be doing. I would ask that people come forward with their vision. He may have a different strategy than we do today. I respect that. Therefore, why would he be concerned? If small is beautiful and we are wrong, then he should not be concerned.
I keep hearing the Goldilocks principle, that we will be too big in Canada but too small to go anywhere abroad. I am having trouble reconciling the arguments. It is his point of view. I am not here to attack the Bank of Nova Scotia but you are forcing me to defend myself, even though no strategy or vision was put forward by that one critic. I am forced to respond to what I think is misleading information being given out for whatever reason.
Senator Tkachuk: You made a comment that we should be waiting for OSFI and the Competition Bureau. They are so smart and so bright and so competent. Do you say that Canadians do not have a say in this debate -- that we should not be discussing the merger?
Mr. Barrett: I am not saying that. I am saying that the government has started a process of review. That process, by the way, is not unique to the merger. By law, the Competition Bureau will weigh in on any combinations or permutations of business behaviour in order to assure Canadians, regulators and policy makers whether or not any undue concentration exists. That is their raison d'être, and they have no axe to grind. It is a little premature to be debating whether there is undue concentration or not before we have heard from an expert agency, appointed by government, which does nothing else but examine that issue.
I remind you that if there are hurdles of safety, soundness and competition, then there will be public hearings specific to the bank merger in which public concerns will be addressed. We have said that we are looking forward to producing the public-interest impact-assessment document, which I hope will deal with any concerns the public may have.
Senator Kroft: As legislators and parliamentarians, we try to bring to this matter not only whatever expertise we can muster, but also what we encounter in our daily comings and goings, whether as business associates, golf buddies or whatever. I like to think that part of my job is to ask the questions that those people would ask if they had the opportunity to be here.
Based on my own anecdotal evidence of what people think, I must tell you that at this point I find very few people -- in particular business people, as almost everyone is today -- who would say that they support the merger. My progress report to you is that you are still a long way from shore on that account.
In that context, I should like to invite you to comment on one or two things that may be of comfort to some of those people and may help turn them around. Unquestionably, the underlying thought that disturbs most Canadians is the idea that, as a country, we would allow ourselves to be reduced to having two banks. You may say that it will not be two; that there will be more. MacKay will say the whole system is designed for new competition to enter.
However, the time factor says that it will be a long time before Canada Trust, or the credit union movement by its own admission, will be able to provide full and broad competition.
In my experience, Canadians are concerned about the prospect of just two banks, either because of a lack of choice or because of the possibility of one's failure. That is the kind of argument that is being brought forward -- one involving not the security and soundness of the bank, but rather the security and soundness of the system.
What comfort might you bring to Canadians at the prospect of there being two extremely large institutions relative to the rest of the field?
Mr. Barrett: In the end, the proof will be whether the Canadian public benefits and sees tangible benefits as a result of these mergers. I believe that they will, and that we will be able to convince them of that.
The issue of concentration in the MacKay task force report points out that there is a misperception that the banks dominate financial services. That is because banks are so ubiquitous in this country. The MacKay task force report points out that we have less than 50 per cent of the financial services assets in the country.
I think there is a question of granularity. If you move into any of the urban and suburban areas -- cities and good-sized towns -- you will find 10 competitors. Where it starts to get worrisome is in more rural areas where you are the only bank in town or where there are only two. We have already made public commitments to those people that we will not close any of the rural branches. I have put posters up in every town that was involved, as has John Cleghorn. We have signed in blood, if you like, that they will not be denied service.
The challenge for Canadians will not be one of choice. They will have lots of choice.
With regard to the second part of your question in which you ask: What if one fails? Again, you must look at the anatomy of why banks fail. In many respects, history indicates that "too small to survive" is a bigger problem than "too big to fail," if the history of bank failures since the 19th century is any indication.
To give you an example, a major bank has not failed in Canada since 1920, which means Canada came through the 1930s without a major bank failure. We have an outstanding supervisory and regulatory regime in the country. The two institutions involved are AA rated. They would have a combined capital base of $25 billion before you would ever get anywhere close to a loss.
I argue that when you combine banks that are strong to begin with, you reduce the risk of failure.
The other thing that is terribly important is the risk profile and risk management philosophy of the banks. The other reason banks fail is because bank chairmen go crazy. They over-concentrate their risk or they get into undue concentrations of risk in any given sector, such as industry, derivatives, products, or whatever.
Last year, in terms of risk management, the Bank of Montreal was rated by independent agencies as one of the top three banks in the world. The Royal Bank is right up there as well. Thus, we have two banks whose number-one priority is individuals and small to medium-sized companies that are inherently diversified, and 75 per cent of our business is in that area. Therefore, the risk profiles of both banks are very strong.
The theoretical possibility of a failure is always there, but the probability is very low. History would support that, as would the ratings that the banks enjoy.
Forging a much stronger, bigger and more diversified bank with quite conservative risk management practices and policies is very good news. Further, the increasing transparency and disclosure by banks that regulators and the SEC and OSC are demanding on the granularity of the risk being taken and the potential under a disaster scenario provide additional protection.
It is a theoretical possibility, but the probability is so low that I do not think it is one that should give you, sir -- or your golf friends -- undue concern.
Senator Kroft: On listening to your argument, my next question would be whether you have to be larger in order to compete effectively on the international stage.Could you give us examples or types of situations in which your modest size would leave you at a disadvantage, both in terms of your own institution and very much in terms of Canadian companies?
I would be interested in looking at the impact of this on the economy. A whole range of Canadian industry could be disadvantaged because its banker is too weak a player on the international stage.
Mr. Barrett: There are elements of that. Certainly, one's ability to underwrite risk is a function of one's capital. Therefore, if you are being prudent, you cannot bet your balance sheet on individual clients. The bigger the bank is as a percentage of its capital, the more risk it is able to absorb.
We will be moving forward in the weeks and months ahead. I have spoken publicly about a new bank for international business. We will talk about an export-import bank and how we can help Canadian exporters. A bigger bank is able to do more for its clients because it can safely underwrite a higher degree of support for that institution.
Senator Kroft: Is higher volume risk really the normal practice?
Mr. Barrett: That is increasingly so. Less risk is being warehoused, but we then have underwriting risk where you take on the commitment and then in turn you must syndicate that commitment out. There will be an underwriting risk limit because you must take into account what happens if the market backs up and you are stuck with the position you have just underwritten, even though you know you will syndicate it out.
Senator Kroft: For a large syndicated transaction on behalf of a multinational company, would you undertake 100 per cent of the front end of the risk and then lay it off for syndication after that, or would you not put the syndication package up front?
Mr. Barrett: I would do it both ways. Sometimes it is a function of competition, of who has the lead-bank position. The lending is not always profitable.
Senator Kroft: That is a calculation you make in terms of your available margin.
The Chairman: I want to make sure that I understood something which I inferred from your response to Senator Kroft's risk question. You spoke about the way information can be used to manage the risk by making the public understand the risk.
As you may know, this committee looked at the issue of the New Zealand regulatory system, where there is substantially more public disclosure and less regulation. We favour this system, and we think that it is probably a more intelligent system. I could have inferred, or perhaps I wanted to infer, from your answer to Senator Kroft that you would not necessarily be opposed to such a system.
Mr. Barrett: Not at all. If you permit a boast, the Bank of Montreal was rated as one of the leading corporate governance banks in the world. If you hold that position, you must have a strong commitment to transparency and disclosure. The stock market will discipline you on the basis of that.
I absolutely believe in more granularity and more exposure to the public and investors. I do not fear it at all because it will tend to favour the bank with a prudent risk profile. Therefore, we have a good incentive to have good granularity. Micromanagement by regulators would be terrible.
Senator Oliver: The forces of the free market have been good for the Canadian economy and consumers. When the CRTC has not regulated certain things in the telecommunications industry, it has been wonderful for consumers; the price has been kept down and they have had good service.
When I read the task force report, the one thing that sticks out is that they said that it would be good to have a new product, but let us regulate it. When you read the report, there is an overabundance of regulation that will tend to hurt consumers, slow the competitive forces and make things more difficult.
Yesterday, I asked Peter Godsoe if he agreed with Mr. Baillie and Mr. Flood who said that they found that the task force recommendations would create over-regulation, particularly in three areas: privacy standards, coercive tied selling and accountability statements.
What is your view on whether or not this will produce over-regulation and take more of your senior people's time and expense?
Mr. Barrett: It could do all of those things. Perhaps I am a bit more sanguine than my colleagues and peers because we have had an operating presence on the ground in the United States since 1984. I have had to live with pretty draconian regulations down there, so perhaps I have come to be blasé.
Mr. McNally: The CRA legislation in the United States was wonderful public policy. It was enacted in the 1970s when the U.S. cities were deteriorating from the inside out. That sort of public policy forced the banks to pay attention to a subject that they should have been paying attention to for years, and it has worked well.
There are elements of legislation and regulation there, but I must tell you that the competition is fierce. Other than having to pay attention to things such as CRA legislation-- which we do because we believe it is good business to do so -- I do not spend much of my time doing anything other than trying to serve customers better than the competition does.
Mr. Barrett: I am trying to lift myself above the normal reaction I would have. I would love to have no regulations at all.
Senator Oliver: I hope you are not afraid to be critical because you need the Competition Bureau, the minister and the regulator for what you are trying to do. I am hoping that you can assist us with the public policy debate. Will there be too much regulation?
Mr. Barrett: I am not sure yet. For example, tied selling has already been passed into law and centred only on the banks, which is interesting; it must be legal everywhere else.
Senator Oliver: Tied selling, as recently proclaimed, is not the tied selling that was being discussed in the MacKay task force. MacKay recommends going much farther, as you know. Would you like to see what MacKay recommends, or are you pleased with what was just proclaimed?
Mr. Barrett: I must admit that I did not sweat all of the details of what might happen. I was looking at the broad public accountability statements. Those do not intimidate me because I have a different agenda or a different strategy. Some of my colleagues are concerned about the increased costs of regulation. However, I would argue that if that is the price we must pay for the acknowledgement that the Canadian financial services system is indeed one of the best in the world, then I will pay the price. I am not unduly concerned by it.
Senator Oliver: When Capital One appeared before the committee in the other place, they spoke about the future of banking not being built on bricks and mortar. They say that you will find many more niche players. Who wants to come in and spend a lot of money on bricks and mortar when they have one or two main products that they want to push?
In terms of retail banking, you said that we must upgrade our delivery system as we move from a business that was once almost entirely centred on the branch to one that offers a wide choice of delivery channels, including the traditional branch.
What do you now see as the future of branch banking in view of what Bank One and some other American competitors are looking at doing?
Mr. Barrett: That is a dilemma, and one of the challenges is that you have a generational problem. We launched the first virtual bank in Canada as a pre-emptive strike because we sensed that foreigners would do it if we did not. Sure enough, a month later Dutch ING opened a virtual bank in Canada. We were right, but it was expensive to be right. As it turned out, launching a virtual bank is not cheap.
There is a challenge. Canadians will get very upset with you if you try to bully them into one form of distribution or the other. You must allow them to make a choice.
It is a bit generational. Our generation -- particularly in communities such as Victoria where there are many seniors -- does not want to play Beethoven's Fifth on a PC. They enjoy the relationship they have with their bankers. They want the high-touch, high-personal service. They do not want what they feel is the anonymity of machines or technology.
Technology is new technology only if it was invented after you were born. For our children, this stuff is as routine as a slide rule was when I joined the bank. There is no way the next generation will line up on pay days; there is no way they will pay their bills manually.
I just spent some time with a scientist from NCR's lab. Breathtaking advances are being made in technology. There is speech recognition, voice recognition, and even iris recognition. You will not need to be able to browse the net.
Senator Oliver: You are not quite getting my question. If Bank One can compete with you and does not need the infrastructure of a branch, how will you be able to compete? What will that do to the heavy infrastructure and shackles on you because you have this branch network? Will you keep your branches open as a result of it, and what new things will you do there?
Mr. Barrett: This is one of the dilemmas and it is a difficult concept for me to get across. You have hit the nail right on the head. When competitors come in, they tend to adopt a cream-skimming strategy. They centre on the urban areas with high population and target the more financially active and profitable customers. They keep their fixed costs low. For example, Wells Fargo is now competing for small business in Canada from a call centre in Denver.
I am concerned about people such as the Dutch ING. We are the ones with the physical distribution network in the B, C, and D communities. That is why, as I have said in the past, this is not a contest between mergers and the status quo. That is a very difficult point to get across. People think that we have the choice to stay the way we are or allow the mergers. If the mergers do not go through, restructuring will happen. I worry that, if we do not get our efficiency and our productivity in order and keep pace with the competition, they will take our better customers and we will be left with the less profitable ones -- who are increasingly difficult to cross-subsidize -- and we will marginalize our rural and small-town operations. We will die a death of 1,000 cuts. You lift a mortgage from here, a credit card from there, a small business loan from here. Before you know it, your total network starts to wobble because it is focused on the cities.
The strategic response of a businessman confronted with that is to decide whether you want to be all things to all people, which John Cleghorn and I do want to be. We want that because of our history of being a nationwide, sea-to-sea-to-sea bank. We prefer that option to the niche strategy. However, you can absolutely adopt a niche strategy. I am just not sure that people understand the strategic implications of what a niche strategy might mean for Canada.
Senator Oliver: And what it might mean to you and your branches.
Mr. Barrett: Yes.
Senator Stewart: My question arises from questions asked by other senators, particularly Senators Kroft and Oliver.
I have the impression that soon after your proposed merger was announced, there was considerable emphasis -- in what you said publicly -- on you being a flag bearer around the world. Today, you did not push that very hard. Rather, you have pushed the implications of new technology. Just now, in response to Senator Oliver, you said that you are very uneasy, indeed worried, about the impact of new technology, which will introduce players into Canada who will pick off profitable niches.
Is this just prudent forward thinking, or can you give examples from the recent past that show that this new technology has already affected upon your business? Perhaps it is both foresight and hindsight.
At one time, you talked about the dangers to the Canadian banking system that the new technology may pose unless the system changes. Then, in answering Senator Kroft, you talked about the tangible gains. That was not protection; it was ambitious.
Could you tell us more? You have talked about the new technology. Have you any specific examples that would help to sustain your case?
Mr. McNally: As a proud Canadian working in the United States, I might use the perspective from south of the border in terms of the implications -- both in Canada and in terms of our expansion in the United States and abroad.
In the last year in the United States, we have moved from regional consolidation to nationwide consolidation. It happened very quickly. As that has happened, very large institutions have been, and are being, assembled. As an example, the Bank of America, which just consummated its merger with Nations Bank last week, now has 40 million customers, compared to the Bank of Montreal and Harris Bankcorp who together have 7 million customers. They now have economies of scale in information technology and economies of skill in terms of the depth of resources brought to component lines of business.
I can assure you, from my day-to-day work in the marketplace, that a large number of both banks and non-banks are coming into Canada, and they are bringing information technology, cream-skimming and a non-branch-based approach. As we speak, the players are here right across the full range of financial services. These players are five to 15 times the size of our players.
Senator Stewart: On this point, the other day I was quite surprised to receive an AmEx card for Senate expenses. Is that an example of the competition that exists?
Mr. Barrett: We are always urging the government to keep costs down, so it should go for the best deal, and I do not want this to be interpreted as a criticism of government. As an example, however, the Bank of Montreal bid on the credit-card business of the Government of Canada. I wanted the prestige of winning that business and instructed my people to bid at the break-even point. I lost it, as did all the Canadian banks, to Citibank. We could not compete.
Then came the travel business, and we all lost that to American Express because of their scale. Their unit costs are lower and, therefore, they could price it better.
Senator Stewart: Let me ask this question, which I think you may have already answered. Were they able to underbid you because they were more cost-efficient, or because they used this as a loss leader?
Mr. Barrett: No, they were more efficient. Citibank has 50 million credit cards. I think we have 6 million.
Senator Stewart: Specific examples would be very helpful to us. You have made a general argument, which is somewhat convincing, but there is nothing like specific examples.
Mr. Barrett: I will give you one more, if I may. When Dutch ING came in with its virtual bank offering, it targeted only GICs. In the space of six months, a brand that was never heard of in Canada amassed $800 million to $1 billion of GIC money by offering a higher price because they had no fixed-cost base. They drew off that $1 billion in a very short period of time using a virtual bank approach on a narrow product market. There will be more of this as time goes on.
Senator Oliver: Banks should compete with banks. In your statement, you said you hoped that there would be a second tier of smaller regional banks. You will have no difficulty competing with them because of your size and expertise. It seems it me that the true test would be to bring in and let in more good foreign banks.
Earlier in your response to another senator's question, you said that there is, of course, the U.S. border. Walmart and Home Depot come up and compete easily, but banking is regulated. Citibank has looked at Canada before and they have not stayed.
If Canada and Canadians would be better served by having more large, international foreign banks in here to compete with the likes of you and the Royal Bank, what should be done, from the point of view of public policy, to get them here?
Mr. Barrett: There are some tricky issues for the regulator. I say that with respect.
Philosophically, I believe that you liberalize entry. Then there are issues of national treatment. Does the other country give you similar rights there? There are issues about the CDIC and the FDIC -- deposit insurance. I think most of those can be overcome.
My view is that you should have open skies and permit the best players in the world -- not just the Americans, but wherever they come from -- to come into Canada to discipline domestic institutions. We think we can hold our own. We did so for many years.
The reason most banks did not come to Canada for many years is that they could not match the deal. It was a tough sell to the average Canadian, perhaps. The reality is that the only reason we would not get foreign competition would be because they could not get a competitive advantage.
I am saying that if you allow us to organize ourselves, we think we will be the best deal in town, which will keep some foreign banks out. That is not bad for Canadians. If we are not the best deal in town, we can be sure that every competitor in North America will crawl all over the customer base.
I am in favour of liberalization. We would have to look at things, such as permitting branching without creating subsidiaries.
The superintendent has to satisfy himself and the minister on the safety and soundness considerations. A year ago, the government announced its intention to liberalize the entry of foreign banks. They are coming in.
Deposit-taking is the critical variable. When we talk about all the things we do, the one thing that is of most concern to the regulator is the protection of the depositor.
Senator Oliver: If we could find a good way to permit the entry of more big foreign banks, would it be good for the Canadian financial system?
Mr. Barrett: I absolutely believe that. I believe that to be true because to do otherwise would be to deny Canadians the best possible deal. We do not try to make television sets that compete with Sony.
This is where I am coming from. I am passionate about this. All things being equal, as a nation, I would rather be a producer than an importer. Therefore, in a globalized world, we must ask ourselves, what strategic industries -- which is a fancy term for sectors of the economy -- will have sufficient comparative advantage to be able to hold their own, first in the defence of the home market, and second, abroad?
Senator Oliver: Communications is an example.
Mr. Barrett: I am concerned that if we do not restructure the industry in Canada, we will not have a competitive Canadian industry. I am concerned that we will end up as a branch plant or a suburb of the United States. I do not think we should allow that to happen.
The Canadian banking and insurance industries have been world-class for 200 years. I now feel that there is discontinuity and a threat. I would like to see them continue to be world players, and I would like the same for other sectors. I think we need public policy to promote that, not a policy that ties their hands behind their backs.
We do not want to get into multilateralism and ignore the flip side of this question, which is opening our markets to tough competitors. I am not saying, "Let the private sector have its way with Canadian policy or public policy," but we must have a policy that is neutral or friendly towards the formation of businesses in Canada that will be able to hold their own. This is what I termed "positive nationalism." Negative nationalism is to close the border and build the Wall of China. I have rappelled down the Wall of China, and it is not that impressive. That Rubicon has been crossed.
The issues confronting Canada in the 21st century relate to forestry, telecommunications, energy, manufacturing, auto dealers, auto makers and retailing. If we lose our wealth-creating sectors of the economy to foreigners, we will be a lesser country. I am saying that the MacKay report gives Canada a shot at continuing to be a globally competitive financial services industry.
Senator Kroft: On this issue of entry, do you foresee any of the foreign banks developing a branch structure in Canada?
Mr. Barrett: Not outside the major centres, no. My guess is that they will centre on the urban areas because the marginal cost of going into the lesser communities will probably dissuade them. We are already there anyway, so they probably will not.
If I were to look at it from their point of view, I would see 90 per cent of the population strung along the border within 100 miles of the United States. I could make a living by going into that market.
I want to wrap myself in the flag. Foreign banks will not have the necessary social conscience. It may sound strange for someone to believe that a bank chairman has a heart, but we do care about this country. We do have a social conscience, and we do believe in trying to provide access to all Canadians.
The Bank of Montreal entered into a joint venture with the government on post offices to put banking in places where it has never been seen before. We have opened 16 branches on aboriginal reserves. Did we do that to make a ton of money? No. We did that because we believe that we should try to provide access for Canadians, to the extent that it is affordable to do so. We are a land mass bigger than all of Europe, with a population of only 30 million. We are trying to preserve that rather than retreat into a niche strategy.
Let me not be alarmist. I could make money on a niche strategy. I know how to do it, but I would rather not do it. I would rather have a full-service, nationwide strategy and leave others to adopt niche strategies. That is a strategic choice.
To my critics, I would say that of course it is not the only choice, but I am not sure Canadians would like it if everyone reverted to cream-skimming strategies and a narrower focus.In the United States, the CRA legislation came up in the first place because of red-lining. Something like 50 million people in the entire U.S. were disenfranchised from financial services.
I have been in the business since I was 18. Any sector of society that is disenfranchised from access to financial services is a society doomed to a vicious circle of poverty. Literacy, fluency, having a bank account, and so on, are important things.
We are not trying to build toxic chemical plants or pollute rivers with this proposal. We are trying to preserve what we have had for 200 years, which is a good, nationwide banking system. The alternative is not the status quo.
Senator Kenny: To correct the record and set it straight, did not National Bank also get the other half of the government credit card business?
Mr. Barrett: I do not know if it was half, but it got a piece of it, yes.
Senator Kenny: It was a significant piece.
Mr. Barrett: It was good for Quebec.
Senator Kenny: I thought that your point was that no Canadians got any.
Mr. Barrett: No, I just said that I lost and the other members of the big five did; the National Bank did not.
Senator Kenny: In your brief, you only deal with the MacKay report briefly. Clearly, you like it. Are there parts of it that you do not like? Are there areas where you take issue with the report?
Mr. Barrett: They are not strong issues, but this goes back to Senator Oliver's question. Reading about all the regulatory conditions made me nervous until I discovered that there might be a benefit in it for us. The only thing that left me really nervous and confused -- and I am still a bit confused about when the process ends -- was something that Mr. MacKay said in subsequent appearances. He has said that a lot of things can be done concurrently rather than sequentially. I have inferred from that statement that the process will look something like this, namely, that the Senate Banking Committee and the Department of Finance will do their deliberations on the MacKay report themselves. I do not know when OSFI will join in the deliberations -- perhaps in November or December -- but the Competition Bureau has said that it will begin deliberations in November. After that, there will be public hearings. Concerning the time, it looks like the earliest time for a decision would be in the spring. That is 15 months from now.
Senator Kenny: Before you get a decision, do you want to see a draft paper for discussion? The process is important to discuss. Could you share with the committee how you want the process to end? Do you want it to end with legislation, with a government announcement, or with a draft paper for further comment, which, inevitably, will take more time?
Mr. Barrett: The minister controls this process. This Minister of Finance is all-powerful, so I do not know.
Senator Kenny: What is your advice to him on this?
Mr. Barrett: I am not sure that the minister is impressed with my advice, but I would ask for this to occur as quickly as possible. It is not easy to keep institutions on hold. You can only keep that level of uncertainty hanging over a 35,000-person organization for so long. All the evidence will be heard soon and this will have been debated to death. If you go back to the MacKay report and everything else, this has been occurring for years. My plea is for a decision on our merger to be made sometime in the spring.
Concerning the broader subject of the MacKay report, again, I am not an expert on these issues. However, I was trying to empathize with the challenge. A triage approach may be possible. It is done in business. You often say, "Let us do the ones that are easy because they do not require regulatory change." Those issues are within the minister's discretion. I might add a set of high-priority issues to that. Obviously, I would ask you to allow the mergers and open competition, to provide more powers, and to open the payments system to local as well as foreign players. That will give you a big boost. Things that require regulatory and statutory change, such as auto leasing and insurance, could come much later.
I do not know how the minister wishes to handle it, but I hope that a decision on the self-interested or more parochial issue of the merger of the Royal Bank and Bank of Montreal will be made soon. The minister will pick his own timetable, but the process that he has asked us to respect will be completed by December.
Senator Kenny: On page four of your remarks, you talked about the four major challenges that your organization needs to meet. What public policy changes do you need or would you like to see to help you achieve those objectives?
Mr. Barrett: I am not thinking so much of changes because bank mergers are permitted with the minister's approval. There is no specific prohibition.
Senator Kenny: Page four did not mention mergers.
Mr. Barrett: No, but the mergers are a facilitating vehicle. By dint of the economies, we can get on with investing in those issues more aggressively. That is what I mean.
Senator Kenny: I am trying to set aside the mergers for the purpose of this question. You addressed four points to us: transaction-based business, a wide choice of delivery channels, technology, and a successful entry into foreign markets. Aside from mergers, what public policy changes would you like to see that would assist you in achieving those objectives?
Mr. Barrett: There is not a lot. For years, I asked that Canada harmonize its accounting rules with those of the United States. It was a national absurdity to have accounting regulations that were hamstringing all Canadian businesses from expanding throughout NAFTA when the Americans were allowing pooling of interest. By happy coincidence, that particular issue seems to be getting some attention recently. Being allowed to pool interest cross-border would help, as would some relaxation of the 10-50 rule, which would allow us to take minority positions in some companies.
We are big enough to look after ourselves <#0107>that is, putting mergers aside <#0107> but I would like to include the mergers, if I may.
Senator Kenny: You really want to talk about mergers.
Mr. Barrett: I only have one shot at you, so I am trying to convince you that this is a good thing.
Senator Kenny: Trust me; mergers are coming later. We are talking about the MacKay report now.
Mr. Barrett: If you agree that those are legitimate challenges, then anything that helps to meet those challenges is a good thing. That is the line of logic I am trying to get across.
Senator Kenny: I follow you.
Mr. McNally, you have a perspective that is interesting to the committee. Could you contrast for us the future that you see for banking in the United States environment vis-à-vis the future you see for banking in the Canadian environment?
Mr. McNally: What has happened in the United States in the last year has changed the U.S. banking system forever. What had been inching its way from local-community banking to regional consolidation to nationwide consolidation has created some enormous financial service companies.
As that process was going on, we have also seen the development of monoline players over the last decade, who saw niche opportunities. When you are playing in a market 10 times the size of the Canadian market, what would be a small opportunity in Canada becomes quite an interesting opportunity in the United States. While this banking consolidation was happening, there was the development of some very successful monoline companies who applied information technology and provide a better value proposition than the banks were providing.
Meanwhile, as the banks have consolidated, they have begun to acquire many of these monoline players so that they can provide the full range of financial services. Credit cards would be an example. They bought those big monoline credit-card companies. In the United States now, you have almost a bipolar banking system developing. The very large players are increasingly nationwide, and the numerous small community banks are competing in the old way, based on local relationships. Information technology is making that an increasingly difficult game for those small community banks. In the middle, the mid-size banks are a vanishing breed. They are rapidly either being acquired or combining. In some cases, you would say that they are clearly doing so in order to become a better acquisition target for the large banks.
If I could move into Canada from that base, it is absolutely clear that these financial service companies are clearly thinking in North American and global terms. Certain companies are as big as they will get in the United States. They are moving, as we speak, into Canada in ways which I find Canadians do not always aggregate. It is happening everywhere, across every line of service.
These companies are also moving into the United Kingdom and Australia, and they are taking a very formidable value proposition, a business model, and oftentimes operating off their U.S. platforms. They have their fixed costs sorted out and they put a front end in the other market.
When I look at the issue of competition in Canada, I do not think of it as two or three or four Canadian banks. In this country, we will see a huge amount of competition from the south, and it will be good competition. As a Canadian, I am passionate in the belief that we must have a level playing field so that the Canadian banks, who have served this country well, will have the opportunity to compete in our own country, in the United States and in other markets.
My concern is not about the Canadian consumer. The Canadian consumer will be well served because these U.S. banks will come as finance companies, which are already here, or they will come cross border like Wells Fargo, or they will set up Schedule II banks in order to be here on the ground. That will happen and they can do that, as I understand it, under the current policies.
What concerns me more is that we look after Canada's position, first of all as a financial service provider. Toronto is the third-largest financial service centre in North America and is the fastest growing. I worry a great deal about whether, if the Canadian banks are unable to have the economies of scale and information technology in all these businesses, that will erode, and erode pretty quickly.
I will give you an example close to home. Illinois has paid a huge price by leaning against the development of its banks. Here we have a city, Chicago, which is the transportation hub and service hub of the United States. It has a commodity exchange and financial exchanges. Chicago should have, would have, could have given New York a heck of a run to be the money centre of the United States. Unit banking legislation in Illinois stayed for many years and only began to unravel a little bit at a time in the mid-1980s.
The Chairman: Would you please define "unit banking?"
Mr. McNally: Unit banking legislation had two main components; a bank could only have one branch and no bank could be within two miles of another bank. What happened, of course, is that the Illinois banks did not develop as the banks did in other states. Today, what is the result? In Chicago, which is the third-largest metropolitan market in the United States and which has a GDP more than a third of Canada's, the banking system is dominated by the Dutch, the Canadians and the folks from Ohio. There is not a single local Chicago bank left.
More importantly, from a public point of view, there are 2.3 times more the number of financial services jobs in New York than there are in Chicago. By leaning against the development that was required of its banks, Illinois has paid a huge price. I can tell you that this became well-understood too late in Illinois. It is a huge sacrifice of enormous numbers of well-paid jobs, and it has had a huge impact on the economy.
Senator Tkachuk: On page 5 of your presentation, Mr. Barrett, when you talk about "if we are not allowed to merge," the last sentence of that paragraph:
Bank of Montreal would emerge as a much smaller entity -- no longer a national, full-service bank.
What do you mean by that?
Mr. Barrett: I was addressing the question, "what does the status quo is not an option mean?" If not mergers, what else? Why can you not pursue niche strategies? I say that that is absolutely true -- you can do all those things -- and that is what I meant by more focus and selectivity.
All I would say to you, as CEO of a company which I am privileged to lead, is that I have come to the conclusion that it is dangerous to try to be all things to all people when I am spread so thinly. I would need to rethink whether that was a good use of shareholder capital, whether it was a good use of funds, whether I could sustain competitive advantage.
We are from sea to sea to sea here, and we are trying to expand into the United States. Last year, 57 per cent of our income came from outside Canada. I am having trouble because Mr. McNally here has the appetite of an elephant for capital. He is always looking for more money in order to expand because he feels threatened in Illinois. We opened in China in order to help Canadian business in China. We bought a position in Mexico, and they joined NAFTA, so Canadian companies would have a three-country operating capability through one bank.
I am starting to look at this and the appetite it has for more and more money. I am also considering my productivity problem, and I say that I must cut the suit to fit the cloth. Without the efficiencies that I would get from a merger with the Royal Bank, I would have to take a narrower focus and, therefore, I would not be the bank I am today. I have not worked out all the details of that because I am hopeful that the more positive plan for growth that we have put forward is the one that will be adopted.
I have not gone into great detail about what happens if our plan is not adopted, but in broad strategic terms, the response would be one of more focus and selectivity. In practice, that means that you would likely be smaller, and you would trim down your balance sheet. You would invest only in businesses that provide a decent return to the shareholder; you would chop away at fat; at excess capacity; you would try and get your expenses down, and you would try to bolt on more scale on those more profitable. You would start to decide to get back into many of those monolines we have talked about, you would start running the bank and then you would allocate capital and influence to whichever monolines could make a decent return on capital.
Without having worked it all out in detail, my instincts are that the end result of that would be still very profitable. I do not wish to mislead you on that -- we would still do a good job for our shareholders under that scenario -- but it would probably mean that the character of the bank would be different from what it has been for 187 years.
We would no longer see ourselves as pursuing a strategy of being all things to all people in every community in Canada.
Senator Tkachuk: It is a fairly dismal picture. Would this be happening to the other banks as well? Would they be doing the same kind of things?
Mr. Barrett: When Mr. MacKay said that to delay is to deny opportunity, and when he said that the status quo was not an option, he was signalling you, as I am too, that, one way or the other, the Canadian industry will need to respond to these changes and threats, and therefore to the public policy challenges.
I believe that the plan we have put forward, and frankly that TD and CIBC have put forward, reduces the pain of that transition considerably. It is good for customers. We are quite willing to invest the benefits we get from it in not having any mass lay-offs. By doing so, we would avoid the dislocation that has happened in other sectors and, frankly, within the government itself. We would try to minimize that pain as well.
I am not saying that it is a dismal picture, but it is a different picture. You must respond, and different people will respond differently.
Senator Tkachuk: Would the mergers prevent that situation? Would you still be able to offer full service?
Mr. Barrett: I believe so. We have independent studies which indicate that, with the core competencies and strengths of the two institutions, we have a legitimate shot at not just defending our flag in Canada, which is job one, but also of taking it to the competition, particularly in the United States. We would worry about Europe and Asia a little later. NAFTA is a big enough market for my generation. I will let the next one worry about Asia and Europe.
Senator Tkachuk: Logic, then, would tell me that if banks are to survive without mergers, they will need to become niche banks rather than full-service banks.
Mr. Barrett: Yes.
Senator Tkachuk: After the merger, what will happen to the Bank of Nova Scotia, the credit unions, and the other banks that are supposed to provide competition to the full service banks? There would only be two left.
Mr. Barrett: That is an interesting question. You had better be able to find a competitive advantage, either by dint of localism and intimacy with the client or in specializing in certain products, or yes, you will have trouble. The only thing that worries me more than running a bank the size of mine is running a smaller one.
Mr. McNally: From a public point of view, you can count on a great deal of U.S. competition coming in across the board, in my judgment.
Senator Tkachuk: They can come in now.
Mr. Barrett: They are.
Senator Tkachuk: Not on the retail-branch basis, however.
Mr. McNally: Not yet, because they are completing their nationwide consolidation. However, they will come, and it will be in a way where they can add most value to the customer, which is the only way they can grow. The form and shape will change as society changes. However, there is no question that, right across the service stream, those U.S. competitors are coming north, and they will give Canada and Canadian financial institutions a great deal of competition.
Mr. Barrett: I do not want to duck your question, because it is insightful. A reasonable conclusion is that the smaller institutions in the world will have a tougher time competing.
We launched MBanx and "The times they are a-changing." That was very expensive. If you want to launch a national product and get brand awareness quickly for a new product, you are looking at $15 to $20 million in advertising and promotion costs alone. To launch a virtual bank, you are looking at $100 million to $200 million to put the good technology in place. The smaller player will not to be able to do that.
The business the big banks can do is to use their scale to sell their economies of scale, however. You heard from some credit unions this morning. I am happy to tell you that they are customers of ours; we do their back-office processing for them. That is what the term "correspondent banking" means. Sub-scale players buy operating services from the larger players that have economies of scale. I think you will have some of that.
However, it will be a tough row to hoe for some of the smaller players.
Mr. O'Neill: The inescapable logic of what has been said is that if you believe that size makes a difference in a number of lines of business -- and certainly the MacKay report points that out and you found it in your own studies -- you have two choices. You can selectively choose those lines and get the size you need to be competitive, but you will have a narrower range. You will either be product-line specific or geographic specific. If you want to be a full-service bank across a country and also compete across borders, you need a scale that allows you to get the size necessary to be competitive in those multiple product lines.
To get back to your question, if you have banks that can do that, then they can be full-service national banks and also be internationally competitive. If they are not large enough to achieve that, they will be forced into some kind of specialization. What that will be, obviously, is a strategy they would have to consider. I do not think it is for us to suggest what it will be. However, those competitors will still be there. It is not that they will disappear; they will just be more selective in where they compete.
At the same time, it has been suggested that you have foreign competitors coming in already, because technology allows them to do that. The notion that that will not continue or is not already significant is simply wrong. Look at the American situation where monolines have had an impact on key markets. You have Wells Fargo, now the largest direct-business, small-business banker in the U.S. In the space of about four years, they have gone from seventh to first by focusing on that strategy. Now they are taking that strategy into Canada.
Mr. McNally: With no incremental fixed costs.
Mr. O'Neill: With no branch costs, certainly. Some conventional views on retail banking were that it would never be done outside of conventional, stand-alone branches. The fact is that they have already done $50 million worth of business. They did it within about three or four months, and they are planning to expand further. The standardization of those kinds of product lines, which many people thought could never be done outside a relationship in a branch, is already beginning to experience that kind of distance-lending or distance-operation.
Mr. Barrett: I would add another idea that you might find interesting. The other big change, which is an arcane subject, is customer buying behaviour. In the old days, when I joined banking, people bought on a bundled basis. You had a relationship with your bank from cradle to grave. You did everything with them unless they beat you over the head with a stick, which they apparently did occasionally, if you believe Stephen Leacock. However, generally they bought in a bundle.
You know for a fact that the average Canadian has 3.5 financial institutions and that Canadians are buying much more on an unbundled basis. They go for the best deal. If someone has a better mortgage deal, they get the mortgages. Our challenge is to get back to relationships as distinct from being commodity providers.
Senator Joyal: Mr. Barrett, I should like to come back to the MacKay report, especially Recommendation 49, which deals with the merger process. I have a general question. What is the difference between the corporate interests of the financial sector and the public interest of Canadians as a whole? Is there a difference, or are the two equivalent?
Mr. Barrett: I think that banking is a business, but it is a business with a difference. Its first priority is to depositors and its second is to shareholders. That is unusual in a business, but that is the way it is.
If you are granted the privilege of gathering up people's deposits, then you have to live with that fact. I do see it as different in that way. You should know my bias, sir; I believe in a market economy.
Senator Joyal: I do, too, by the way.
Mr. Barrett: Therefore, from that view of the world, I would argue that the private sector should be permitted to do what it wants to do and to organize and mobilize itself. To stop them from doing something, it should be clear that the proposed activity is not in the public interest. In most countries of the world, and particularly in financial services, that tends to mean competition considerations because of the potential for abusive pricing and, in our business, it also means safety and soundness.
In my brief, I said that if we are lucky enough to meet those two tests -- and I would not have gone into it if I did not think we would meet them in the end -- then, philosophically or ideologically, I would find it difficult to accept a "no" because I cannot imagine what would be outside the public interest. I think we would be doing what was good for Canada, good for our shareholders and good for our employees.
Since there was nothing egregious about it from a competition or safety point of view, why would you not allow us to do it? In that sense, what was good for us would be good for the public interest.
Senator Joyal: I would like to come back to that recommendation because it adds an important element to your presentation. You say the guidelines that the Minister of Finance should be publishing in the public-interest review process should require merger proponents to submit a detailed public-interest impact assessment, and then you list all the components of that assessment.
In order to speed up the process of studying your proposal, can we expect that you will be in a position to provide a detailed public-interest impact assessment from the Royal Bank and the Bank of Montreal to this committee?
Mr. Barrett: We are looking at them as we speak, sir. I believe there is a little caveat in there about anything else the minister might want to add.
Senator Joyal: Yes, that is right.
Mr. Barrett: I am hoping to hear one way or another from Ottawa: that is, whether that is sufficient unto the day or whether they want more things added. I do not want to come out with a document only to find out that it is not the one that the minister wants. The minister is the boss and when he specifies what he wants, I promise I will produce it for you, probably within a month.
Yes, I would intend to go public with that document. We have been trying to shoot darts at what we think might worry people or at what might appeal to them. We have been shooting blind. I was so relieved that someone has finally framed the meaning of public interest. Otherwise, everyone could have a different idea. Whether it is that document or a more expanded one, we will make that document public within four weeks' time.
Senator Joyal: As I understand the procedure, you have said that another step could be added in the process of approving or making a final decision. If that document is produced, there is no doubt in my mind that it will be for public debate. It means that further to the report of the Competition Bureau and the OSFI recommendations, there will be at least two documents. One will come from you and the Royal Bank and, of course, another one will come from TD and CIBC. After that there should be another stage of public hearings before this committee or before the House of Commons committee, or in some other forum. That could add another period of time before you get the final decision.
Mr. Barrett: The delay will not come from us, though. I agree with you 100 per cent. I do not think one can hold meaningful public hearings on the merger unless that document is out there to be tackled by the hearings. All I am saying is that I see no reason why we cannot produce that right away.
I have some of our people checking with Ottawa saying, "We are working on this now. When do you want us to publish it? Do you want us to wait for the Competition Bureau or the MacKay task force?"
In this case, I am driven by the Minister of Finance and his officials. I am a little cloudy on it, but I agree with you that it is essential to have that document in the public domain before the public hearings begin. I am saying that I will do that within four weeks, if that is sufficient. I do not want to do it and then be told next February that it is not the proper document. That would unnecessarily delay the process.
Senator Joyal: In view of the turmoil in the global financial market, average Canadians have a tendency, like any business people, to stand back and say that it is not the time for big changes. We could be on the verge of a world financial crisis. The common wisdom is that when you are in such a difficult period of time where the outcome is not clear, you do not know which players could be wiped out of the market and you do not know exactly where the losses will hit. That is not the time for profound changes like the ones that are advocated by you and your colleagues from the other banks.
Six months ago, things seemed to be rather smooth. The Asia-Pacific market was a tremendous opportunity. Russia seemed to be a tremendous opportunity. With the problems we see now, Canadians do not generally feel that this is the time to shake things up and totally change the rules of the game. How do you answer those fears?
Mr. Barrett: My colleague will join in because this is his field of specialty. We must first understand what this global crisis is all about. It is extremely serious in Southeast Asia and in Russia. There has been a "vodka effect," rather than a "tequila effect" in some areas of South America, but let us not get carried away.
The fundamentals in Canada are very good. The fundamentals in the United States are very good. America does more business with Puerto Rico than it does with Russia. There is some debate, but I would see it shading GDP growth in Canada or the United States by .5 per cent to .75 per cent.
Our outlook is not as bleak as some. Our belief is that the fundamentals of the Canadian economy are very good. It will probably do 3 per cent of GDP next year. The United States will do about 2 per cent. Frankly, a little cooling-off in the U.S. economy is not bad because it was getting overheated. This is more of a global stock-market nervousness.
Could the worst happen? It could, if the psychology of it filters into the minds of consumers. If they start to pull up on domestic consumption, then they could pull down the GDP. That is not our forecast at the moment, but I will turn to the expert.
Mr. O'Neill: On the macro side, Mr. Greenspan was quoted this morning as saying that there is no credit crunch yet in the U.S. They have already made a pre-emptive move should that possibility emerge. The indications and the expectations are that they will do more interest-rate cutting.
The Bank of Canada will follow suit. You already have a macroeconomic mechanism to deal with the impact on the North American economy.
In Europe, the head of the Bundesbank has also signalled that perhaps it would be prepared to ease rates as well. In that sense, the economic side is potentially capable of being even further protected from that turmoil.
The other part that is important is that this is a cyclical issue. When you are talking about the MacKay report recommendations, and our own particular proposal in that regard, you are talking about long-term structural changes. One has to be very careful about mixing the two in an unnecessarily frightening way.
The fact is that the global economic crisis has been devastating for East Asia. It has been devastating for Russia. It may be more of a problem for Brazil than we thought a few months ago. However, we are not talking about a global collapse, certainly not of the financial services sector. If you have a storm on the seas, it is still quite conceivable and quite appropriate to think about additional improvements or repairs you can make to the boat. That is because you are not out there on the seas, as are the East Asian economies. You are in a safe harbour. You have fairly strong North American and European economies.
I do not think it is necessary to assume that the global turmoil has made the MacKay report and its recommendations about restructuring and the urgency that is expressed in it somehow pass-by events. I do not think that is the case at all. In particular, I do not think it would be the case for the mergers.
The structural changes we have been talking about for the last two hours -- that is, changes in competition and in technology -- will continue apace. They will still be there a year from now as fierce as they are now, or fiercer. It is in that context that the structural, longer-term changes we are talking about need to be addressed, not the current cyclical problem of what will eventually be an economic turmoil that will dissipate.
Mr. Barrett: May I add to your comfort with that by saying that this is not five-minute rice. The restructuring, whether by merger or not, is a three- to-five-year proposition. For example, we all have to get by Y2K technology issues, et cetera, before we start harmonizing technological platforms.
We are taking a prudent, cautious approach -- one that involves no disruption for our customers, certainly on the technological front. If we start this now, it will be five years before the full benefits of it are seen. We would pace the changes in quite a prudent way.
If you are trying to do something that will bring about massive change overnight, this will not be it. Unfortunately, it will take three-to-five years.
Senator Meighen: As you said, the ground has been pretty well tilled. I will try to do a little bottom fishing on one or two subjects that have not yet been finalized, at least not in my mind.
We have not said much about structure and ownership. Do I understand that, in general, you are happy with the MacKay task force recommendations in terms of ownership and, in particular, the 10-per-cent rule?
I think Senator Tkachuk is concerned about the continuing existence of a broad network of retail branches to handle the core banking business. Could it not be argued, contrary to MacKay, that if you were to get rid of the 10-per-cent rule, you would allow the players that remain after the mergers -- assuming that there is such a world -- to be bought out by a foreign institution in order to maintain a retail-branch network of some size and scope?
Mr. Barrett: I think MacKay got around a delicate issue with some skill. If you read our submission to the MacKay task force, you will see that I said something very controversial. I said, "Drop the 10-per-cent rule." I was asked at one committee -- and I cannot remember which committee because I have appeared before so many -- if I favoured the elimination of the 10-per-cent rule. I answered the question and it caused all kinds of confusion in the media.
I answered the question as a businessman, a CEO responsible for advancing the interests of his shareholders. Any restrictions on the saleability or value of my stock is bad news. Therefore, as a businessman, my view would be to take away the 10-per-cent rule.
I had a second reason for wanting the 10-per-cent rule gone. I am tired of hearing critics say that it has provided us with some kind of wonderful protection that none of us want. If people think that the 10-per-cent rule is protection, then take it away. Now, that is a businessman speaking.
If I were the Minister of Finance and were asked if I would drop the 10-per-cent rule, I would then say to myself: Do I want to lose sovereignty over my banks? Banks are the engines of the economy.
Senator Meighen: That would surely follow.
Mr. Barrett: Absolutely. I have been approached three times by American banks for a takeover. They know nothing about the 10-per-cent rule. We would be in play in 10 minutes.
Mr. McNally: We would not last until suppertime.
Mr. Barrett: It would be great for my shareholders.
By the way, Canada is not uniquely protectionist in that regard. Many people do not have 10-per-cent rules, but try to buy a clearing bank in Germany, France or even in the United States. We can buy Harris. If I took a run at Chase, I might get caught up in that vortex for 50 years before I got approval.
Most countries still worry about credit allocation decisions. A fundamental role and mission of the financial industry -- in particular of the banks within it -- is the mobilization of pools of savings and investments in the country, followed by the diversion of those pools into financing risk-taking in the economy. If you move the policy making on risk appetite outside the country, then the country may not be as well served as it currently is by players who feel an obligation to finance activities that they might not finance from abroad.
I guess what MacKay said is, " I understand the dilemma. The dilemma is how to ease up on the 10-per-cent rule to allow some takeovers of foreign institutions by widely held institutions," which I think is fine, "and not allow the other?" I think he found a way around it. It is not a bad finesse. Frankly, if there were a way of eliminating the 10-per-cent rule domestically, I would do it and keep it internationally, but then you get into national treatment problems on NAFTA. I think he tried to skate around that as best he could.
Senator Meighen: Perhaps Mr. McNally has something to add here. I hear you saying time and time again that, in this day and age, you have to be nimble and be able to adapt to rapidly changing situations. Are the recommendations sufficiently flexible on the holding company? He advocated a regulated holding company. Does that get you all excited, given the fact that it would be regulated the same as a parent-subsidiary relationship and you can regulate by function?
Mr. Barrett: I would like to have the option, only because it is an organizational option. I can create logical holding companies rather than physical ones. The original bogeyman about holding companies was commercial financial linkage, and whether or not you could get that kind of contamination through a holding company. Therefore, it was banned outright.
Mr. McNally: I think the holding-company approach -- which we have in our own company in the United States -- works well. Regulations have been tweaked in order to allow different regulatory agencies and bodies to work together better. There is less rigidity now between the subsidiaries. There used to be more rigidity and less ability to serve customers across the component subsidiaries. That seems to have been worked out over the last decade, and today I find it works quite well.
Senator Meighen: Mr. Clark, CEO of Canada Trust, appeared before us yesterday. He dealt with the question raised by Senator Tkachuk -- that is, the post-merger world, with few very tall trees and some somewhat-less-tall trees left on the landscape.
He was concerned that the differential would be too great, and he suggested divestiture as a way of remedying that problem. Given the presence of Mr. McNally, divestiture has been a time-honoured procedure in the United States, if I am not mistaken, when there have been mergers.
Mr. Barrett: From a Competition Bureau point of view, I am not concerned about the macro-aggregates but, as you may know, the Competition Bureau drills down into very local communities. It would not be at all unusual for them to come out and say that these elements must be remedied because of some localized over-concentration or whatever.
We would then address those remedies. That might call for some shedding of distribution, or it might not. I do not quite know yet, but it would not be unusual. In most major mergers or major acquisitions, anti-trust legislation often calls for a divestiture of some piece of the business.
My point is that you can have a few toenails, but the operation is not on if you want my heart. If you came out with a series of remedies, and meeting them invalidated the entire reason for going into the venture in the first place, then you would say goodbye and proceed with a different plan.
Senator Meighen: You would be intrigued to know that even on the toenail analogy, Mr. Clark was concerned that areas that have been shed do not always stay that way, and might return from whence they came. That is, if you were forced to divest yourselves of your customers, some might not go.
Mr. Barrett: Customers have a habit of doing what they want to do. They vote with their pockets. They do not like to be told. However, it is a possibility that we will look at. I do not know what they will come out with, so I do not know whether it will be at the margin or insignificant. When Mr. Clark comes back, tell him to have a big chequebook. He will not be surprised to know that I have had calls from several of his competitors.
Senator Meighen: You put a great deal of emphasis on the NAFTA geographic area rather than on the world. If the merger between you and the Royal Bank were to go forward, many people wonder if that would get you up there with the really big players? With five or six really big mega-banks, which would be global institutions, are there levels that you seek to reach? Can you reach an acceptable level of size and scope within North America with this merger, but would the next level require more mergers, if that is what you want to do on the world scale?
Mr. Barrett: You are right, it is not game-over if we get the mergers. There is a significant amount of other stuff to do in the world. That is not going to solve the world's problems. We still must grow in the area of wealth management. Wealth management is about the average mutual-fund holder of about $14,000. We need to do more on that front.
We would look at buying more monoline-type companies, and bolting on them so as to compete in North America. Our analysis is that this gives us sufficient scale to take us to the next step. That is why something as arcane as market cap is so important, because the capitalization in the stock market of the combined bank allows us the currency to do acquisitions of companies that would otherwise be impossible for me to do alone.
We would have to continue to expand. We could not stand still; one rarely can. The analyses we have done, and that our consultants have done with us, suggest that we have a good shot at it.
Senator Meighen: You would agree that size does not guarantee success, that it merely allows you to start.
Mr. Barrett: I remember the Prime Minister said that he did not need to be 350 pounds to be Prime Minister. I wanted to phone him up and say "but it helps if you want to be a line backer in the NFL". Size does matter, depending on how you want to use it.
The Chairman: Mr. Barrett, thank you and your colleagues for your patience. I realize we went way over time, but all of my colleagues wished to ask you questions.
The committee adjourned.