Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 32 - Evidence, October 22, 1998 (a.m.)
MONTREAL, Thursday, October 22, 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: Our witnesses this morning are no strangers to the committee. To lead off, we have Mr. Henri-Paul Rousseau, the President of the Laurentian Bank. He has assisted us in the past on other issues.
Mr. Henri-Paul Rousseau, President and Chief Executive Officer, Laurentian Bank of Canada: Mr. Robert Cardinal, the CFO of the company is with me today. Our position on many of these issues has been made public, but I will summarize our main proposals more precisely this morning. We have given you a copy of our brief.
Our main theme is that the Canadian financial system must be restructured and we think that this should be done by strengthening our financial institutions and enhancing competition within the industry. We believe that this can be done if the government encourages financial institutions that are active in many business sectors, banks, insurance companies, mutual fund companies and security dealers, to consolidate. In fact, that approach was adopted by the MacKay task force. We think that it provides a real opportunity to promptly create such consolidation and hence enhance competition.
Our proposal would be that your committee should recommend to the Finance Minister that he establish priorities and split the decision-making process into what I call three stages.
First, I do believe that the MacKay report recommendation concerning corporate structure, ownership and accounting principles should be implemented as soon as possible. I strongly believe that these new rules of the game would bring about new transactions and create new competitors. I think this should be your first priority, to make sure that this is implemented as soon as possible. Then, given these new proposals and these new transactions, the government should look at all of them as well as the current merger proposal. I believe that then many of the issues will be looked at quite differently.
Once you have changed the rules of the game and when the players will have played the game, then I believe many other issues should be looked at, and they concern other aspects of the regulatory framework.
I want to stress that if the MacKay report had been written under the assumption that the government would have implemented, let's say, the first 45 recommendations of the report, I am convinced that many of the other recommendations would have been slightly different and some of them fundamentally different.
In a sense, the MacKay report is saying, let us try to have more competition in the marketplace. There are three ways to do that: You can open the barriers to foreigners; you can reduce the barrier of entry to others; or you can put incentives in place for Canadian players to consolidate and create new critical mass in the form of new competitors.
My position, and the one of my company and board, is that the third group should be the one that we push first and see what happens.
I am convinced that a lot of capital would be put together if we were to do this. In other words, the approach that is taken by the MacKay report is a flexible one, and it is urging the government to adopt rules for the industry to become more competitive. More precisely, you all know that the current legislation is such that a bank can own subsidiaries. In fact, a Canadian bank under the Bank Act, as you know, is in fact a financial holding company, even though it is a bank, because we are all organized as such.
The trick, though, is that a bank cannot itself be a subsidiary of any other holding because the Bank Act stipulates that a bank must be widely held.
Moreover, under the current legislation, we can form business combinations with other institutions only through mergers or acquisitions. The legal framework and the accounting rules we have are such that the only transaction proposals you have in front of you are the two big mergers. This is not by accident; it is a natural consequence of the legal framework and the accounting rules that govern all of us in Canada.
To make my point clear, let us say that I am trying to combine my own bank with an insurance company or a mutual funds company. If I were to do that and pay the right price, we would create a lot of goodwill, for one.
Second, because these two are from two different kinds of business, there is not much synergy on the cost front. Because of that, there will be no economics beyond this transaction that would make sense. Because of these two interactions of the legal framework and accounting rules, you do not have new competitors coming in. These are our key points: that you should focus first on these rules.
I have read that you have been asking many of the other witnesses questions on the holding structure. You have a lot of concern coming from the experience of other regulators and other jurisdictions. I think these concerns are right, but let us not miss the point here. The issue should not be, "What is in theory the best approach or the best concept?" The issue should be, "What is the best process by which we will have new competitors in the Canadian marketplace?" This should be your focus, it should be how we bring new competitors into the marketplace, and because of that, the guiding principle should be the one by which you look at everything else. Given this, we are recommending that the MacKay report, on its first group of issues and recommendations concerning competition, should be implemented as soon as possible.
We have an important nuance here: You are facing contradictory views on whether the bank should be allowed to sell insurance; should the bank be allowed into the auto-leasing business, or the leasing of like vehicles; or should the payment system open to insurance and mutual funds companies.
My view on this is a little bit different than both the banks and the other guys. If the guiding principle is to make sure that all those who are not in the four big banks merge, this will create a critical mass of new competition. If this is what you want, make sure that we keep differences between them. Let the insurance people and the mutual funds companies out of the payment system so that they have a real incentive to talk to the trust companies, to the other banks, in order to get together. For this is one way by which they will have access to the payment system. If you open the payment system to everybody, then you reduce the incentive of the others to get together. Second, the same argument can be made concerning the power of distributing insurance and the auto-leasing business. You want the insurance people to get closer to the other banks and trust companies. If this is to happen, do not give the insurance and trust companies the capacity to sell insurance directly, give them positive and negative incentives to regroup. The positive one is the new legal framework, the holding company, the new accounting rules. The negative ones are to keep some differences between them.
There is also another good argument. As a policy-maker, you know that you cannot change the law overnight. There are too many recommendations. Even if any one of them was good, you cannot implement that overnight. It is a political process and a policy. It is too risky. My final recommendation is that by implementing the first group of recommendations, you will have new players coming in, a new reality. By doing this, you will be facing moreover easier political choice.
The Chairman: Thank you for a very direct and stimulating statement. I have two specific questions: On the ownership structure, the MacKay task force recommends effectively maintaining the 10 per cent rule with the flexibility to go to 20 per cent or more as a transition measure. But then it would have to fall back to 10. What is your reaction? I picked 20 per cent for a particular reason. The investor with the 20 per cent is allowed to use equity accounting, which for many people would be a better way to handle the investment rather than simply handling it as an investment. Would that add a further incentive for other people to come in and want to play?
Mr. Rousseau: I think the main consequence of this will not be at the first degree. The first degree is new accounting rules and a new legal framework and incentives. Once you have that 20 per cent, it will give all of us, everybody in the industry, the capacity to attract new capital and then enhance competition because of that. This is precisely why I would agree to this, but I do not think it is a big deal if you do not do the rest.
The Chairman: I would agree with that.
Mr. Rousseau: I would go for the 20 per cent vote because of the equity accounting: it will bring in new capital through these new players. Let us say you put together an insurance company, mutual funds company and a trust under a holding company concept, most likely the first thing you will have to do is change your name and build a new name.
One of the key areas of fixed costs in our business is building a name, a brand name. Fidelity is a big name, it has been there for years and everybody knows that, but it is costly to build a name. If you create a new entity by bringing together three different entities, the first challenge is to build a name. Then you need some capital to do that and the 20 per cent rule may be a way to attract new capital to help you do this.
It is the same thing for the training of employees, and the same thing for technology investment. I would agree with you that that is a natural thing to do once you have done the others.
The Chairman: On your holding company structure, what are the differences? When we were in the U.S., we had this debate going on about whether we wanted a holding company structure or a parent subsidiary structure. From a business standpoint, is there, in fact, a practical difference between a holding company structure, where you have a holding company and then a bunch of subs, one of which would be a bank or an insurance company, and a parent subsidiary structure where the bank itself is the holding company and the subs are underneath?
Mr. Rousseau: The reason why the holding company model would be better in the current situation is precisely because of the process aspects. I'll give you an example. As a bank, we try to build a parent subsidiary company by inviting an insurance company and a mutual funds company to join us. In that case, that group of shareholders, coming from the two others, will receive Laurentian Bank shares.
For perception and accounting reasons, and many others, it will be a lot easier if, on approaching somebody else, we propose to our shareholders, and you to your "mutualists," that they receive the shares of a new holding company. That company will be the owner of all the companies on a pro rata basis, so process-wise, perception-wise, it is a lot easier.
I see the difference between the two, especially on the aspect of how much regulation is placed at the top, be it the parent or the holding company. Second, I would think that the recommendation that the CBA has tabled concerning using the Bank Act and not creating a new charter or new law would be a good way to approach it. You would say simply that you have banks and holding companies within the Bank Act approach. It would also make life easier for everybody, from a constitutional point of view.
The Chairman: To summarize, your big argument in favour of the holding company model as opposed to the parent subsidiary model really hinges on what you think is an easier model to market when you are sitting down with partners and striking a deal. In a sense, it looks more like a genuine merger of interests and less like a takeover.
Mr. Rousseau: Right. And legally, even though we are saying that we qualify for a pooling of interests, if it is the bank, it would be the bank buying, and that is something. You know everything that has been said about big banks, so if you want things to happen, you have to make sure that you let the system put all the incentives in place.
[Translation]
Senator Hervieux-Payette: Thank you for your comments. They certainly provide food for thought. I find your approach to be quite realistic and as such, constitutes a very important contribution in my view. I have two brief questions for you. One of them, however, does not relate to your brief. The witnesses that come before us generally represent industry, rather than consumer organizations.
In Ottawa, however, a representative of the Consumers Association asked us to consider the possibility, as part of our review of the report's recommendations, of describing the balance to be achieved between consumers and financial institutions and strengthening consumer associations by giving them access to public funding. Thus they would be receiving less funding from government sources, and would have complete freedom to represent the interests of consumers through one mechanism available to them -- namely the clients who receive a monthly bank statement.
He asked that all financial institutions issue a small pamphlet asking associations to make a contribution towards establishing serious, well-funded consumer associations across the country, so that there can be an ongoing, coordinated dialogue with financial institutions.
Some consumer associations are publicly funded in part, while others receive much of their funding from government. It certainly cannot be said that there is a balance of power. Indeed, I would say these associations have lost much of their power.
In order to respond to what the MacKay report is recommending, and with a view to being a dynamic and competitive force in the market, would a business such as yours be prepared to issue biannually, for example, a pamphlet prepared by these associations inviting your clients to become members of a consumer association?
Mr. Rousseau: In various areas, we already have advisory committees in which we invite bank clients to participate so that they may provide suggestions and share their views on any new directions we may be taking with respect to sales and marketing.
I think what we need is legislation that would allow someone other than us to choose the institutions to be put in place. We would not want to have to decide who is best able to represent Canadian consumers. That should not be the role of each bank or institution.
However, if someone else were making those choices, and there were consensual decisions to be made on who should do what and who will be representing whom, I would have no objection to doing something like that systematically -- for example, twice a year.
I should add, however, senator, that in my humble opinion the real way to give more power to consumers is to give them more choice. I think that what will make a difference is the number of institutions, as well as their ability to compete in different markets. That is why the whole point of my presentation was to encourage you to adopt rules with respect to consolidation that meet the criteria we described earlier.
That is where the consumer will be a winner. In markets where there is significant competition, such as the cellular phone market, you may hear complaints from consumers, but they do not have to do with a lack of competition. Competition is very vigorous. Why? Because the market is totally open and everyone is playing by the same rules.
Senator Hervieux-Payette: My understanding, first of all, is that there are national associations, but that they could be strengthened in a number of areas, including the amount and quality of research conducted and the training of competent, qualified personnel.
That obviously does not concern only the banking sector. There is already a consumer association in Canada. But it is actually a different association that brought forward this proposal. If I talked about the idea of having two or three associations, it certainly was not with the intention of inventing two or three new ones.
It seems to me that there are currently a number of associations in place that have done their homework. There is a lot of information out there to pass on to consumers and a lot of education to be done. Despite the efforts banks are making in terms of consumer information, you must admit that the more products there are and the greater the choice, the more complicated it becomes for consumers.
I believe we need an organization that is completely independent from financial institutions which, from time to time, through its contact with consumers, can prepare analytical tables explaining to people what the best choices are, and which company, in the insurance sector or otherwise, has the most to offer.
In that way, consumers will at least have access to an expert who can explain the data in plain language, because even though they are not financial experts, consumers are looking for certain products. Someone like this could help them make the right choices.
The banks apparently spent some $20 million recently to reach out to Canadians. I would be very interested in knowing whether Canadians are satisfied with that or not.
An independent association might provide a better answer. Do you agree?
Mr. Rousseau: Yes, I do. However, you might run into some practical problems, because a number of corporate entities operate here in Canada that are not all under federal, provincial or foreign jurisdiction. There again, everyone would have to be playing by the same rules.
Senator Hervieux-Payette: I would like you to clarify your proposal with respect to insurance companies and the last suggestion you made. You may want to provide a somewhat less technical explanation in French, because it is important that ordinary voters understand our report.
Mr. Rousseau: The point is this: According to estimates you can do yourselves, roughly half of the banking industry's capital is in other areas, including insurance, mutual funds, brokerages -- which are not bank owned -- and trusts.
That capital is actually quite scattered, if I can put it that way. It may be held by small financial or banking institutions. That capital could be pooled and generate new forces of competition in the Canadian market if the ground rules were changed. That is what we are proposing, and many of the MacKay report recommendations are along the same lines.
I might add, though, that if you want that to happen, you have to not only provide positive incentives -- by amending the accounting and legal rules -- but maintain the differences between the institutions.
Let me explain. If you offer insurance companies the ability to provide chequing accounts and thus to participate fully in the payments system, out of a concern for equity or a level playing field, you have to give banking and deposit-taking institutions the right to distribute insurance.
A number of people have made that suggestion, as has the MacKay report. My point is, that is fine in theory. In practice, however, by taking that step, you are eliminating one of the main reasons for an insurance company and a bank, or an insurance company and a mutual fund company, to merge.
If our primary goal is to bring new competitors into the market, we have to do everything we can to make sure that happens. The market will adjust based on whatever public policy guidelines are in place.
It is with that in mind that I emphasize the need to retain those differences for the time being, and to say to insurance companies, who want to play a greater role in the payments system, that they should form closer ties with whatever banks and trust companies remain, and also say to the banks, who want to distribute insurance, that they should establish closer ties with insurance companies. The same would apply to mutual funds companies and brokerage firms.
So, that is the most important point. This is not a permanent view. I am biased as regards the goal of ensuring that this capital, which is currently widely scattered, be consolidated in six or seven institutions that will foster new competition.
The MacKay report follows exactly the same logic when it talks about getting new players involved, such as community or cooperative banks. That is absolutely true, and it is something that should be done. I certainly agree with that approach, but it is not much in terms of the amount of capital involved.
Most of the new competition has to come from two sources: a consolidation of other institutions, as I am suggesting, or the arrival of foreign banks. Based on the theory that Canadians prefer to retain control over their system for the time being, that is the choice we should make, and I base my recommendations on the specific goal of introducing new competitive forces into the market.
[English]
Senator Oliver: The MacKay task force spends a fair amount of time saying that the Canadian financial services industry has reached the point where substantial change in structuring must take place, or harm and damage may come to consumers, and so on. MacKay's reasoning is that things are happening internationally and globally, and he spends a lot of time talking about the impact of global events on Canadian institutions. I want to ask a couple of generic questions about this globalization, and how you think it affects Canada.
Is it advantageous, for instance, for Canadians to participate in global financial markets through Canadian-based institutions? Or does being globally competitive, which is the word that MacKay uses a lot in his report, refer only to Canadian operations abroad, or rather to competing effectively in domestic markets with foreign institutions?
Mr. Rousseau: The global situation has changed quite substantially over the last six months, as you realize. I believe that the tone and many of the conclusions of the MacKay report would be slightly different if we were writing the report now instead of six months ago. That is a general statement. That is not to say that globalization has stopped, just that globalization is a complex phenomenon. Concerning your two questions, I would think yes, it is advantageous for Canadians to deal with institutions that are able to compete globally. This has to do with the view of the future; what is the likely future of this industry.
We have all been banking with institutions locally at a branch where we were doing our chequing and basic banking business. As we were going into that branch, you and I, we were talking to somebody and that somebody was talking to us about our investments or our loan activities. By what I just said, the three basic activities of financial industries were in that local branch: payments-related services, credit services and investment-related services. The industry is, in fact, consolidated, not only in Canada, but worldwide. Why is it that the banks in the European countries and those in the United States are merging? The industry that is in the process of merging is, in fact, disappearing, and a new type of business is coming in. Take the payments services related activities. With the technology we have, this is now converging with telecommunications, cable industry, and all this. We have a word in French called "domotique," which is the business of having all your services in your home -- the convergence of the cable and the phone. I would think that the business is a new one, and sure, it is related to the banks right now. We are doing a lot of the payments-related service, but look at the Internet. Look at how quickly you can transfer money through the phone booths. We were not able to do that before. Looking forward 10 or 15 years from now, you will see the convergence of telecommunications, computer business and domotique. They will be very linked together. We are talking about opening the payments system to other financial companies, and in the future it will be open.
Bell Canada is already a payments system because they have a card and their phone booths can transfer money from one locality to another. They do not operate through the banking payments system, but through their own. That is a new industry that is coming in.
As for credit, you can borrow money just about everywhere now. You do not have to go to a branch. Advisory services -- the big research coming from the major investment dealer in the U.S. -- is available on the Internet at a very cheap price. For $29 per month you have it all, and you have it now. What is the usefulness of traditional brokers? It is true that the business is really changing, and because of that it is advantageous for Canadians to be dealing with institutions that are able to cope with these new trends. Some of that business needs economies of scale because of the changes, and this is where mergers come in.
The Chairman: As I listen to you, you are really saying that your vision of the future is the emergence of the eight to ten financial players, as you say in your opening statement. But do you see those financial players being constructed from cross-pillar mergers rather than mergers within a pillar?
Mr. Rousseau: Yes.
The Chairman: You see, that was essentially a broadening of scope as opposed to purely focusing on scale in a particular pillar. That fundamental perception then strikes very much at where we ought to go with public policy.
Mr. Rousseau: Yes. The reason why this is the case has to do with the fact that the trends within the industry are such that you need economies of scope in this future world.
The Chairman: We had that same argument, by the way, from Banque Nationale, but some of the other witnesses have argued that we only need economies of scale; economies of scope lead to quite a different set of public policies.
Senator Oliver: Those first two questions I put to you are based on the importance of the Canadian flag flying and these things that we, as Canadians, are doing.
Mr. Rousseau: I was going to get to that point. Looking forward, the payments system is going to be open, as is credit. In wealth management, there is a relationship and related activities. This is where you want to be confident, have trust and know your clients. You have an intimate relationship with your customers. You are dealing with their financial future. You are sitting down with people and discussing their retirement, total income, assets and liabilities, and helping them to plan their future. You cannot have a more personal relationship. I believe that Canadians want to deal with a Canadian institution in such matters. You can have a totally open world, but reading and looking at what is happening now, I do believe that on this side of the business there will be resistance to completely opening that area.
Senator Oliver: And there will be reluctance to move the 10 per cent rule.
Mr. Rousseau: Right.
Senator Oliver: I was fascinated by some of the things you said about the influence of high-tech. I was also interested to hear you say that if MacKay were writing his report today, it might be a little bit different. Several things have been happening in terms of mergers and telecommunications in the high-tech sector, both south of the border and within Canada. There has been a rise in financial services on the Internet from technology firms, like Microsoft. It is now thinking of becoming a bank because it has Quicken and new one-stop shopping web sites like Money or On-Line Mortgage Exploring. These changes have made it apparent that the definition of what constitutes a bank has changed even since MacKay wrote his report. Banking is now a much looser concept because of what you can do on the Internet.
Mr. Rousseau: I think the reality is a complex one. At one end of the spectrum you have high-tech providers and high-tech consumers. At the other end completely you have very low-tech, very personal, one-on-one interactions. At what speed do they -- the consumer and technology -- evolve so that we are going from one spectrum to the other?
Five years ago, that spectrum was probably here, and now it is further. An increasing number of people are using the technology, but there are still many, and it is an increasing number of people, who want to be talking to a person at their locale.
Senator Oliver: Particularly the elderly.
Mr. Rousseau: You would be surprised. Take the phone banking. We have clients that are delighted to use the phone banking and who do not come to the branch. If you are living on the third storey of a building and it is snowing in February in Montreal, you probably would be better to use the phone than to go the branch, so the elderly are pretty happy with the technology. They have grown up with the phone. They are not using the Internet because they have not grown up with the computer. My kids will -- that is the difference -- but this is a complex reality.
My comments about the MacKay report and the global situation have to do more with the risk outside and the necessity of capital. I think that if they were writing the report right now, the section on abolishing tax on capital and making sure that we have not only a competitive market, but that institutions are able to compete and remain stable, would be highlighted.
Senator Austin: The first question I would like to ask you relates to the timing of the implementation of your various recommendations. Do you feel that the consideration of the major merger issue should be deferred?
Mr. Rousseau: Come the next federal government budget, say in early March, I would hope that the financial ministers will be tabling a document that would more or less serve as the blueprint. I hope it will establish the rules of the game on everything, including competition.
I assume that this will be coming out of your report as a key recommendation and that the government will apply this. With respect to the process, it would mean that we will have a policy orientation from the government. Then all the institutions in Canada will know the framework under which we will be governing our transactions concerning the legal framework, accounting rules and the areas of the first 40 recommendations that I am looking at. Assuming that this is there in the paper, and that this paper is close to being law, it is very clear that this is where we are going. If we were to have that in February, you would have a bunch of business combination proposals coming in very rapidly. The market out there will react to this. You will see all this coming in March, April, May, June and July.
As you are in that time frame, you will also have received the document, "Serving the Competition Bureau" concerning the two mergers. Then you will be facing a new policy reality and a bunch of new transactions to compare with the other banks.
My suggestion would be that, come summer 1999, the government should be able to not only look at the two merger proposals, but also the five or six or seven other transactions in front. That will imply that we will change the rules of the game before we say yes or no, or "no, but..." or whatever to the mergers.
My recommendation would be to fast-track this first. Get the new rules of the game, and then look at the total situation. I believe it is to the advantage of those who want to merge, because if you have a more competitive market you will look, as a policy-maker yourself, quite different than if you do not. If you are just facing the two mergers and the status quo, it would be pretty hard to say yes to these mergers. If you are facing new rules of the games and new competitive forces and the mergers, it would be quite different.
Senator Austin: You are addressing precisely the right issue. There can be little disagreement that what we want to foster, as a matter of public policy, is an open, transparent, competitive market for the cost of money and the cost of financial services. The question you address is how we get there. You correctly, in my view, addressed the stimulation of what sometimes is called, in code, the second-tier financial institutions. You are addressing the critical path, which is the question that I am pressing you on.
The question, then, is what gives you confidence that second-tier financial institutions with different financial services will be stimulated to talk to one another, to develop different corporate patterns, ownership patterns, to be more competitive? If they will, is there a substantial time lag in that particular process before the issues can be worked out?
You told us that if the minister gives the signal in the budget as to the nature of the new framework in February, then by summer the minister will have seen a number of applications in front of him. But to quote the old philosophy professor's phrase, the inarticulate major premise is that the second-tier financial institutions will, in fact, react. If they are going to react on your time frame, they must be preparing to react almost as we speak. Would you comment on that?
Mr. Rousseau: We are talking about seven to eight insurance companies, the four majors being in the process of demutualization and the three others around it. We are talking about six to seven independent mutual fund players. We are talking about the other banks that are not involved in the mergers, which include ourselves and some trust companies, and we are also talking about the others, who could be distribution networks and smaller players.
Now, this is not 2,000 players, this is 20 to 25 players. When the incentives are there, things go very fast in the marketplace. We are all paid and we are all focusing on one thing, to make sure that our shareholders have a great value for their investment. We can deliver this by having committed institutions in that marketplace.
Do not forget one thing. The reality that you are facing is the result of the rules we have now. Why is it that you have only the two mergers of the big banks? They are the only ones that are legally, accountably and financially able to do it. The other guys do not do it for it does not make sense. Look at the insurance company mergers, like when Great-West bought London Life. Why does it make sense? This is a consolidation within the same industry. We are talking here consolidation across.
In order for this to happen, you need to change the rules of the game. Now, these players will act and react very rapidly; you will be surprised. First, the analysts will do their job; then consumers will do their job and the papers and the political people will do theirs. But the pressure will be there for that to happen, because you have created the momentum for it. Secondly, without revealing anything, you know that everybody has been talking to everybody else for the last two years about why there is no transaction. It does not make sense because the rules of the game preclude us from doing it. I have been talking to a bunch of people and they have been talking to others. We have been dancing with everybody, but it does not make sense. We do not have the same chance as the other guys have because the rules are such that they are the only ones to do the dance, to be on the floor, so I am pretty clear on that. Do it and look at it.
Supposing I am wrong, what is the consequence? There are no negatives. You only have an upside, you do not have a downside. The status quo will prevail. Then you can look at a lot of things. I am saying that we need more competition, and I believe it can come from Canada. I am just asking you to give it a chance. Give a chance to Canadian players to play the game. Give a chance so that consumers and small business will be better served by an industry that will be consolidated within itself across the pillars. This is the main point.
Senator Austin: One major bank CEO commented that time is critical to their merger application, that business circumstances change and that therefore the possibility of merging on the terms they have settled are changing. Your scenario, as I understand it, brings together, in the critical path of decision making, a major bank review and applications from the second-tier group at the same time. It would be next summer at the earliest that the Minister of Finance would be in a position to consider the major bank mergers.
Mr. Rousseau: First, the comment is right: timing is key. Second, the reason why their process is delayed is because they have been working the other way around, completing a business deal without knowing the rules of the game and pushing for the other way around. Put in the rules of the game, and we will provide you with a business deal. That is how it should be. This is a marketplace, but only under specific rules of the game that are put in place by governments.
Third, second-tier transactions do not raise competitive issues for the Competition Bureau as much as the other big banks. If we wanted to merge with another insurance or mutual funds company, whatever, I do not even know if we would go before a committee. We will go there, but it is not a big deal because we are not providing new competitors, closing branches or consolidating anything.
Finally, whatever you do on this, I would be surprised if there will be an answer before next summer for a bunch of other reasons.
Senator Austin: The consolidation of the U.S. banking system and the significance of that process in both scope and scale need to be fleshed out. Perhaps we can come back to that or some other senator can take those issues on because they are very relevant to the competitive situation in Canada.
Senator Tkachuk: The conundrum that we all have been dealing with is a question of competition in providing choices for consumers in the wake of what has transpired with the merger question, and all the rest of it. You have put together an orderly process in your presentation, but how will a bank merging with an insurance company help the farmer in Estevan, Saskatchewan, who has maybe four or five choices now and may only have three? How will you, merging with an insurance company or a bank in the west, make one bit of difference to him or her?
Mr. Rousseau: In my opening remarks, the written part, I mentioned something about it, but I did not verbally. Let us say that the merger of a bank and an insurance company will create new competitive forces up to the point where consumers, small businesses and farmers will have new choices.
Now, what do we put together? We put together, basically, the capital of our investors, of our shareholders, in a holding company, and that capital will be used to deploy our resources in four areas. These are the four areas where you have fixed cost aspects, and economies of scale are important. First, you have the fixed cost of training our employees. You have R & D, the material and everything you need to do that. You have the cost of training employees in credit finance, wealth management and other areas. This is key if you want to be competitive. You are good because you have good employees; otherwise you are no good. Training is important and training is much easier if you have a larger capital base.
Second, technology is available, but some technologies are more costly, and because of that, you need larger capital.
Third, brand name is a key fixed-cost element. The farmer you are talking about does not know me, but he may have a chance to know me if I am a lot bigger because I will have the capacity to publicize myself in the market, which is not the case right now.
Fourth, capital is another fixed cost. If you have a larger capital base, you can raise new capital more easily than if you do not.
These four elements create a critical mass in these new institutions. Given that, you will have institutions that will be choosing to go where there is a better margin, and there are pretty good margins in a lot of finance industries. For example, we have started financing small businesses over the last two years. We have been ranked number one by a company based in Toronto, Art and Associates. This company serves all the small business people across Canada. They are paid by the bank to do an independent assessment, and they rank quality efforts as number one. Why were we ranked number one? We decided to go into a niche market and be there as a newcomer. We are creating a new competitive force in Kitchener, for example, where we opened a lend centre. This is how the market will be working. It is not theory, it is reality. If you have new competitive forces in the marketplace coming from the regrouping of institutions that are in different fields, you will have new competitors and you will better serve Canadians.
The capital that you have can be deployed in different areas. You can choose to go into the securities market in lending in other aspects. This is a matter of strategies. However, when you have competitive forces, institutions will have the incentive to go where you can make money and serve clients, and that is how the market will react.
If you do not have that, if you only have four big banks who serve clients, you have to regulate it a lot to make sure that they are where you want them to be. You do not have competition, and competition in the financial industry as a way of delivering the product and the service to clients is no different than it is in the cellular phone business. It is the same approach.
Mr. Robert Cardinal, Chief Financial Officer, Laurentian Bank of Canada: I would like to raise an additional point. Would a new organization, such as a merged bank, like Laurentian Bank, and let us say an insurance company, be able to use alternative distribution channels that the banks do not use presently? Those channels are the independent insurance brokers, through which we can distribute banking product packages, and those distribution channels are unique. They have not been developed by the banks yet, but this is one of the major synergies that could exist with the merger of a smaller bank and a life insurance company.
Senator Kroft: I want to continue exactly where Senator Austin was. I understand clearly what you are saying: We should create the rules that will allow the competition and let the competition know where they stand. Then everything will happen more quickly than we think it will. However, that runs contrary to a lot of what we have been hearing.
The theory of the MacKay report is that there should be no absolute prohibition by definition against merger if there are opportunities for new or reorganized competition. I am having trouble with the time line. We have heard again and again that the power of the existing major banks, because of their franchise and their position in the marketplace, is so great that it is unrealistically optimistic to assume that new entrants or other combinations, such as some expansion of the credit union industry, would succeed. Great West and London Life, for example, have indicated considerable disinterest in this process, including the payments system and everything else. They say, "We are in the insurance business and that is where we build."
You have very articulately and enticingly given us the theory of how one might like the process to go. However, that does not seem to square with the concern, which we have often heard repeated, that the major financial institutions, especially in the case of a merger, would have so overwhelming an edge or lead that the balanced competition you expect within months would not be possible. I am having trouble reconciling those two visions.
Mr. Rousseau: Your comments and questions touch on many aspects of the subject. I have read other submissions in the papers. I understand that you have received mixed reports on some of the major issues, including, for example, competition in the retail market. Some people will suggest that the retail market is competitive, while others will argue the opposite.
Your question assumes that if we go ahead with what we propose, the merger of the two banks will automatically move forward. That is implicit in what you said. But, the new competitive force will counterbalance that. Those are two different issues. I did not say much about the merger in my brief.
We, as Canadians, are facing quite a dilemma. This market is spread over our country. Given the number of transactions, the number of consumers, and the wealth of the management, it is not a large market by world standards. You want to create a degree of competition in that market, and, at the same time, given the preference of Canadians, you should like to keep this in the hands of Canadians as much as possible. That is the challenge and the dilemma everyone is facing.
There are not too many ways through that dilemma. I do not know the future, and I am not sure what we will end up with exactly, but the odds are that competition will increase, since there is not much of a downside what I propose and it will most likely bring new transactions if the incentives are there. Those new transactions will bring new competitive forces. That is not the end of the world. It will probably not change the big decision you must make concerning the bank merger, and it will not preclude some of these merged banks from being forced to sell some assets in order to make the deal acceptable if it goes through. That is a related but separate issue.
We would like to have more competition within that marketplace. It can come from newcomers, either from inside or outside. Several people and institutions and a lot of capital would be available if the right incentives were put in place for this to happen. At least you will have that.
You would be surprised at the speed at which that can happen. Everybody knows the story about Great West and London Life and how quickly it was done. Most business deals are done very quickly. They may not be good deals, but your question is about the speed. Normally, business animals are pretty fast to give a shot at something if there is a real incentive for doing it. I would not be worried about this. The opposite case will probably occur, and there will be a lot happening.
Let us do that, then. There is a real upside, no negative side, and no big downside. It will have some influence on the merger, but only if you reverse the process, put that in place first, and look at the merger afterwards; otherwise, it does not make sense. I am not saying do only this, I am saying do this first. You still have the choice to do many other things later, but this has never been done.
I agree that if there is a chance that some corporate movement could regroup and create a new bank, they should do it. I am not talking about second-tier banks. I am talking about second-tier financial institutions resulting from deals between all the second-tier companies together.
How can we break the lead of these big guys? We have 150 years of business. We are one of the oldest Canadian institutions. We have been in business for a long time. We are number nine in Canada. We have been providing a dividend to our shareholders. Since day one we have been a public company. We are smaller than many of our competitors. Royal Bank out-produces Laurentian Bank every year. That is a good thing to think about when I wake up in the morning so that I have something to do that day. However, although size is not crucial for doing a lot of things, it is a key element for doing big things. We must be focused. We must be a niche player.
For example, we are number one in several product lines: serving financial intermediaries, serving independent brokers in Canada, deposits and mutual fund loans, and others. Why is it that we are number one in some of the product lines? It is because we are so small. We have 2 per cent of the Canadian banking market share, so the likelihood of serving an independent broker in Kelowna who is already serving one of my clients is 2 per cent. The likelihood of any capitalization between my business on this side and my own business is close to zero. Hence, I can provide new services to the consumer through that back door. In fact, I can retail at the branch level and wholesale through the back door through these independent brokers.
On the other hand, if I were too big, say 12 per cent of the market share, every day I would get phone calls from branch managers and branch employees saying, "This guy is on my turf." Competition is a tricky game. Let us have a bit of confidence in the marketplace. Let this happen. You will be surprised at how the big banks will feed the competition at the local market.
It would be different if you were talking about Bell Canada servicing the Bombardiers of this world. That is not our market, and that may not be the merged bank's market, because the Bombardiers of the world have access to the world's first-class institutions and will be served by them at a highly competitive level. So your concern is for the level of competition in the local marketplace, and that concern can be much diminished if you do have new competitors emerging from that regrouping of institutions.
The brand name aspect, the fixed costs, the training, and the four areas I mentioned are key for competition. Those are coming with the new deals.
Your final point was will that happen. Honestly, I do not know for sure. I would give it a try, and the sooner, the better.
Senator Austin: Given your confidence that diverse financial institutions at the second-tier level have a business interest in coming together, why do you feel we need the addition of rule structure to give those institutions an incentive? For example, earlier you discussed denying some institutions access to the payments system so that they will come together with those who have access.
It seems quite artificial for us to create that kind of a policy when there are natural economic and market incentives to come together in any event in order to be competitive and to drive unit productivity.
Mr. Rousseau: I do not think that is right. First, under the current legal rules of the game, the only way for us to get together with an insurance company is to merge with them. We must acquire them and then amalgamate.
Second, the only way we can do it financially is through a transaction that will create a chunk of goodwill, because that transaction is cross-border and not economical.
Senator Austin: Let us agree that we can change the accounting rules and then look at the other additions you are proposing.
Mr. Rousseau: The ownership aspect is very simple. Already implicit in the Canadian Bank Act is the concept of a bank holding company. This is what we have. We are a bank holding company even though we are called a bank. Just change one paragraph in the Bank Act to say that either a bank that has a sub or a holding company that has a sub, which could be a bank, can be regulated by this act
That is important, because then you will have put in place legal and accounting rules that will be the same for everybody, and you can say that you do have a level playing field for everybody.
Senator Austin: I am comfortable with that. However, I am not comfortable with the following scenario: A medium-sized trust company that has access to the payments system comes into a financial negotiation with a mutual fund. The mutual fund does not have access to the payments system because we have decided to restrict it. Therefore, we have conferred an economic value on access to the payments system, which carries over into the negotiation between the two organizations.
Mr. Rousseau: You have also conferred economic value on the part of the business that is selling insurance. Take the opposite rule. You are comfortable with the legal and the economic points. Where you are not as concerned is the status quo that I am proposing concerning the legal capacity of doing what the other guys are doing.
Senator Austin: Here I just see building economic values that might be artificial.
Mr. Rousseau: Take the opposite road. We will implement access to the payment system and allow banks to sell insurance at the same time, so that we have equal powers. We know that once you get into the insurance distribution capacity, other concerns, other issues arise, including the question of how to protect consumer information and how to implement all of those regulations.
Moreover, the only reason I propose the status quo there -- and this is in my document -- is the facility with which you will be able to process this politically. In this country, we do not have consensus on the questions of insurance distribution, car leasings, and the payment system. That is evident from the testimony you have heard and the questions you have asked. I am presenting the issue from my side and you will have to look at it further down the road, but the important thing is not individual power; it is the capacity to have this process occurring. It is not a big deal. I am not against that. If you want to do it, do it. If you do it on top of the other things, there will probably be delays.
Mr. Cardinal: I know the financial point of view. The rule of economies of scale suggests that if you leave the status quo, that is, if you do not give the insurance companies access to the payments system and, at the same time, if you do not allow the banks to sell insurance products in their branches, then you force the institutions to stick with what they know, to stick to their netting. Because of the high costs, especially in terms of technology, associated with entering the payments system or implementing the sale of insurance products in bank branches, in the short term, you will not build economies of scale. However, eventually you will build those economies of scale, because of the entry cost of those institutions.
It is more efficient, if indeed your objective is the ultimate efficiency of the whole financial services sector, to encourage, to set the rules, to let institutions which have complimentary forces to stay in what they know, but to allow them to merge.
Senator Austin: I agree with you conceptually. I am looking at the micro-deal, and it does not change, in my opinion, whether or not we keep the status quo barriers or we allow entry into such things as the payments system and insurance and so on. You made the point that a bank does not necessarily really understand the insurance business. As a bank, you should not belittle the talents of the people with whom you want to negotiate by saying that banks doing insurance will not change anything. But you are not doing it because it is an enormous thing to do and it is a very different business. An asset business is very different from a liability business.
Mr. Rousseau: I am pleased that we agree on the first two points, the legal and the accounting matters.
Senator Austin: For the purposes of this discussion, we agree.
Mr. Rousseau: That is also the purpose we have. Regarding the third matter, on which we might differ, ultimately the payment system must be open or the insurance system must be open. My concern is more for the process. If you find a way whereby the process is not in any way reduced or impaired by that, I will vote for you.
Senator Austin: In the same area, there is another consideration of time on which I should like your views. Other systems are being put in place by non-regulated financial institutions such as GE, Blackstone, or Microsoft. They are all rushing into this business offering different ways of providing those services. How much time do we have before external competitive forces make some of our debates quite academic?
Mr. Rousseau: I believe the announcement of the proposed merger is almost a year old. The impact of time on these business deals is crucial for many obvious reasons, and that causes increased concern. However, I do not think there will be a big change in the competitive situation in Canada in the next six months. The global situation has changed and everybody is retrenching, giving us a little more time than we might otherwise have, because people will be a little more prudent about ventures here and there. Look at the results of last quarter. Therefore, Canada should take the time it needs to get the policy framework that Canadians need.
These deals have been announced. They took that risk. It is their own risk, not yours, not mine. It is sad, but this is the fact of life. We should spend all of our energy putting into place the new rules of the game, and then we should look at all of this together.
Senator Austin: Your objective is to increase competition in the Canadian financial market, particularly through the development of the second-tier financial system. Are the large merger proposals intended to increase competition in the Canadian market, or are they designed to create an integrative pattern in the North American financial system?
Mr. Rousseau: Large mergers will not create new competitors in the Canadian market; rather, they are a concentration of the activities of capital. That is for sure. They will create more competitive Canadian institutions on the North American scene, because, if you want to be a player, but not America, you should be a bit bigger than I am. I am not out there because I do not have the capacity to be there. It has to do with the capital base you have.
Senator Austin: What is the public policy value in Canada of having large North American competitors owned by or based in Canada?
Mr. Rousseau: One of the big, crucial challenges they face -- and here I sympathize -- is a brain drain. We have that problem in Montreal where, for example, it is tough for me to find three money market dealers. The only way out is to try to lure one from the other institutions in Montreal. The same problem exists in Toronto. If local decision makers are not in place, you will not have the capacity to retrain or to keep good people. That is where the system falls down, and at the end of the day, you will not have much Canadian expertise in the financial industry.
The financial sector is probably one sector you want to be Canadian. Even though they do not love the banks, Canadians want their banks to be Canadian.
Senator Kelleher: I should like to focus now on a second-tier banking system. The members of the MacKay task force, being very concerned about whether sufficient competition would remain in the marketplace if we permit the four mergers, tried to determine where the competition could come from.
The United States has second-tier community banking. In England, as a result of all of the mergers, the building society stepped in and became a type of bank. Here in Canada, the MacKay report suggests that we should change the rules to facilitate entry into a type of second-tier banking system, which would involve the credit unions and the caisses. This appeals to some of us who have seen what happened both in England and in the United States.
Do you think this is a realistic and viable suggestion?
Mr. Knight, Chairman of the Board of Credit Union Central of Canada, appeared before us in Ottawa. He was quite enthusiastic and said that they are certainly ready to, as he said, "reinvent" the credit union movement. He discussed at some length how VanCity works and the hold they have in the market out there.
Mr. Rousseau: It is a good suggestion. We should look at all Canadian sources of competition, and that is one of them. The big question is not whether it is a good idea, but how much new competition it will create.
The credit union movement is certainly big enough to have one or two or three banks of a given size in different markets. In fact, VanCity is a major competitor of ours in B.C. They are doing a fantastic job. If they obtain a bank charter, I would have no problem with that, as long as they play by the same rules of the game that we do.
The angle that should be considered is the similarity of the rules governing regulation, taxation, and so on in different markets. If VanCity pays the same taxes that we do and has the same obligations and power, then that is acceptable. They already have the knowledge, the systems, and the people to be there, so they should be there.
How much new capital will we be able to attract to that mode? That is one of the new elements raised in the MacKay report. In the United States, which is a very dynamic market, a new bank is created every week. Why do people create new banks which, five or 10 years later, they will sell to another bank? Is that the way the world should operate? We do not have that kind of dynamism in Canada, although maybe we should have it to a degree.
In any event, I totally agree with recommendations 1 to 42 of the MacKay report. They represent phase one of what should be done, and that includes the creation of these second-tier institutions. However, it will not make a major difference in the short term.
Why is there such a concentration of Canadian banks? In the past, we had many more banks, but we had a bad experience. Since then, mergers have reduced their ranks to the six, seven, or eight banks we have now.
As we have moved forward, concentration in the Canadian banking industry has increased for a number of reasons. Principally, this is not a very large market. With respect to the size of the banking market, Canada is comparable to California. Keep that perspective in mind. We can create many rules similar to those in the United States, but this is a different market, and we will not have as many new banks coming in.
Yet, for all of this, most likely the credit unions will be players. The question is: How much new capital will be created from their participation? My proposal has a greater chance of creating a new force of competition.
Senator Kelleher: From your discussions with Senators Kroft and Austin, am I correct that, if the credit unions and the caisses come in as a second tier, you propose that we set the rules for them, and give them a little time to start up and to become players before the mergers actually proceed?
Mr. Rousseau: No. They are two separate matters. It is one thing to add a policy statement that outlines the rules of the game and, once you have done that, you can consider the mergers. I do not care which comes first. You have changed the rules of the game. However, you should not wait until the credit unions have established their banks before you approve of the bank mergers, if that is what you decide to do.
Senator Kelleher: You do not think that is a good idea. Would that hinder the development of this second tier?
Mr. Rousseau: No. It does make sense for them to do it. Whatever happens regarding the merger, the main barrier to entry for the credit unions is that they do not have the legal capacity to proceed. However, if they were to get that capacity they would proceed, as the chairman of that group has told you.
Senator Kolber: The MacKay report states that the status quo is not an option. However, as you look back over the years, you must conclude that the financial industry in Canada is in very healthy, buoyant shape. Everybody seems to be making profits, and return on equity is excellent. Why should we do anything?
Mr. Rousseau: That is a good question. Over the past 35 years the value of the companies in the banking industry has been very close to the book value. There have been good years, like the recent 18 per cent return on equity, but there have also been bad years. Overall, the banking industry has been a good investment, with good dividends, good returns and, in the last couple, of years it has done nicely. That is not what we have seen in other industries.
Senator Kolber: They have not all done as well as Microsoft; we understand that. I dare say that you could have made other investments and gone broke too.
Mr. Rousseau: I agree with you. Although we have been successful, we have not been as successful as some others. Further, we are now entering a period when I do not think the banking industry will remain at its former level of profit.
Why is it that the status quo cannot be maintained? My reading is that we want to try to have it all -- the 10 per cent rule. We want to keep a Canadian system, and at the same time let the market outside evolve as will so that we also have GE Capital and MBNA. You probably received at your home an MBNA proposal as I did last night.
Maintaining the status quo means retaining the rules of the game and saying no to the mergers. However, by doing that, we will not have the capacity to react to what is happening, not outside Canada, but inside Canada, with new competitors, technological change, and other developments we see every day.
The role of the government is to adopt new rules of the games as the marketplace evolves. The question is how much of the industry will be in the hands of Canadians as a consequence of your regulations.
Senator Kolber: Is it fair to conclude from what you said that, if the government went along with all the changes and the new rules that you would like so that you could get together with a whole bunch of other companies your own size or slightly bigger in order to create more competition, you would generally be in favour of the two proposed mergers?
Mr. Rousseau: As the MacKay report states, the two mergers should be looked at on their own. My answer is "yes, but," and in the "but" there will be included some of those investments by the merged banks. The two areas to consider are local branches in some Ontario markets where there will be a concentration of investment banking. For example, in Montreal, RDS and Nesbitt Burns will create a huge powerhouse as an investment bank, because there are few players in that market. This will probably be a consideration by the Competition Bureau. Those two banks should be asked to demonstrate how, exactly, their business plan will ensure that the "but" is taken care of.
Senator Kolber: Why would you not buy an insurance company right now?
Mr. Rousseau: It would be too expensive, given the present rules of the games.
Senator Kolber: If they changed the accounting rules, however, would you need to do it?
Mr. Rousseau: We cannot do it. It does not make sense.
Senator Kolber: Would it make sense if they changed the accounting rules?
Mr. Rousseau: I would have my business plan tabled in my board and presented to this committee.
Mr. Cardinal: The playing field between Canada and the U.S. is not level for a number of reasons: the status quo here, free trade, the fact that the American and Canadian markets are opening up, and the fact that the pooling of interest is much more liberal in the U.S. than it is in Canada. The status quo, at least for the pooling method, is not acceptable.
Senator Kroft: You have reminded me of other points we heard about in recent weeks.
For example, we have heard conflicting views regarding the future efficacy of face-to-face branch banking. We heard an entire range of attitudes. Some say that, with technology people, will no longer brave bad weather to go out to a branch. We also heard that, despite problems like duplication created by mergers, the branch system, with its power to create business, is still a very powerful tool. Canada Trust went so far as to say that branch banking is really the core of their business and that the great power of their business lies in that face-to-face relationship.
Other research suggests a correlation between age and banking practices. In fact, the heaviest users of branch services are also the heaviest users of technological services.
What observations can you make about public policy issues as they affect what happens in communities?
Mr. Rousseau: This is an important element in the decision concerning the bank mergers. It is also an important consideration in the policy making that the government will be facing. The branch bank's capacity to be close to its local clients will remain its key asset. However, the contempt levelled at what is happening within the branch is totally different now from what it was five years ago and it will continue to change. There is a lot of misinterpretation and misconception.
Many Great West insurance agents and brokers either visit their clients at their homes or they meet with them at the branch.
In the good old days of banking, we did everything at the branch level: withdrew cash, made deposits, paid bills, secured credit, took out loans, and made investments. Nowadays close to 90 per cent of the basic banking transactions such as deposits and withdrawals are done by phone banking, ATM, electronic banking devices. It was only about 55 per cent five years ago. This is a trend in the market. It does not mean that we no longer have payment related service at the branch, but it does mean that the number of hours of operation at these branches is fewer.
Five years ago there were few credit transactions at the point of sale. Now we use credit cards extensively.
As another example of how the situation has changed, a customer can visit a pool distributor on a Sunday afternoon and the distributor, with the assistance of a fax machine and other devices, can make arrangements for the customer to finance his purchase of the pool through our bank. On Monday the purchaser will receive a call from our employee welcoming him to Laurentian bank. The bank has booked a loan over the weekend. This is not done through the branch. However, the new client will be invited to the branch closest to his home or workplace, and our bank will have a new client.
The branches will play an increasing role in the area of wealth management, specifically because of the fact that we now have an aging population. Planning for retirement and seeking investment advice is all part of wealth management. Banks, insurance companies, trust companies and investment dealers are all in the business of servicing and advising their clients in this area of activity.
If you were to ask your witnesses what impact wealth management will have on the future of the branch system, they will tell you that it will be an important element. However, the branch that will deal with that area may be designed differently. It may be on the second floor of a building with no front door on the street. It will be close to the clients so they can easily meet face to face with their advisor.
Senator Kroft: Since we have consistently heard that it is unlikely that American or other foreign banks will establish any sort of a bank infrastructure in this, country -- presumably because of the local knowledge requirement -- should we include, as part of our policy formation, anything that would enhance the maintenance of the branch structure? Does it not flow from what you have said that that will be an important factor in maintaining a Canadian foothold in the marketplace?
Mr. Rousseau: The important factor will be the maintenance of the distribution capacity and the distribution network. Some of that will be done by the traditional bank branches, and another part will be done by brokers.
When Merrill Lynch had a bout with Midland Walwyn this is exactly what they did. They bought a distribution network which is not a bank branch's network.
What is important in my branches is not the colour of the floor, or the type of bricks, it is the quality of the people there, the product line, the pricing and the brand name. In terms of the future, there are two important elements, the wealth management business and that the distribution capacity be at the bank branches. We must adjust to the client's needs and preferences, otherwise we will be out of business.
Senator Kroft: A proposal was put before us by another witness to the effect that a technique that could possibly be used in the proposed merger is to require a divestiture so that assets would be spread to other players in the marketplace. This has happened in respect of other industries in the U.S. where their industry rationalization required it. It would, however, be a new concept in the financial industry in Canada. What is your reaction to that? Do you see yourself as a player in that type of option?
Mr. Rousseau: We believe we will be around in the future because, in the past, we have been able to grow as a natural progression and also through acquisitions. We will maintain that approach as we move forward.
This is probably an area where more research should be done because we have not experienced this in our country. What has happened in the past has been an unconditional approval or rejection of any merger. There have been no qualifications. The condition or conditions to be attached to any merger proposal is the important thing.
I would be very careful about making any investment. For example, in some southwestern Ontario localities four out of five players could be involved in the proposed merger. If there are two players after the merger, and the merged bank sells a branch but maintains business in that locality, the asking price will be challenged. Perhaps the approach should be to sell adjacent branches, and have an open bid so that another entity can be a new competitor.
If you do not have strict guidelines in place, the seller may end up with a very low price or the outcome may be that a branch will be closed. You may not end up with more competition in the marketplace.
We need more research on this. We should consider non-traditional approaches. One might be, in specific areas, they are asked to sell, period. Then the purchaser would have the capacity to acquire clients.
Senator Austin: The last question I asked you had to do with the business direction of the large bank merger, and particularly its interest in being integrated in the North American financial market. What is taking place in the U.S. bank and financial institution market? What is driving bank consolidation: large bank consolidation, and small bank consolidation? What changing market circumstances do you see in the U.S.? Do those circumstances influence what will take place in the Canadian financial markets?
Mr. Rousseau: Many of the factors behind the consolidation in the U.S., as in the other industries, have to do with the economies of scales and with the economies of scope. If you consider the U.S. rules of the games, you will realize that they would rather buy their competitors than anybody else. There is every incentive for that to happen.
That being so, we are not surprised to see two things happening at the same time, a lot of newcomers and a lot of consolidation. There is a real incentive to create value for the shareholders.
About 10 years ago the U.S. market was made up of 14,000 or 15,000 banks. They had the savings and loan institutions. However, there have been many changes specifically related to deregulation on a geographic basis -- the original compact concept. They have also reduced a number of barriers to competition between states.
Now they have about 10,000 banks and they want to consolidate because they believe they have too many banks with too small branches. We do not have that situation domestically.
Senator Austin: Does the evidence indicate that larger banks in the U.S. are more productive and have a better investment yield than smaller banks?
Mr. Rousseau: They have better efficiency ratios, that is, the ratio of expense to income is approximately 50 to 60. Some small banks do very well and some large banks do very well. However, the U.S. market is much bigger with a much larger number of players. What is happening is a consolidation of a major industry, due to the fact that there has been a major change in the rules of the game.
Some of the small players are doing very well because local markets are different in the U.S. as compared to those in Canada.
Senator Austin: You told us that certain Canadian players should be in the continental market for Canadian public policy reasons. Can our major Canadian banks be competitive with the best American banks? Recently the CEO of a major bank made some interesting comments regarding a comparison of bank efficiency ratios. This is dealt with in the tables in the MacKay report, but my own numbers indicate that major Canadian banks measure by calculating the ratio of non-interest expense to revenues. They are consistently worse than U.S. and international financial institutions.
Mr. Rousseau: That is why I mentioned the figures, 50 and 60.
Senator Austin: Canadian banks spend from 60 to 65 cents of every dollar earned on non-interest expenses. In the U.S. that averages 53 to 55 cents. What is the cause and where is the effect? Would Canadian banks perform better if they had that U.S. market competition to deal with, or will they be behind the curve for a long time to come?
Mr. Rousseau: The U.S. market is a lot different from the Canadian market. The spread between the prime rate and the cost of funds for the banks in the U.S. is about 100 or 125 points larger. That is the result of many factors. It is a fact of life that in the U.S., the margin is higher overall. Given a higher margin, if you do process the same loans, the same dollar amount, you will automatically have a better efficiency ratio.
Federal policies have been aimed at keeping the banking system in good shape. Moreover, in the U.S. you can loan to somebody at prime plus 5 and you will not be considered to be crazy. In Canada if you propose that to a business man, he will call you a Shylock.
Adjusting rates for risk in the U.S. is a natural thing to do. In Canada we do not have that. This is why there are so many complaints about bank lending to small business. We do not have the culture of lending according to the risk level.
They have a better efficiency ratio for two reasons. One is the spread on prime, and the other has to do with the risk premium situation that we do not have. Therefore, if you operate in the U.S. you will have better margins. We have competitors who have beaucoup business in the States in small business, and they do well there.
In the Quebec market where we have a lot of competition for small business, and the spread benefits those businesses. The competition is so intense that you cannot price the loan according to the risk.
The answer is yes, the marketplace in the U.S., probably creates certain advantages that we do not have.
Canadian players are already in the U.S. and are doing business. They are not big, and that raises another question which is: Must you be big to be profitable? That is another issue.
Senator Austin: I appreciate that. I have one last question.
The MacKay report recommends a graduated form of ownership depending on equity. At the moment, you fall, I believe, below the $1 billion equity level. Do you agree that close holding is better for building small organizations, and that wide holding is desirable at the end of the process?
Mr. Rousseau: One of the reasons we do not have the competition that we might in Canada is that we have all pushed globally for one standard. Everything must be alike. One of the positive aspects of the MacKay report is flexibility. The members of the task force have one major objective -- to create more competition -- and they realize that, in order for this to happen, they must do some non-standard things. I have some sympathy with that. We cannot have it all.
We have a small market. If we wish to keep it Canadian, yet we want a more competitive market, there must be some compromises. If everyone is alike, it will not happen. This is one of the big problems with the Bank Act; everyone is alike.
What MacKay is saying is that you can have more flexibility on the ownership of small players -- the second tier. It does make sense, and it does create more dynamics in the system. I feel it would make sense if you were to do the other thing too. If you were only to do this, I would have a problem. What I like about MacKay is that if you want more dynamics in the small market, again, you cannot have it all. You must compromise, and that flexibility is good.
Senator Callbeck: I have a supplementary question on pricing for risk. You mentioned that here in Canada we do not have that culture. Why not?
Mr. Rousseau: I am not an expert on that, but it is a well-documented fact that, when a Canadian bank is proposing to adjust the rates for risk, in most cases businessmen will say no. I feel we should look at some factors like the capacity for small business to obtain financing from government -- both provincial and federal -- so that on the demand side they have a way to say no; they can go to the other side.
On the other hand, there are some negative aspects, in that if you charge the right price, it is not accepted. I do not know why exactly, but I have seen that in the past. It is much easier for a Canadian banker to say "this is too risky," than to say, "if I loan you money, I will charge you prime plus six."
I run an institution, and if I were to say that to my people they would tell me that our clients would go to another bank. What people do is to turn around and try to find some capital to reduce the risk. In that regard, I honestly believe that government programs are quite active. The Canadian Development Bank is a big competitor in that market, and it is doing its job.
There are also many other subsidies at the provincial level. I believe taxation, government subsidies, government intervention and regulation, are probably having some effect, but I do not know the exact answer. I just know that in Canada we do not have dynamic lending. That is why we have so many complaints coming from the marketplace. People feel they do not have access to capital, but at the same time, they do not wish to participate in a risky business.
Senator Callbeck: In your own bank, have you had situations where you have tried to price for risk?
Mr. Rousseau: Yes, and in most cases I lost that business to the competition. We should look at this. I do not know the answer, but I am sure that we can talk to the bankers about activities in different areas -- let us say Quebec, Ontario, B.C. and the western United States, and there will be a difference. A business person in the U.S. will accept prime plus something much more easily if it is justified.
Over the years we have said to borrowers: "We know you do not wish to pay prime plus five, but how about if you pay prime plus two and you give us a bonus if your business is growing." This is working. In some cases the business people will accept that, since we are sharing the risk, we will also share the rising profit. It is rare, though.
Senator Callbeck: You are doing that in your own bank?
Mr. Rousseau: Yes, we are trying that, but it is not easy to change a culture of both borrowers and lenders. People have been trained to do things in other ways. Banks are fairly conservative institutions, which is why they are not risky. At the same time, implementing change is a challenge.
Senator Callbeck: Are small businesses open to that?
Mr. Rousseau: Only the ones with activities in the U.S. and in Canada, in which case they are no longer small businesses. In most cases, they will look at government subsidies, and try to get their loans in other ways.
The Chairman: Senators, our next witness is Mr. André Lizotte.
Mr. Lizotte, please go through your brief and then my colleagues and I will ask you some questions.
[Translation]
Mr. André Lizotte: Mr. Chairman, I would like to begin by expressing my thanks to the committee for giving me the opportunity to present my views regarding the recommendations of the Task Force on the Future of the Canadian Financial Services Sector.
In reading the task force report, I was most interested in how the issues of competition, competitiveness, profitability, and the soundness of our financial services industry had been addressed. I was also curious about what the Task Force had to say in connection with the two proposed bank mergers. I certainly was not disappointed. The task force members are to be congratulated for the outstanding quality of their work. Also, I fully endorse the report's recommendations as regards, first of all, allowing life insurance companies, mutual funds and investment dealers direct access to the payments service; second, supporting the rapid demutualization of major life insurance companies, so that they are able to compete with the large banks; third, allowing foreign banks to operate in Canada and open as many branches as they wish; fourth, establishing a framework that will provide clear rules whereby foreign firms can make loans to Canadians without establishing a physical presence here in Canada; fifth, empowering financial services consumers; and sixthly, improving the regulatory framework, including strengthening the mandate of the Office of the Superintendent of Financial Institutions in order to ensure that consumers are protected and allow it to balance competition and innovation considerations with its present statutory obligations as regards the safety and soundness of the financial system.
It was no surprise to me that the task force has come to the realization that our major financial institutions do not currently enjoy the confidence and support of Canadians. I can only applaud its recognition that there is a legitimate basis for higher expectations with regard to the behaviour of our big banks. Canadians are absolutely right to believe that, in return for being awarded the privilege of operating in the financial services industry, the large banks should be held to a higher standard of behaviour than is generally expected of other financial institutions or other businesses. Canadians know that such high standards are not always met by our big banks, and they deeply resent it.
It should then come as no surprise that, when faced with the merger proposals involving the Royal Bank of Canada, the Bank of Montreal, the Canadian Imperial Bank of Commerce, and the Toronto Dominion Bank, the reaction of Canadians is one of considerable reluctance. One of their concerns is that economic power will become even more concentrated in the hands of relatively few powerful institutions and individuals who already exert tremendous influence over people's ability to manage their lives and pursue their plans.
[English]
I experienced the heavy-handed tactics of a large bank in late 1991 and early 1992. Rather than bow to a bully, I decided to fight back with a multi-million dollar breach-of-contract lawsuit. The case is to be heard at last in a Montreal courtroom this fall. Therefore, I have no difficulty whatsoever in accepting the views of most suspicious Canadians regarding big banks and the individuals who run them.
Mr. Chairman, it may be of interest to this committee to know what this case is all about. In a nutshell, it has to do with a large bank -- as represented by senior management -- breaching a legally binding partnership contract, and then resorting to a pretext in order to cover up its liability and to frustrate me in competition. This case has to do with the value of commitments and the sanctity of contracts; a matter of trust. The central issue here is nothing less than good faith and integrity in business transactions; very serious issues indeed.
[Translation]
I noted that the task force recommends that each bank merger proposal be assessed on its own merits. It adds that big bank mergers should be permitted only if, after implementing any necessary remedial and mitigating steps, the Minister of Finance is of the opinion that: first of all, markets will remain competitive; second, that there are no material safety and soundness concerns; and finally, that the merger is in the public interest.
As an ordinary Canadian and small businessman, Mr. Chairman, I would like to express my strong opposition to the proposed bank mergers. I am absolutely convinced that such mergers would in no way serve the best interests of bank customers and the Canadian public. The only ones who stand to gain by such mergers are a small group of senior executives and the shareholders of these big banks.
That is it is essential that the Minister of Finance not confuse the narrow interests of the big banks' senior executives and shareholders with the wider interests of financial services consumers and the public at large. He also has to be fully aware that authorizing these bank mergers would be an irreversible decision resulting in the immediate elimination of one-third of our country's banking system. This would have far-reaching consequences for Canada.
As a general rule, Canadians believe that their large banks are big enough as they are, and as far as I am concerned, they're absolutely right. However many justifications have been put forward by Messrs Cleghorn, Barrett, Flood and Baillie to support big bank mergers, I have yet to hear any compelling arguments to support such a plan.
[English]
In summary, Mr. Chairman, I believe that the strong and pervasive report of the MacKay task force has satisfactorily addressed the concerns of competitiveness, profitability, and the soundness of our financial services industry. Now it is now up to the Government of Canada to respond promptly to this report and to begin implementing those recommendations that do not require legislation, as it has already done in banning the practice of tied selling by banks.
As to the mega-bank mergers, I see no compelling argument to support the contention that the banks must merge in order to become big enough to compete with large foreign banks. Moreover, such mega-bank mergers are not in the interests of consumers and the public. The Government of Canada should turn them down. We do not need bigger banks; we need better banks. As far as I am concerned, after wrestling with an 800-pound gorilla for seven years now, I would hate for the Government of Canada to permit it to metamorphose into a Godzilla.
Senator W. David Angus (Acting Chairman) in the Chair.
[Translation]
The Acting Chairman: Thank you, Mr. Lizotte. What kind of business are you in?
Mr. Lizotte: I run my own small business here in Montreal where I live. I should point out, though, that in the last seven years, I haven't been doing much business because I have been so busy with the lawsuit that is now before the courts and which, fortunately, will be heard this fall.
I was active in the immigrant investors industry. I was associated with a securities firm that was responsible for investing the funds of would-be immigrant investors, with a view to their obtaining residency status in Canada.
However, this securities brokerage firm was taken over by a large national firm.
[English]
Senator Callbeck: You seem to be fairly comfortable with the recommendations of the MacKay task force, and you seem to feel this will make our Canadian banking system better.
If all these recommendations are implemented, where do you see the industry in 10 years? Do you foresee the development of a strong second tier, as discussed here this morning? Do you foresee many foreign banks coming in? What about the notion we heard from some witnesses, that we will have less bricks and mortar, and more niche players with one or two products to promote? What about banking services in the Canadian Tire stores and so on? Where do you see the industry in 10 years?
Mr. Lizotte: I envision much more competition than exists today, and I think that, with the implementation of the majority of these recommendations, we will have a more level playing field on which the financial institutions can operate. I think it will probably be much more interesting for the consumer of financial services.
Of course, I think that there will probably be more niche players, because I suspect that some large financial institutions will realize that they cannot be all things to all people.They will probably abandon some of their lines of business, whereas other institutions will find that they can compete in that sphere of activity.
Ten years from now -- provided most of these recommendations are implemented -- we will probably have a financial services industry that will better cater to the needs of small business, ordinary Canadians, and also large business.
Senator Callbeck: In one sentence you stated that Canadians know that such high standards are not always met by our big banks, and they deeply resent it. If that is the case, does the MacKay task force address that, and will its recommendations improve that situation?
Mr. Lizotte: I do not see the MacKay report as the panacea for everything. It does raise the issue, however, and it tries to address it. It certainly alerts the Government of Canada to that situation. I believe it is good just to have raised the issue, especially in the context of the merger proposals. There is no doubt that public criticism of the banks serves as a hindrance to these two merger proposals.
I think that going through that experience, whatever the outcome, will serve a purpose. Perhaps it will make them more humble, much more attentive to the needs of the public, and hopefully, in the end, we will have a better banking system.
Senator Kroft: I ask this question with absolutely no desire to raise any of the issues of your particular problem, because I do not believe it is really appropriate for us to deal with that here. I am asking for a general response regarding the mechanisms for the remedy of a complaint about an institution. Did you attempt those? Were they adequate, or do you think that the ombudsman recommendation in the MacKay report might have provided a better avenue?
Mr. Lizotte: Unfortunately, I did not find anything in the MacKay report. I did not read anything that would apply to my particular case because my status was basically as a partner to a bank, or, in this case, a subsidiary of a bank. The MacKay report basically addresses the status of the consumer -- that is, the ordinary Canadian. I think that my predicament would be neither better nor worse if, for example, the MacKay report recommendations were implemented. I believe it is a matter for the court to judge. I realize that this is not the venue to speak of my own experiences, but if one must wait for seven years to get into court, there is something wrong somewhere.
The Acting Chairman: Were you here this morning when Mr. Henri-Paul Rousseau spoke with us?
Mr. Lizotte: Most of the time, yes.
The Acting Chairman: His opinion seemed to be that the structure that presently exists for the banks is like a straitjacket, and that it militates against diversification, mergers, free competition, and some of things for which you are criticizing the banks. Do you disagree with anything that you heard Mr. Rousseau say?
Mr. Lizotte: He spoke for two hours, I believe. Many of the things he said made sense to me, no doubt about it, but I could not, for example, point out any or all of the issues he raised and state whether or not I agree with him. I certainly do not wish to criticize his testimony in any way, shape or form. Overall, I thought his presentation made a lot of sense.
I will just say that I am all in favour of a better banking system, where Canadians would be well served and where the larger institutions -- because they are all large when they are facing individual Canadians -- would be much more attentive to the needs of ordinary Canadians. Despite what they say today, I believe there is much improvement to be made. That is my experience.
The committee adjourned.