A. Business Environment Overview
B.
Objective: To Foster Canadian Control of the Key Institutions in the Financial Services
Sector
C.
Objective: To Provide a Framework for Healthy Competition in the Financial Services Sector
D.
Objective: To Ensure the Safety, Soundness and Integrity of the
Canadian Financial System
E.
Objective: To Enable Consumers to Make Well-Informed Decisions
and to Protect Consumers from Improper Business Practices:
F.
Objective: To Fulfill the Stewardship Responsibilities of Financial
Services Institutions
The Committee's Vision of the Financial Services Sector of the Future
In chapter 4, the Committee gave the five objectives which it believes financial institutions public policies should try to achieve. The Appendix to this report contains the Committee's detailed analyses of the recommendations in the Task Force Report, and the Committee's conclusions and recommendations for changes to existing public policies that affect financial institutions. In this chapter, the Committee outlines the impact that its set of recommendations, when taken in their entirety, would have on each of the five objectives. Thus, this chapter presents the Committee's vision of the financial services sector of the future.
Before turning to each of the five objectives, the Committee first gives a brief overview of the international context within which financial service reform will proceed.
In 1990, free market capitalism was the dominant philosophy guiding public policy on economic issues. The 1991 collapse of the Soviet Union was seen as a triumph of open markets and minimal regulation over extensive intervention in domestic and international economies.
There was a movement globally to deregulate and open domestic economies to the discipline of international competition. Controls on the movement of capital across national boundaries were dramatically eased. The World Trade Organization was established in 1995 to administer a system of trade agreements designed to remove impediments to international trade in goods and services. Globalization became the "buzzword" of the nineties, a term used to describe the interconnectedness of markets worldwide.
There have, however, been serious problems in financial markets globally. In 1992 and 1993, exchange rate shocks were experienced in Western Europe. In 1994-1995, Mexico experienced banking and currency crises. Similar problems occurred in East Asia in 1997-1998, and in Russia and Latin America in August 1998. Japan has had a banking crisis for a number of years and is still seeking a solution.
Conventional wisdom, the mantra of free markets associated with Hayek and Friedman, is being challenged. The focus on free trade, deregulation, and privatization, it is now argued, needs a careful re-examination. Unbridled private market competition may generate outcomes that are not socially acceptable. Economists at the International Monetary Fund still favour capital-account liberalization, but they are facing opposition.
Following in the tradition of Keynes, who provided a theoretical rationale for the instability of financial markets — basically the herd behaviour of financial asset traders — some prominent economists, such as Stiglitz, chief economist at the World Bank, question the deregulation of short-term capital flows. He argues that allowing for the free flow of short-term money in and out of domestic economies can exacerbate the instabilities of the international financial system.
In a speech before the Asian Development forum in March, Stiglitz stated:
The standard theories of the efficiency of competitive markets are based on the premise that there is perfect information. The problem is that financial markets are inherently different from other markets and have even less perfect information. Left to themselves, financial markets will not become deep, efficient, or robust.
Even the IMF, the supporter of capital liberalization, acknowledges that the restriction of short-term capital flows is appropriate in countries with weak financial systems. Critical to allowing capital flows free entry and exit to an economy is a strong financial sector with a robust supervisory and regulatory system.
What has changed dramatically over the past decade has been the massive increase in international liquidity. Cross-border asset-holding, increased trading and credit flows have exposed institutions to considerably more risk than in the past. And it is clear from recent experience with hedge funds that the large "sophisticated" global financial institutions are not immune from making serious mistakes — mistakes that some argue could have, in the future, serious implications for global systemic stability.
Work is ongoing, by financial institution regulators globally, to deal with the problems faced by financial institutions today. Improved capital adequacy standards and capital controls are under discussion.
What has this to do with the ongoing reform of legislation and regulations that will set the rules for the federally regulated financial services sector in Canada? The Canadian economy is an open economy. Capital as well as goods and services flow relatively freely into and out of Canada. These flows expose our domestic financial institutions, and thus the economy as a whole, to constant risk.
The CEO of one of the life insurance companies the Committee heard from assessed the current situation facing the financial services industry in general, and his industry, in particular:
[One] the pressure of change continues unabated and the size of financial institutions globally is increasing geometrically; and two, Canada cannot isolate itself from the fact of consolidation in the financial services industry.
The consolidation is driven by two factors. There are too many players at a time when the market for traditional life insurance product is declining, and historic life product providers are reacting to new, non-traditional competitors particularly in the wealth accumulation business. Mutual funds and banks are major players here.
In this context, I believe the regulatory framework being considered must encourage and foster as much freedom of choice and innovation as possible. It must be prudent free choice, but free choice nonetheless.
It is prudent and necessary to protect legitimate public interests, particularly to ensure that we have financially strong and competitive financial companies. It is also necessary that the regulatory framework encourages and recognizes free choice by ensuring the rules of engagement are not unnecessarily bureaucratic, restrictive or cumbersome. (David Nield, November 2, 1998)
Canada has a strong financial services sector supervised by a robust regulatory regime. It has held up well in the face of serious international financial crises. This strength should be maintained.
While it is important to encourage competition and innovation within this sector, it is also important to keep in mind that the financial services sector is the backbone of the Canadian economy. What emerges from the reform process must be financial institutions that will continue to be strong, operating within a regulatory regime that has the powers and resources necessary to maintain that strength.
This Report begins its description of the Committee vision for the Canadian financial services sector by describing the impact of the Committee’s recommendations on the Canadian control objective. As stated in chapter 4 of the Report, all five objectives that this Report proposes are important and they are not ranked in order of priority.
The Committee begins with the Canadian control objective, however, because it has implications for the four other objectives addressed in this Report, particularly the healthy competition objective. It is important to a thorough understanding of the Committee’s vision for the Canadian financial services sector to first understand the Committee’s stance on ownership.
This section begins with a discussion of ownership rules concerning the issue of demutualization.
The Committee strongly supports, as it has in previous reports, the demutualization of Canadian mutual life insurance companies. The Committee also believes that, as stated in the government’s draft demutualization regulations, the newly demutualized companies should not be allowed to amalgamate with, or be taken over by, any other company for a period of three years, regardless of whether the proposed amalgamation or take-over is categorized as hostile or friendly.
The Committee believes that demutualization, which will give mutual insurance companies the same access to capital markets as publicly traded companies, will strengthen these companies. Providing them with greater access to capital markets is important to their business objectives, and therefore important to consumers.
Demutualization is also in the interest of policy-holders, particularly the approximately two million policy-holders who will be entitled to shares in the newly demutualized companies. The consumer benefit of demutualization is also substantial because the improved access to capital of demutualized insurance companies should permit these companies to improve the quality and range of products they offer.
The Committee regrets that the government has not proceeded more quickly with demutualization. We hope that the delay will not continue.
The Committee agrees with the Task Force that all life insurance companies, banks and trust companies should have a common set of ownership rules. It also agrees with the Task Force that the ownership rules should vary with the size of the institution, with different rules applying to small, medium, and large companies.
In the Task Force report, small companies are defined as those with less than $1 billion in shareholder equity, medium-sized companies are those with more than $1 billion and less than $5 billion in shareholder equity, and large companies as those with more than $5 billion in shareholder equity.
The Committee is not able to form a judgement as to whether these dollar limits of $1 billion and $5 billion are the correct limits for the definition of each class. The Task Force report does not offer a convincing rationale for these thresholds, and no evidence on this question was presented during our hearings.
Therefore, the Committee believes that before specific descriptions of each class size are legislated, it is essential that the government conduct analysis that will demonstrate the impact on the life insurance and deposit-taking industries of various definitions of class size. Accordingly, in the descriptions that follow, this Report simply refers to small, medium, and large companies.
This analysis must also consider criteria for class size other than shareholder equity. For example, it may well be that market share (of retail deposits for deposit-taking institutions, and annual premiums for life insurance companies) is a more appropriate and effective description of class size than shareholder equity.
The Committee believes that small companies should be able to be closely held, including 100 per cent ownership by one person or one company, and that the owners need not be Canadian.
The Committee agrees with the Task Force that medium-sized companies should be required to have at least 35 per cent of their voting shares widely held and publicly traded.
The Committee agrees with the Task Force that the largest financial institutions should be required to be widely held. However, our definition of widely held is that no individual, or group of individuals acting together, shall control more than 20 per cent of the voting shares, and shall not own more than 30 per cent of the equity.
Thus, the Committee’s definition of widely held differs from the current rule in two ways. Firstly, the current 10 per cent limit is raised to 20 per cent. Secondly, ownership is distinguished from control.
The Committee believes that while the current law, the Task Force Proposal, and the Committee proposal, all contain some form of widely held rule, the Committee proposal has the following advantages over the other two:
•It provides added flexibility for mergers and acquisitions, as explained fully in the Task Force Report.
•Larger shareholders (20 per cent) would tend to more closely monitor the performance of management, and to take advantage of equity accounting rules, thus strengthening management accountability to its board of directors.
•Allowing a shareholder to own up to 30 per cent of the equity lets non-voting shares be used if a merger or acquisition requires more than 20 per cent to complete the transaction.
•It eliminates the excessive use of ministerial discretion that the Task Force Report calls for. The exception is the requirement that the Minister approve any shareholder whose ownership exceeds 10 per cent using the "fit and proper" test which exists in current legislation.
Existing companies should be grandfathered. This means that they should be allowed to keep their current ownership structure, regardless of that class size they fall into, for as long as they remain in their current class size. Further, the current owners only should also be allowed to exercise all powers granted to other members of that class, regardless of their ownership structure.
If they grow to the point where they move into a bigger class than the one they are in on the date the new rules come into effect, and, consequently, are required by the rules to have a larger public float, they must meet all ownership requirements of the new class into which they have graduated. Such firms, however, should have five years in which to effect this transition.
Alternatively, if the grandfathered institutions remain in the class in which they are today, the grandfathering will end when the institutions are sold. At that time, the company will have to meet the conditions of the class that the company is in.
The Committee recognizes that there will be anomalies in the system. The task of the policy-maker is to ensure the intent of policy changes are realized without creating unacceptable inequities in the system. Institutions granted exemptions have to balance the net benefits they receive from their exemption, with the net benefits they would receive from giving up their exemption. The Committee's recommendations strike the appropriate balance.
The Committee recommends that large banks and large life insurance companies not be able to buy each other. This recommendation is not driven by a desire to return to the isolated pillars of the pre-1992 policy. In fact, in terms of the products and services which both life insurance companies and banks well offer in the near future, the Committee envisages the further collapse of the pillars, as is explained in detail in the next section of this chapter.
This recommendation is driven by the Committee’s belief that if the major life insurance companies and banks were to merge, the result would be too much concentration of economic power in too few hands. The Committee is uneasy about reducing major institutions in the financial services sector to only four or five companies. The Committee believes that in a pluralistic society it is essential that there be a multitude of powerful decision makers.
Moreover, allowing excessive concentration across the full range of financial services could well create a level of systemic risk that would be unacceptable. This can create the conditions for the moral hazard problem of "too big to fail."
The 1992 financial services policy changes led quickly to the virtual elimination of the independent trust company sector; similarly, the independent investment dealer sector was quickly dominated by the banks after the Ontario government removed the restriction on investment in securities dealers by other financial institutions in 1987. The same should not be allowed to happen with respect to the life insurance sector.
This does not mean that banks should not be allowed to buy small life insurance companies, which they are now permitted to do. Nor does it mean that insurance companies should not be allowed to buy small banks. Currently, only a widely held insurance company may own a Schedule 2 bank whereas, under the Committee’s proposal, any insurance company would be able to own a small bank. The Committee’s recommendation means simply that large institutions should not be able to buy other large institutions from another pillar.
This recommendation should not impose any significant constraint on the future evolution of the large companies. Most financial services CEOs who testified before the Committee said that their primary interest was in consolidation within their own industry rather than across pillars. They made it very clear that it is intra-pillar consolidation that will yield the greatest efficiencies and cost reductions, not inter-pillar mergers.
The Committee believes that its recommendation that large shall not buy large across the pillars is essential if Canada is to continue to have a reasonable number of major financial services companies, and thus prevent the problem of too much concentration of economic power in too few hands.
The Committee also believes that the recommendations in this section of its Report offers greater flexibility, with greater certainty, than the Task Force proposals. The Committee's recommendations offer this flexibility in many ways, but, in particular, by not allowing the creation of the irreversible situation that could result if large companies were allowed to buy large companies in the other pillars. Moreover, if such a policy went forward, whereby large could buy large across the pillars, the risk is that some institutions may reach a size and scope where they are determined to be "too big to fail." The Committee’s proposal thus negates this moral hazard problem in the case of institutions buying across the pillars.
In addition, the Committee’s proposal also offers greater certainty to companies whose strategy is to grow through merger or acquisition, since it eliminates the complex ministerial discretion proposals of the Task Force Report.
These recommendations also help to ensure that the Canadian control objective is met. However, the Committee notes again, as it did in chapter 2, that the "national treatment" of financial services under NAFTA requires that Americans cannot be distinguished from Canadians with respect to ownership policies. Thus, even widely held companies could have non-Canadians holding a majority of their voting shares.
The Committee raises one final caveat on the ownership issue. The Committee realizes that circumstances may arise in the future where a company is in financial difficulty and extraordinary steps are required to prevent its insolvency. Under these circumstances, the Minister of Finance should have the power to be able to violate the ownership rules in order to deal with the problem in the most effective manner possible.
Given the ownership policy described in section B of this chapter, this Report will now turn to a description of what the market structure of the financial services sector would look like under the Committee’s recommendations. It will seek to show how this structure will provide for healthy competition across the entire sector.
The market will contain a small number of unaffiliated large banks and life insurance companies, all of which will be widely held.
There will likely be a relatively small number of medium-sized banks and insurance companies, each with at least 35 per cent equity that is publicly traded and widely held. Some medium-sized companies will come from existing firms (eg. Canada Trust, and Mutual Life) and some will result from companies that began as small companies but grew into medium-sized companies over time. Some companies in this size group may have up to 65 per cent of their shares foreign owned, although not by a single foreign owner.
There will hopefully be a number of small-sized companies (which were referred to as second tier companies in chapter 4) in both the life insurance and banking industries.
A second tier already exists, consisting of approximately one hundred firms, in the life insurance industry. While the Committee anticipates that the consolidation that has occurred in this sector over the past few years will continue, it also believes that a vibrant second tier will continue to exist in the life insurance industry for many years to come.
In the deposit-taking industry, with the exception of credit unions, there are only a very few second tier firms (eg. Canadian Western Bank, Laurentian Bank). Clearly, bold new policies are needed if a second tier in deposit-taking is to develop.
The Committee is hopeful that the set of Task Force recommendations aimed at enabling the credit union movement to create one or more community banks will lead quickly to the creation, in the near future, of a national institution capable of competing almost immediately with the large banks. Such an expanded credit union movement would improve financial institution service, particularly in small towns and rural communities. The evolution of the credit union movement will be achieved quickly only if officials in the Department of Finance and OSFI make policy development, and federal and provincial harmonization, a priority.
While the strengthening of the credit union movement will be a positive and constructive development, the Committee cautions that its impact on the competitive balance in the banking sector should not be overestimated, especially in the short term (see the detailed comments made on this point in chapter 5).
The Committee recommendations that will encourage new, small banks to be established, and provide increased competition to the large banks from existing deposit-taking firms, are:
•Closely held control for small firms;
•Access to the payments system, with the appropriate safeguards, for such financial sector providers as investment dealers, life insurance companies and money market mutual funds;
•Access to fully functional ATM networks, for all consumers and financial institutions, for all services that can be dealt with through ATM networks without imposing unmanageable prudential concerns. This will enable the introduction of new services and substantially increasing the number of electronic branches each small institution has;
•Closely held firms will be supervised more tightly with respect to conflicts and self dealing and internal governance, but will not have to comply with some of the more onerous oversight provisions that are especially designed for large institutions;
•The elimination of capital taxes on financial services companies; and
•Lower capital limits to establish small financial institutions.
The Committee also believes that ways should be explored to address the back-office advantages of large deposit-taking institutions, such as cheque processing, so that competition with smaller deposit-taking institutions can focus more on front-office services. In order to provide a firm foundation for competition in core banking, it is in the interest of smaller firms to develop strategic alliances among themselves, or to contract out, for back office services. This will enhance the efficiency in Canada's deposit-taking industry and also facilitate entry to an industry where the natural barriers to new firms are very high.
The key to the success of the new smaller entrants in the life insurance and deposit-taking sectors will be their ability to serve those niches in the market that the larger firms are unable or unwilling to address. The latter do not have the flexibility to provide products or services that require customization for small, or highly specialized, market segments. The Committee believes that small providers, whose focus is not the widest range of products for the widest range of consumers, can develop the expertise and the cost efficiencies that will enable them to prosper with a relatively small or specialized client base.
The Committee recognizes that the creation of new small firms in the deposit-taking sector will add some risk to the financial system. It does not believe, however, that the added risk is unmanageable, particularly because some of the systemic risk will be avoided as a result of the fact that all the new firms will have their "deposits" insured by CDIC. Moreover, the Committee believes that the liability of this added risk is more than offset by the potential benefits of the added competition that new entrants would bring to the deposit-taking sector, and hence to consumers.
The Committee cautions, however, not to expect instantaneous competition to materialize from the set of new policies designed to encourage new entrants. As explained in chapter 5, the Committee anticipates a lag period in the order of three years before new competition becomes meaningful and effective.
The market will also include an increased number of foreign banks. The entry of these banks into Canada will be made easier by the branch banking policy originally developed by the Committee in its 1996 Report titled, Lowering the Barriers to Foreign Banks, and supported by the recommendations in the Task Force Report.
The Committee does not expect, however, that this will lead to a significant increase in the number of foreign banks entering the retail financial services market. None of the foreign institutions who appeared before the Committee, with the exception of the Hongkong Bank of Canada, expressed much interest in becoming a retail bank in Canada. They do, however, want to increase their wholesale and business lending activities. Accordingly, the foreign bank branching proposals to encourage this should be implemented quickly.
The market will also contain an increased number of "niche" players. Some will be targeted at a specific market segment, such as Wells Fargo’s focus on that segment of the small business sector that is seeking loans with no related products or services. Others will be monoline, or so-called "category killer," firms that offer a single product in large volume, like the credit card operations of MBNA and Capital One, or the mortgage products of Countrywide Mortgage. There will also be Canadian niche players, a few of which already exist (eg. First Nations Bank, Newcourt).
The Committee has some concerns, however, that the way Wells Fargo has structured its business in Canada has enabled it to avoid being classified as a company "doing business in Canada." There is something wrong with a legislative system that enables a firm to offer small business loans across Canada without meeting the legal test of "doing business in Canada." In particular, there is no assurance that the objective of consumer protection will be met if the government does not act.
While the Committee welcomes the product that Wells Fargo is offering to Canadian small business firms, this example illustrates the increasing integration of the North American financial services market, and the need for increased harmonization of Canadian and U.S. policies. Such harmonization would lead, the Committee believes, to greater innovation and to new products being offered to Canadians. It would also avoid future situations, like the Wells Fargo case, where Wells Fargo set up a structure to avoid having to pay Canadian taxes, taxes that are much higher than the taxes imposed on U.S. banks.
The Task Force recommendations require an "offshore" institution to submit voluntarily to Canadian oversight of its activities in Canada. A Canadian regulator, however, has no power over an "offshore" provider who chooses not to follow Canadian directives. Thus, given the fact that most "offshore" financial service providers will likely be American firms, the Committee believes the government should work with American policymakers to develop a joint policy to deal with cross-border providers such as Wells Fargo.
The Committee recommends that, in the short term, the government develop a concrete proposal for discussion with American policymakers to deal with "offshore" financial service providers. This policy should enable Canada and the U.S. to ensure that rules and regulations governing financial service providers in Canada (and the U.S.) are respected by those institutions providing financial services in those countries, even though they may have no physical presence in the country where they are conducting business.
Once such a policy is developed on a North American basis, it should be extended on a global, bilateral, or multilateral basis to other countries wishing to operate a financial services business in Canada.
Finally, the market will also contain unregulated firms, such as Newcourt and GE Capital, which will provide a range of specialized financing services that the major Canadian financial institutions have not traditionally offered. In some cases, major Canadian financial institutions have not offered these products because they do not have the specialized expertise in the area in question needed to be successful.
If regulated companies wish to compete with unregulated financial service firms, they should be free to do so. The Committee therefore supports the recommendation in the Task Force Report that allows regulated firms to establish regulated financial services holding companies, with regulated subsidiaries and unregulated affiliates.
The Committee believes that there should be no restrictions on the corporate structures available to financial institutions unless such restrictions are clearly necessary for safety and soundness reasons.
In addition, one of the big competitive advantages that unregulated firms have at present will be eliminated if the Committee’s recommendation that capital taxes on banks be eliminated is adopted by the government.
The Committee supports the recommendation in the Task Force Report that the Interac network become fully functional so that it can be used by all payments system members for as many functions as technology allows, including the making of deposits through any ATM to any participating deposit-taking institution. This step alone will enormously increase the number of "branches", albeit technological ones, which each deposit-taking institution has. It would also increase the amount of competition almost immediately upon the successful implementation of full functionality.
The Committee also recommends that a number of intermediaries (the life insurance industry, money-market mutual funds, and investment dealers) be given access to the payments system. This would create the potential for the insurance companies to provide, over time, meaningful competition to the banks in their core banking activities.
The Committee's reasoning for this conclusion is that the life insurance companies’ present annual pay-out to their clients amounts to some $35 billion. The Committee learned that insurance companies want to capture a share of these annual pay-outs in the form of deposits from their clients. At the present time, the typical path of these benefits payments is from the insurance companies to the banks of their customers. The consequence of this process is that the insurance industry loses long-standing clients to the chartered banks.
Direct access to the payments and Interac systems by the insurance companies would permit them to offer their customers access to their funds on deposit. Insurance companies customers could then access these funds, via debit cards, ATM-type cards, and by some form of negotiable withdrawal order (something comparable to a bank cheque). In this manner, insurance companies could begin offering individuals another choice for some core banking services. This will build meaningful competition in the financial services sector.
Presumably, if the insurance companies begin to gather deposits in the fashion described above, they will have to search for assets that match the term of these "deposit-like" liabilities. It is then reasonable to expect that the life insurance industry will develop a willingness to engage in lending to customers (beyond current mortgage financing), and in lending to small and medium-sized enterprises (beyond acquiring securities under private placements as they do now).
If the insurance companies were able to capture as deposits as little 10 per cent of their annual pay out, within a decade, their stock of "deposits" would total at least $35 billion. This compares with the banks’ 1997 stock of personal deposits of some $66 billion.
In time, the activities of both insurance companies and the banks would begin to blur well beyond what is now characterized as the wealth management activities that they both now engage in.
If insurance companies are to engage in the deposit gathering business, such deposits should be insured in the same manner as deposits held in banks. The Committee feels that the operating principle ought to be that "like instruments are treated in an identical fashion" from the perspective of protecting the consumer. The financial instrument held by the consumer needs to be insured against the possible insolvency of the institution holding the deposit. It is not the institution that is being insured against insolvency. The rules as to what constitutes an insurable deposit must be spelled out clearly, so that only "like instruments" are treated in an identical way.
In summary, the Committee feels that the life insurance industry offers an outstanding opportunity for a new credible source of competition for the banks in core banking activities, once the industry has access to the payments system and a fully functional ATM network.
The banking and life insurance industries have as their principal focus the provision of financing services, wealth management services, and investment services.
The Committee feels that property and casualty insurance fits into none of these services. Property and casualty insurance is essentially "a pure risk protection product." It has none of the investment or wealth management characteristics of life insurance. Therefore the Committee has concluded that the current rules, whereby banks can own a property and casualty insurance company but cannot sell property and casualty insurance in their bank branches, should not be changed.
The only justification for changing the law to allow deposit-taking institutions to enter into lease-financing arrangements for automobiles would be if such a change in public policy would be of benefit to consumers. Currently, deposit-taking institutions can lease-finance all kinds of vehicles except automobiles. Allowing new institutions to lease-finance automobiles would clearly increase the amount of competition in the lease-financing market. But, to be of benefit to consumers, this increased competition would have to lead to lower lease prices.
The Committee recognizes that guaranteeing lower prices is impossible, even with increased competition. However, the weight of evidence available to the Committee on this issue suggests that lower consumer prices would result from increased competition in the lease-financing market.
Consider the following facts:
•General Motors in its 1997 Annual Report stated that their "decline in U.S. and international retail and lease revenues from 1996 to 1997 was attributable to continued competitive pressures in the markets";
•Canada is the only major industrialized country in which banks are not permitted to lease automobiles; and
•when banks entered the mortgage and mutual funds markets, the degree of competition increased significantly.
This evidence suggests that it would be in the consumer’s interest to allow deposit-taking institutions to enter the automobile lease-financing market because it would broaden competition.
The Committee’s challenge, therefore, was to find a way of formulating a public policy that would allow deposit-taking institutions to enter the automobile lease-financing market in a way which would not create unfair competition for automobile dealers.
This challenge requires that any change in public policy concerning automobile lease-financing arrangements address the key concerns of automobile dealers. The public policy solution must, therefore, prevent deposit-taking institutions from by-passing automobile dealers and acquiring automobiles for lease-financing purposes directly from manufacturers, or from entering into an exclusive supply arrangement with a large dealer to the detriment of smaller dealerships. It also requires that the function of deposit-taking institutions be solely one of providing a financial service, in this case financing a lease, and not one of negotiating an acquisition price of an automobile directly or indirectly with the customer, or one of dealing in the sale of new or used automobiles.
With regard to the mechanics of how a deposit-taking institution automobile lease-financing arrangement would work, the Committee believes that it is possible to develop a lease-financing policy that satisfies all of the concerns of automobile dealers. Consumers, in the Committee’s view, should be free to acquire vehicles, and arrange lease-financing through the dealership of their choice. Deposit-taking institutions, in their dealings with consumers for an automobile lease:
•should not be able, as lessors, to impose any terms and/or conditions on the identity or place of the vendor of the vehicle. This means that automobile leases from deposit-taking institutions will be offered through automobile dealers, and consumers should be able to negotiate those leases from the dealership of their choice;
•should not be able to enter into any strategic partnerships with any dealership or auto manufacturer to offer their products exclusively. This means that a specific dealership cannot be by-passed or prevented from offering the same products as their competitors offer; and
•cannot act as an agent of the vendor or the buyer of the vehicle. That is, deposit-taking institutions should not be able to enter into an arrangement whereby they are buying or selling automobiles on behalf of consumers or automobile dealers.
Automobile dealers have also expressed concerns about potential conflicts of interest arising from banks simultaneously financing and competing with dealers that have their own automobile lease programs. Automobile dealers, however, are not restricted to using banks to meet their financing needs. They have a broad range of alternate sources of funding (e.g. trust companies, credit unions, insurance companies and finance companies). The Committee notes that the manufacturers’ finance companies are in a similar relationship with automobile dealers in that they finance them while simultaneously competing for leases and financing arrangements by those same dealers.
Automobile manufacturers and dealers have also argued that bank participation in automobile lease-financing would significantly reduce the profitability of the manufacturers’ finance companies and thereby weaken the ability to act as the lender of last resort to those auto dealers in small markets, or those with marginal credit ratings, particularly during economic downturns. Accordingly, it is suggested that some dealers may be forced out of the market. The manufacturers’ finance companies, however, have the incentive to continue financing dealers to maintain their distribution networks. Moreover, it has not been established that the manufacturers’ finance companies would be weakened by bank participation, particularly given the deep pockets of their parent corporations.
The policy choice, therefore, is between adopting a course of action, which evidence before the Committee strongly suggests would benefit consumers through lower prices, and a course of action that calls for maintaining the current policy. The latter would ensure that the manufacturers’ finance companies (principally outside of Canada) have limited competition and therefore would likely continue to charge higher prices than in the U.S..
Given the choice the Committee recommends that banks be given the power to lease-finance automobiles under the conditions which meet the concerns of automobile dealers described above. Under these conditions, banks will be solely in the business of providing a financial service and, therefore, not permitted to be in the business of dealing in new or used automobiles.
Unlike property and casualty insurance, life insurance is a wealth management service. Therefore logic indicates that banks should be able to retail life insurance products in their branches.
The Committee’s recommendations, however, call for significant changes to the life insurance industry in the next year or two, most notably as a result of demutualization and their gaining access to the payments system. The Committee believes that the life insurance industry needs time to adjust to these changes before facing new competition from banks retailing life insurance products through their branches. In particular, the life insurance industry needs time to develop new products that offer enhanced choice to consumers. As explained earlier, the Committee believes that many of these new products are likely to be in core banking services.
When this adjustment period is over, the deposit liabilities of life insurance companies (described earlier under the heading "Access to the Payments System") should become insured under CDIC and simultaneously, attention should be given to levelling the playing field and effectively eliminating the distinction between banks and life insurance companies, by allowing banks to retail life insurance in their branches. In the meantime the existing prohibition on banks retailing life insurance in their branches should be maintained.
There is, however, one class of life insurance products which the Committee believes banks should be able to offer immediately. Banks should be permitted to retail life annuities in their branches to their RRSP customers when the RRSP plan of a customer reaches maturity (i.e. when the holder of the plan chooses to convert it into a retirement income fund, or is required to do so under the provisions of the Income Tax Act). The banks should only be allowed to market these products to their RRSP customers, and only at the time when the RRSP plan of a customer, which is already held by the bank, reaches maturity. At that time, but not before, the banks could do one of the following three things:
•offer a pay-out life annuity to its customer;
•transfer the customer information to an agent, broker, or insurance company to complete its transaction with the customer; or
•refer the customer to an agent, broker, or insurance company of its choice to complete the transaction.
This proposal would offer increased convenience for consumers; bank RRSP customers could acquire life annuities out of a branch of the bank with which they have had their RRSP, instead of having to initiate contact with a life insurance company, agent, or broker.
It would also offer enhanced options for the retirement savings needs of seniors. Consumer groups have, in the past, made the point that elderly consumers are likely to be uncomfortable developing a client relationship with insurance agents with whom they have had no prior dealings. Life annuities, which currently cannot be sold by banks, are thus a financial vehicle to which consumers may not have had sufficient access.
This proposal also opens up the possibility for more competitive prices. The acquisition cost of a life annuity for a bank RRSP customer may be lower if the customer continues to deal with the same group of companies.
The Committee recognizes that this proposal will have some limited impact on life insurance brokers and agents. Research undertaken by the Task Force, however, reveals that there is a trend for commodity type products, such as term insurance and annuities, to be sold through less expensive distribution channels than career agents. It would therefore be in step with the current transformation of the traditional life agent into one that focuses more on the provision of advice.
This proposal is also consistent with what is happening elsewhere in the world. In the U.S., for example, at least five major Canadian life insurance companies currently market annuities through U.S. banks.
The Committee believes that this proposal has the further advantage of being a test case which would give actual market experience and insight into the impact that broadening banks powers to retail life insurance would have if such a policy change were to be made in three years time.
The Committee supports three proposals in the Task Force Report, all of which are aimed at enhancing competition through harmonization:
•revising Canadian accounting rules relating to the treatment of goodwill in business mergers and takeovers to make them comparable to U.S. rules;
•removing withholding taxes for interest on all arms-length borrowing from foreign financial institutions; and
•eliminating capital taxes to help smaller financial institutions get started, and to move toward a more level playing field with unregulated financial institutions.
In developing its recommendations for providing for a framework for healthy competition, the Committee was guided by the following principles:
•Any proposed policy changes should be consistent with offering more product and service choice to consumers, along with greater efficiency and convenience.
•The primary area where new competition is needed is in traditional core banking activities.
•New policies should incur only manageable risk for the deposit insurance fund and consumers. Neither should unmanageable risk be allowed to threaten financial market stability.
•Because of the uncertainty of how the financial services market will evolve, policies must offer flexibility to both firms and governments so that both have the freedom to respond effectively as the future unfolds.
•Finally, with financial innovation and deregulation breaking down the distinctions among what were, traditionally, very different forms of financial instititutions, the Committee believes the government should consider rationalizing the various laws and regulations governing financial institutions into a single financial service providers act. The Committee believes the rationalization of the financial services regulatory statutes into one statute would be responsive to industry needs as product and institutional lines begin to blur. Such a statute would facilitate the provision of new financial services by both traditional providers and new entrants into the sector.
The Committee’s first objective for public policy is the safety and soundness of financial institutions. This is of paramount importance. For this reason, the Committee strongly opposes the Task Force recommendations with respect to revising OSFI’s mandate, giving it the responsibility to balance competition and innovation considerations with safety and soundness requirements. The Committee believes that such a change in OSFI’s mandate could introduce unwarranted risk into the financial system.
For this reason, the Committee also opposes expanding OSFI’s mandate to include consumer protection regulation. The Committee believes that this function can be performed adequately by the provincial securities regulators and the Financial Services Ombudsman, which will be discussed in section E of this chapter. It will be emphasized in that section that more work is needed with respect to the enforcement powers of consumer protection legislation.
With respect to OSFI’s mandate, the Committee supports, as it has in the past, the consolidation of safety and soundness regulation-making within OSFI rather than having it split (or, in fact, duplicated) between OSFI and CDIC, as is the case currently.
The Committee also supports the recommendation that OSFI have a board of directors. This Task Force recommendation is identical to one made in a recent Committee report titled, Comparative Study of Financial Regulatory Regimes. In that Report, the Committee recommended that two thirds of the OSFI board be independent of government and government agencies.
The Committee believes that Canada has an excellent regulatory system for financial institutions with federal charters. This does not mean, however, that no institution will ever fail. In the past, the Committee has stated numerous times that a financial system that is regulated so tightly that there can never be a failure is a system that will operate to the disadvantage of consumers. Such a system would lead to little innovation, and there would be less capital available to the people and businesses who need loans.
The Committee recognizes that its recommendation to create new, smaller, closely held institutions will add some risk to the financial system. Smaller institutions are generally somewhat riskier than larger ones. Thus, some of the new, smaller institutions may fail and investors in those institutions will suffer a loss. Depositors, however, will be protected by deposit insurance.
While the failure of any financial institution, and the consequent effect that failure has on investors, is unfortunate, the Committee believes that this cost is worth the benefit to consumers of having a wider choice of financial institutions from which they can get service.
The Committee urges the government to work towards a harmonized system of federal and provincial cooperation in the regulation of financial institutions as has been suggested by Canadian securities administrators. Under this proposal, OSFI would become responsible for the prudential regulation of all financial institutions, federal and provincial, and the provincial securities administrators would become responsible for the market conduct regulation of federal as well as provincial financial institutions.
This division of responsibilities, which is similar to the state-federal division of regulation in Australia, and which is based on functions rather than institutions, would be more efficient than the current system of divided responsibilities. More importantly, it would be more effective than the current system, since it would recognize the relative expertise of each regulator: OSFI for prudential regulation, and the securities administrators for market conduct regulation.
The Committee also supports the current initiative of the Minister of Finance to improve the quality of coordination in regulating large international financial institutions. The financial services market has become so globalized that new international regulatory mechanisms are clearly needed. The Committee elaborated its view on this topic in its recent Report, Comparative Study of Financial Regulatory Regimes.
Two observations should be noted.
First, safety and soundness considerations are important factors behind the Committee view that federal and provincial capital taxes on financial institutions should be eliminated. Such taxes are perverse, in that they encourage institutions to keep their capital to the minimum level required — a strategy which works against prudential behaviour.
Second, the Committee believes that OSFI should monitor closely the current regulatory experiment in New Zealand. Under this experiment, a considerable amount of traditional detailed financial institution regulation has been replaced with substantially increased public disclosure, on a quarterly basis, of a bank’s risk exposure, its level of non-performing loans, and so on. In addition, the responsibilities and potential liabilities of a financial institution's board of directors have been enhanced so that members of the board will be motivated to improve their oversight of management.
This combination of increased public information and a more watchful board of directors, if it turns out to be effective, has the potential to reduce the regulatory burden on financial institutions without decreasing the safety and soundness of the system.
The Committee believes that its recommendations will help strengthen an already excellent Canadian regulatory system.
In particular, the Committee believes that its rejection of the Task Force’s recommendations to expand the OSFI mandate is critical. The changes proposed by the Task Force would, the Committee believes, have a serious negative impact on the safety and soundness of Canada’s regulatory system.
A significant part of the Task Force Report focused on the need to protect consumers from improper business practices, such as coercive tied selling and the unauthorized use of personal customer information. The Report also has a number of recommendations designed to empower consumers by requiring increased transparency, increased disclosure, and greater understandability of financial services contracts and marketing documents.
The Committee agrees with the general thrust of all these Task Force recommendations.
Specifically, the Committee supports the intent of the Task Force recommendations to:
•enhance the level of disclosure and clarity in financial services contracts and marketing documents;
•develop a comprehensive regime with respect to the use of personal customer information by financial services providers; and
•develop legislation and regulations that will be effective at preventing coercive tied selling, and will substantially penalize those who engage in the practice of coercive tied selling.
Since the Committee heard little evidence on the specific details of these Task Force recommendations, it makes no comment on whether adjustments to the details of these recommendations are required. It does feel, however, that the recommendations listed above are on the right track.
In fact, it must be stressed that the Committee was impressed by the depth of concern, shared by a wide range of witnesses, about the difficulty of enforcing laws in this area. The Committee has heard anecdotal evidence about coercive tied selling and is of the opinion that confusion exists over the concept of coercive tied selling and bundling services. It is important that financial institutions be clear in their intentions to their customers when offering them bundled services. It is critical that the customer understand that the choice to accept bundled services rests with him/her.
The Committee therefore urges that clear rules, severe penalties, and vigilant supervision be put in place with respect to coercive tied selling. Once this is done, the Committee believes that the level of consumer protection available in Canada will be as good as that of any industrialized country.
The Task Force recommends the creation, by government, of a Financial Services Ombudsman. This Ombudsman would be similar in character to the current Bank Ombudsman, except that its mandate would be broadened to include all federally regulated financial institutions, and all issues of fairness and administrative error by a financial institution could be referred to it. It would be a government agency, not a self-regulating organization.
The Committee supports the intent of the Task Force recommendations — namely to create an independent Financial Services Ombudsman as a redress mechanism for consumers — but the Committee believes that the independence of such an ombudsman would best be achieved by adopting the structure of the current Bank Ombudsman. Currently:
•The board of directors of the Office of the Bank Ombudsman contains a majority of independent directors.
•Only the independent directors choose new independent directors; the bank representatives on the board do not vote on such appointments.
•The board, not the banking industry, hires the CEO, sets the budget of the Ombudsman’s office, and approves all policies.
•The Ombudsman can only be fired with the unanimous agreement of all the independent directors.
Little more would be accomplished by creating a new government agency. Moreover — and this is a critical point — a federal government agency would make it much more difficult to get provincial agreement for the Financial Services Ombudsman to act as the Ombudsman for provincial as well as federal financial institutions.
Therefore, the Committee recommends the establishment of a Financial Services Ombudsman structured with the characteristics listed above, with one further change to the existing Bank Ombudsman structure. Currently the board of directors of the Bank Ombudsman consists of 11 directors, five bank representatives and six independent directors. The Committee believes that the board of directors for the new Financial Services Ombudsman should have fifteen directors, five of which would represent the industry, with the remaining ten directors being independent. The Ombudsman's office would be financed by the industry.
Industry representatives on the board of directors of the Financial Services Ombudsman should include representatives from the life insurance industry and the trust company industry because, as stated above, the Committee believes that the mandate of the Ombudsman should be enlarged to include all financial institutions and not just banks. The Committee believes that all federally chartered financial institutions should be subject to the Ombudsman's powers. This requirement should be a condition of their federal licence.
The Committee recognizes that more work is needed with respect to toughening penalties for those who fail to abide by the industry’s code of conduct or who fail to respond to the Ombudsman’s recommendations as to how to solve a specific consumer complaint. That is, the means of enforcement need to be addressed. The Ombudsman's role is to be a facilitator between the customer and the financial institution. The Ombudsman does not have the power, other than the power of adverse publicity, to enforce a decision, Hence, more study is required in this area before a specific enforcement process can be recommended.
The Committee also believes that, as part of the accountability process of the Ombudsman, the Ombudsman should be required to make an annual appearance before the House of Commons Finance Committee and the Senate Committee on Banking, Trade and Commerce.
The Task Force recommends amalgamating the insurance plan for federally insured deposit-taking institutions (CDIC) with that of the life insurance industry (CompCorp). This is an issue that the Committee explored in depth in its 1994 Report, Regulation and Consumer Protection in the Federally-Regulated Financial Services Industry: Striking a Balance. In that Report, the Committee categorically rejected the amalgamation of CDIC and CompCorp, the Committee does so again for the following reasons:
•The Committee does not accept the life insurance industry’s claim that, since CDIC is backed by the government, and CompCorp is not, this puts the life insurance industry at a significant competitive disadvantage. Any competitive disadvantage is minor at best.
•Putting life insurance protection under CDIC creates a non-level playing field for a whole host of products that are sold by life insurers and not banks. Yet the life insurance industry rejects the idea that the only products that should come under CDIC coverage are those sold by both life insurers and banks. The insurance industry wants all its products to have CDIC-type coverage.
•Since most life insurance companies already own trust company subsidiaries, they can get their deposit-like products insured by selling them through their trust subsidiary rather than their life insurance company.
•As explained in section C, the Committee anticipates that in the next few years, the deposit liabilities of the life insurance industry — the deposit-like products that the life insurance industry will start providing once they get access to the payments system — will become insured under CDIC on the basis that "like instruments should be treated in an identical fashion."
•Deposit insurance was first created as part of Canada’s approach to systemic stability — to stop runs on banks in the event that a bank got into difficulty. This remains the principal rationale for deposit insurance. The same concern does not apply to life insurance products.
The Committee believes that considerable progress will be made toward protecting consumers from improper business practices, as well as providing an effective redress mechanism for consumers, by the adoption of our recommendations in this area.
Moreover, by having the Financial Services Ombudsman be an independent organization, two significant benefits will be achieved:
•the need for the creation of a new government agency will be avoided; and
•the potential for federal and provincial cooperation in consumer redress in the financial services sector will be substantially enhanced.
As explained in chapter 2, financial services institutions, and banks in particular, have obligations that are greater than those of other private sector companies; accordingly they should be held to a higher standard of behaviour and public accountability than other companies. Canadians expect to be well served by the nation's banks. But they also expect banks to play a leadership role in their communities.
As the Task Force explains in its Report, these high expectations stem from a variety of factors: the economic importance of banks, the essential nature of the services banks provide to individual consumers and businesses, small as well as large, and the benefits which banks have received as a result of a set of public policies which were deliberately aimed at creating large, financially strong, truly national banks
These benefits are often unfairly referred to as privileges. They should be more correctly seen as what they are, powers given to banks by government for the deliberate purpose of creating an effective, efficient, and truly national banking system. This was done because such a system is in the national interest.
The question then becomes: how should the stewardship role be reflected in the policies and regulations affecting banks? This issue is dealt with in this section.
Part of the stewardship role includes ensuring access to financial services by low income Canadians. For this reason, the Committee supports the Task Force recommendations with respect to the measures contained therein that ensure that all consumers, particularly low income Canadians, have access to basic banking services. This is an important public policy goal which banks must meet.
The Committee stresses the importance of the Task Force recommendations with respect to governments implementing identity programs under which low-income people, whether or not they are customers of the institutions, can get government cheques cashed immediately.
The Committee also supports, as a means of encouraging all Canadians to have a bank account, the recommendation that the federal government give consumers the option of using direct deposit for all government programs that provide regular benefits (as is now done in the United States).
Another part of the stewardship role involves giving both consumer and business customers of a branch adequate time to adjust in the event that their bank decides to close a branch. For this reason, the Committee supports the Task Force recommendation that a bank must give four months notice before it can close a branch.
This does mean not, however, that the Committee believes that government should interfere with a business decision to close a branch. Consistent with the Committee's view of the role of government with respect to financial institutions, outlined in chapters 2 and 4 above, the Committee recognizes that changing technologies and new means of service delivery (e.g. through agency relationships and putting small branches in retail stores) will inevitably lead to closing branches, just as it led to the closing of post office branches by government in the 1980s.
Branch reductions are inevitable in any future industry scenario. Those who believe that the status quo with respect to the number and location of branches can be maintained are being unrealistic. Modernization of the banking system, like modernization of the post office a decade ago, is going to require branches to be closed.
The question, therefore, is how to ease the customers’ problems caused by such branch closures. The Committee believes that the four month advance notice will enable these closures to be achieved in the least disruptive manner possible.
The Committee also believes that, in addition to the four month advance notice requirement, access to branch services will be substantially enhanced if banks aggressively pursue new forms of branches, as they have started to do in the past year or so. Just as much of the dislocation caused by the closing of post office branches was eased by creating postal outlets in retail stores, such as drug stores and general stores in small rural communities, so too can the dislocations caused by the closing of a bank branch be eased through its replacement by an outlet in a supermarket, a retail store, or a post office branch. The Committee strongly urges chartered banks to rapidly expand their efforts in this regard, particularly in any geographic area where a bank wants to close a branch.
Finally, with respect to branches, it is important to note that evidence presented to the Committee, particularly by CEO's of smaller deposit-taking institutions, indicated that one of the ways of reducing the number of future branch closures was to increase the range of products that could be sold through branches. The increased range of products would help to make the branch more profitable. This is one of several reasons why the Committee supports allowing banks to enter into the financing of automobile leases.
The Committee continues to be troubled by the difficult problem of small business financing. However, the Committee recognizes that there is a limited amount that the government can do in this regard. Even the Canadian Federation of Independent Business told the Committee that two of its most important objectives with respect to banks — to reduce the rate of turnover of branch managers and to have credit decisions made at the local rather than the national level — cannot be achieved by government action.
Witnesses did, however, suggest one change which the government should encourage financial institutions to make:
All financial institutions, particularly banks, should be encouraged to price credit appropriately for risk.
Currently, few, if any, loans are granted by Canada's major banks at rates in excess of prime plus 3 percentage points. In contrast, in the United States, where credit to small business is perceived by that sector to be quite readily available, financial institutions offer their customers a much wider variety of terms and interest rates. Banks in Canada should feel that they can charge the appropriate amount for extending credit without risking a negative community reaction.
The fact that, currently, credit is restrained by risk rather than by price means that some small businesses are deprived of loans. Pricing for their level of risk would make more capital available. The Committee hopes that such a change in bank credit policy would not simply provide a veil behind which the banks increase their spread on the SME loans that they grant anyway.
That said, the Task Force and the Canadian Federation of Independent Business both agree with the Committee that the availability of credit, properly priced for risk, would provide more financing to businesses that need it. At present, such businesses either go without credit, abandon their business plans, or do not begin in the first place because of lack of credit available. Alternatively, owners are obliged to finance the businesses personally by still more expensive means, such as extended payment terms on their personal credit cards. A more flexible pricing policy by financial institutions would resolve these problems.
The Committee also believes that an important opportunity to enhance financing availability for small business exists if the Committee's proposal for the creation of new small deposit-taking institutions is implemented. These institutions, with their community oriented focus and detailed knowledge of the small business market in their communities, should become excellent sources of small business credit. In the United States, and in Europe, where a strong second tier of banks exists, these institutions have become a major source of small business loans. In Canada, the Canadian Western Bank has proven the success of this strategy as 85 per cent of its loan portfolio is with small business in the four Western provinces.
The Committee strongly supports all efforts to enhance borrowing opportunities for small and medium-sized business, but it recognizes that, in many cases, the more important need of these businesses is equity investment. This is particularly true for the increasingly numerous and important knowledge-based enterprises. The Committee urges governments to pursue policy initiatives aimed at meeting this need. Such initiatives should include taxation-based policies to encourage the provision of higher-risk equity investment by financial institutions and individuals.
The Committee heard specifically that raising the exemption on taxable capital gains and reducing the taxation rate on capital gains would help in getting equity financing for small business, particularly from successful business people who reinvest some of the profits that they have made into smaller companies that are growing in their region. This is a source of money which was prevalent years ago, but is not seen as much today.
At current capital gains tax rates there is an unfavourable risk reward relationship in extending equity financing to small and medium-sized businesses. Investors face the downside possibility of losing their entire investment with limited tax benefits, while on the upside, they must share a significant proportion of their return with the government. They are better off making investments in less risky avenues, where there exists a better risk-reward tradeoff.
There is, however, one area of government action related to increasing access to small business financing which the Committee believes is worthy of being adopted quickly. This involves strengthening the role of the Business Development Bank and the Farm Credit Corporation.
The Committee recommends that government instruct these two institutions to enter into strategic partnerships with smaller institutions, such as the credit union community bank recommended by both the Committee and the Task Force, in order to provide these institutions with the expertise in assessing small business lending proposals which they currently lack. This combination of the federally owned banks, with their extensive capital and human resource capabilities, and small deposit-taking institutions, with their extensive network of branches in smaller towns and rural areas, should provide a meaningful new source of small business loans.
In effect, this recommendation seeks to take advantage of the relative strengths of each of these institutions. The credit union movement has a network of branches in many communities in which large national banks do not have a strong presence. These credit union branches could be an excellent source of new small business customers for the two federally owned banks. Moreover, the local community knowledge of the staff of these branches would be helpful to the BDC and FCC in assessing the risk associated with a specific loan proposal.
It should be noted, however, that these branches, generally, do not have the expertise to conduct, on their own, an in-depth evaluation of a loan proposal. That expertise does exist within the BDC and FCC. Thus the combination of credit unions and federal institutions would result in an excellent loan evaluation process.
In addition, many smaller credit union branches lack the capital to be able to finance loans of significant size for small business. Even if they have sufficient capital, keeping the entire loan in a branch could excessively increase the riskiness of the branches’ loan portfolio. By sharing the loan with the BDC and FCC, the risk to the credit union branch would be decreased.
The Committee urges the government to take quick action on this recommendation.
Finally, the Committee supports the recommendation in the Task Force Report that Industry Canada assume responsibility for coordinating an annual survey of SME attitudes to the availability of financing from the perspective of small business. Industry Canada should also conduct and publish periodic surveys of small businesses to provide a comprehensive picture of the financing they require, and the source of financing on which they rely as markets evolve. An initial benchmark survey should be completed as soon as possible.
Proposals similar to those described in the preceding paragraph have been made by the Canadian Federation of Independent Business. The Committee also made a similar proposal to the Minister of Industry, in a report to him sent in August of this year.
The Committee agrees with the objective of the Task Force recommendations that every federally regulated deposit-taking institution and life insurance company should be required to make available to the public an annual community accountability statement. Such a statement would describe its contributions to the communities in which it operates. The objective of such a community accountability statement would be to provide an annual accounting of an institution’s accomplishments on meeting its stewardship responsibilities.
The Committee supports the idea that some form of annual stewardship accounting is desirable, but the Committee does not agree with the Task Force’s proposal for achieving this objective. The following reasons set out the Committee's position:
•The Task force was unable to define community. Communities could be geographically based, gender based, age based, or ethnically based. In short, the recommendation is too vague to be useful.
•The Community Accountability Statements would have no impact on achieving any of the Committee’s five objectives. They would quickly become nothing more than a public relations exercise, an annual corporate boast.
•The Community Accountability Statements would be too costly for small institutions. Evidence to this effect was given by witnesses from these institutions.
•
The Community Accountability Statements
would impose excessive regulation with little apparent benefit because of their being just
a public relations exercise.
•
The cost of the Community Accountability
Statements would ultimately be paid by the consumer through undisclosed fees or service
charges.
•
The Task Force Report gives no
indication of how the Community Accountability Statements would be used. The Report fails
to answer the pivotal question of how such statements would benefit consumers.
Obviously, the Committee has no objection to a financial institution issuing a Community Accountability Statement. The Committee believes, however, that much more thought is required to develop an effective method of disclosure whereby financial institutions would give an annual accounting of their stewardship responsibilities.
We therefore urge the government to study this question and present alternatives before the end of next year. In carrying out such a study, the government should keep in mind the cost of annual stewardship accounting to small firms, and the need for the information to be truly useful to consumers.
The comments in this section relate exclusively to any new proposed mergers involving financial institutions. They do not relate to the two proposed bank mergers that are currently under review.
If two financial institutions propose to merge, there are three different categories of issues that need to be addressed:
•competition policy issues,
•prudential issues, and
•stewardship issues (the Task Force calls these latter issues "public interest" issues).
The Committee believes that these issues should be addressed sequentially.
The requirement that the Competition Bureau be satisfied that a proposed merger is not anti-competitive, and that OSFI be satisfied that it poses no prudential problems, are necessary prerequisites to any merger proceeding. Until the necessary conditions are met, it is meaningless to address the additional set of stewardship issues that apply to financial institutions.
The Competition Bureau and OSFI review processes that currently exist, including the merger guidelines published by the Bureau earlier this year, appear to be reasonable. The Committee, however, has not studied the published guidelines and therefore cannot comment in detail on them.
Assuming that a proposed merger has been approved by the Competition Bureau (most likely after extensive negotiation with the merger participants to resolve problems that the Bureau may have with respect to the initial mutual merger applications) and by OSFI, the Committee is of the opinion that the stewardship review process should begin immediately afterwards.
The stewardship accountability review process should be required only for merger proposals involving two large financial institutions. Since the Committee’s proposals would prohibit mergers involving a large bank and a large life insurance company, the only mergers for which the stewardship accountability process would be required would be merger proposals between two large banks or two life large insurance companies.
The Committee believes that this process should begin with stewardship accountability statements by the merger proponents. Such statements should address the impact of the merger on each of the public interest criteria proposed by the Task Force. These include:
•costs and benefits to individual consumers and small businesses;
•regional impacts;
•employment outlook;
•the impact on the international competitiveness of the merger proponents;
•the impact on their ability to adopt new technologies; and
•any other criteria the Minister of Finance wants to include.
Stewardship accounting statements should then be subject to public comment, either in a set of public hearings, or by a process involving written submissions from the public submitted to the Minister within a specified time frame. If a public hearing process is adopted, the hearings should be conducted by Finance Department officials. This avoids unnecessary politicization of the stewardship review process.
Once the public review process has been completed, the decision as to whether or not to approve the merger should rest with the Minister of Finance.
This entire review process must have a firm timetable, as it does in Switzerland where the entire process is not permitted to exceed three months. The review process cannot be allowed to drag on.
In both the U.S. and U.K., the equivalents of the Competition Bureau and OSFI processes have a fixed period of time within which they must be completed. While the Committee recognizes the need for some flexibility in the amount of time that both the Bureau and OSFI require in order review a merger application, a target timetable for these reviews should be set by the government after consultation with the agencies.
Similarly, the proponents of the merger should have a fixed amount of time, likely about one month, to file their stewardship statements. The public comment or public hearing period should have another fixed period of time, about two months, in which public consultation should be conducted. The Minister should have another month in which to make a final decision.
The Committee believes that a process such as the one described above meets the essential criteria of any government review process:
•the process is clear and known in advance to the firms affected;
•the process has a fairly tight timetable for its completion through all stages; and
•the process is as objective as possible.
Fulfilling the stewardship responsibilities of financial institutions is the most difficult objective for firms to address. It also raises some of the most difficult issues for government to deal with in an objective way. For this reason, a firm’s stewardship practices will always be subject to public criticism, and to public demand for government to force institutions to behave in a specific way.
Nevertheless, the Committee believes that the proposals outlined in this section go some distance towards spelling out the stewardship responsibilities and the role of government in seeing that these responsibilities are met.
A. Business Environment Overview
B. Objective: To Foster Canadian Control of the Key Institutions in the Financial Services Sector
Demutualization
Three Sizes of Companies
Ownership Rules
Grandfathering
Large Shall Not Buy Large Across the Pillars
Conclusions
C. Objective: To Provide a Framework for Healthy Competition in the Financial Services Sector
Market Structure
Access to the Payments System and Fully Functional ATMs
Retailing Property and Casualty Insurance
Powers: Banks Offering Financing of Automobile Leases
Powers: Retailing Life Insurance
Enhancing Competition Through Harmonization
Conclusions
D. Objective: To Ensure the Safety, Soundness and Integrity of the Canadian Financial System
The Mandate and Governance of OSFI
Regulatory Risk
Towards Regulatory Harmonization
Two Observations
Conclusion
Consumer Redress: A Financial Services Ombudsman
Consumer Insurance Plans
Conclusion
F. Objective: To Fulfill the Stewardship Responsibilities of Financial Services Institutions
Access to Basic Banking Services
Access to Branch Services
Access to Small Business Financing
Public Accountability: Community Accountability Statements
Public Accountability: New Merger Proposals
Conclusion
Concluding Observations
A) The Need for a Balanced Package of Reforms
The Committee believes that witnesses who appeared before it would agree with most of the recommendations contained in this report. However, each witness would likely agree with their own unique subset of recommendations drawn from the ones made here. The Committee believes that, since unanimity of agreement on anything with respect to financial institution policy is impossible to achieve, its set of recommendations is probably reasonably balanced.
The need for a balanced package of reforms was also of concern to the Task Force. They, too, recognized that, for example, having government adopt only those recommendations which would add to the regulatory burden on business, such as adopting only the consumer-oriented recommendations, without also adopting those recommendations which would free business to compete more openly in the marketplace, could substantially hurt the industry, particularly smaller firms, and thus ultimately hurt consumers. This is why the Task Force, in its Report, stresses the need for a balanced package of reforms.
As well, many witnesses stressed to the Committee the danger of government "cherry-picking" the recommendations of the Task Force (or of this Committee).
We therefore urge the government to seek a balance in its package of reforms; a balance which reflects both the need to strengthen consumer protection and the need to free Canadian financial institutions so that they can compete effectively in the rapidly changing and increasingly global (or at least North American) financial services market.
The Committee recognizes the political reality that, in Canada, financial institution reform is always contentious and controversial. This is, at least in part, why such reform virtually never takes place in the last year of a government’s mandate. Neither does it usually take place in the first year of a government’s mandate because of the complexity of financial institution policy issues, and the need for a new government (even of the same party) to make the required policy decisions. This history of financial institution policy reform suggests that unless change is accomplished before the end of the year 2000 — twenty four months from now — it is unlikely to be done until 2003.
Given the speed with which changes in the sector are taking place, the Committee strongly agrees with recommendation 1 of the Task Force report: that the government should respond with prompt action; that action on the recommendations should not await the regular review of federal financial institutions legislation scheduled for 2002.
Moreover, the Committee believes that a two year time period is more than sufficient to put the desired reforms in place. One could envision a scenario, for example, in which a government response to the Task Force report, to this report, and the report of the House of Commons Finance Committee is issued by the end of June of next year (presumably via a ministerial statement, a white paper or even a draft bill). This would be followed by three months of intense consultation and a bill tabled in Parliament for first reading at the end of 1999.
If such a bill were given the legislative priority the Committee believes it should be given, it could be passed by both Houses of Parliament, and proclaimed into law by June, 2000 and certainly no later than the end of the year.
The Committee urges the Government to have a balanced package of reforms in place before the end of the year 2000.
B) The Need for Timely Government Action