BUSINESS POWERS
1. The Payments System
2. Interac and Other Financial
Networks
3. Insurance Retailing
4. Light Vehicle Lease Financing
SECTION C
An important aspect of the Task Force vision for the financial service sector is that there should be a fully open and competitive trading and investment environment. The Task Force considered the issue of business powers in this environment from the perspective of the consumer and with the consumer’s best interests in mind. Our bias was to increase consumer choice and benefit unless there appeared to be compelling reasons not to do so.
There are five major areas that the Task Force considered:
- Greater flexibility for credit unions;
- Whether institutions otherthan deposit-takers should have access to the payments system;
- Access of institutions to other networks
- Whether deposit-taking institutions should be allowed to retail insurance products through their branches; and
- Whether deposit-taking institutions should be allowed to offer automobile leases to retail customers.
It is the view of the Committee that the greatest potential for competition rests with existing players. The Committee recommends, therefore, the continuation of existing public policies that would progressively breakdown the remaining regulatory barriers to cross-pillar ventures ¾ it is expected that technological innovation and time will, in large part, take care of the other barriers.
Regulatory barriers include restrictions on membership. In the payments system and other financial networks, and the prohibition on deposit-taking institutions being able to directly sell life insurance and offer light vehicle lease financing within their branch network.
The Committee, however, 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 favours maintaining the current rules whereby banks can own a property and casualty insurance company but cannot sell property and casualty insurance in their branches.
Background
Canada’s payments system consists of a set of separate networks that include the cheque payments system, the credit card systems of VISA and MasterCard, the automatic teller machine (ATM), point-of-sale (POS) terminal and debit card systems of Interac, and the respective clearing systems for debt and equity instruments and for mutual funds. At the heart of these networks is the Canadian Payments Association (CPA), which since 1980 has had the mandate under the Canadian Payments Association Act to fill the following two statutory objectives:
(1) establish and operate a national clearing and settlement system, and
(2) plan the evolution of the national payments system.
Membership in the CPA is presently limited to federally and provincially regulated deposit-taking institutions, of which there are two categories: Direct and Indirect clearers. Direct clearers maintain settlement accounts at the Bank of Canada. They clear and settle their own payments directly through the Automated Clearing Settlement System (ACSS) and, in turn, provide clearing services and access to settlement facilities for indirect clearers. To be eligible to act as a direct clearer, an institution must account for a minimum of 0.5 per cent of the total national clearing volume. Of the approximately 132 members of the CPA, only 13 are direct clearers: the Bank of Canada, eight banks, one trust company, two group clearers (which clear on behalf of the credit unions and caisses populaires) and one provincial government savings institution.
While CPA membership is restricted to deposit-taking institutions, there are mechanisms through which non-deposit-taking institutions may gain more limited forms of payments system access. For example, a non-deposit-taking institution may allow its customers to make third-party payments by establishing a "sweep account" with a CPA member. Under a sweep account arrangement, a corporate entity, such as an investment dealer, sets up a chequing account with an overdraft facility for its client at a CPA-member deposit-taking institution, as well as a deposit account for itself. The client will also have an investment account with that institution. At the end of each day the deposit-taking institution automatically transfers the balances remaining in the client’s chequing account, after cheques drawn on the account have cleared, into the deposit account held by the investment institution, which credits this amount to the client’s investment account. If the client’s chequing account is in overdraft at the end of the day, the investment institution debits the client’s investment account by the amount of the overdraft and transfers funds from its account at the deposit-taking institution to the client’s chequing account. Under this arrangement, the investment firm pays interest on the client’s overnight balances "swept back" to it and has the funds available for its own use. The CPA’s Board of Directors comprises five bank representatives, five non-bank deposit-taking institutions, and a senior official from the Bank of Canada who is also the chairperson.
Currently, all transactions ¾ retail and wholesale, paper and electronic ¾ are settled through the same settlement network, the ACSS. When the CPA’s new Large Value Transfer System (LVTS) begins operation sometime next year, the Bank of Canada will also provide settlement services to those CPA members that participate directly in the LVTS. The implementation of this system will result in the operation of two settlement structures: one primarily for small-value payments and another through which most large-value payment items (i.e., for transactions in excess of $50,000) will be handled.
At issue is whether, in an environment of convergence towards a single financial services marketplace, the CPA should open its membership to non-deposit-taking institutions, most notably to life insurance companies, mutual funds companies and securities firms. While all three groups have requested entry into the CPA, one issue of contention is the possibility that existing participants in the payments system may face both higher costs and risks because of expanded participation. These risks include: the credit risk that a financial institution will default on its settlement obligations; the liquidity risk that an institution will meet its obligation only after some delay; the legal risk that an institution may be legally constrained from meeting its commitments to others; and the operational and security risk that human error, equipment malfunctions, system design flaws or fraudulent access to payment information might result in payment errors or delayed payments.
Task Force Recommendations
13) The Canadian Payments Association Act should be amended to permit financial institutions other than deposit-takers to become members of the Canadian payments system upon designation by the Minister of Finance as meeting criteria related to their solvency, liquidity, and regulatory and legal frameworks. The Department of Finance, working with the Canadian Payments Association, should give high priority to determining the classes of institutions which should be eligible. The Task Force expects life insurance companies, securities dealers and money market mutual funds to qualify with few, if any, restrictions.
14) The Minister of Finance, rather than the Governor-in-Council, should have the power to approve new by-laws of the Canadian Payments Association or changes in existing by-laws. In addition, the Minister of Finance should have the power to review all new or revised rules of the Association, and to revoke any new rule or revision to existing rules which the Minister determines to be contrary to the public interest.
15) The Minister of Finance should also have the power to issue a directive to the Canadian Payments Association to require a change in a by-law, rule or operating practice which the Minister determines to be in the public interest.
Views of Witnesses
Life insurance companies have, for some time requested membership in the CPA. Apart from the seamless attribute it would provide to their product and service offerings to their customers, they believe that being able to directly clear payment instruments is an increasingly important facet of being and remaining an effective and efficient financial institution in today’s demanding marketplace. They claim that:
Our industry has sought this access and governance change for several years now, including the issue of payment cards to our policyholders. Our industry pays out almost $100 million a day to, or on behalf of, individual Canadians. Making these payments as efficiently and is conveniently as possible, in the way consumers prefer, is essential to meeting customer needs and remaining competitive. (Dominic D’Alessandro,, November 4, 1998).
Mutual funds dealers also link the provision of convenient and efficient financial services to their customers with that of being able to have direct access to the CPA. They argue:
Our industry has grown and matured to the point where we can safely and competitively enter the payments system with our money market mutual funds. The Canadian consumer deserves more choice when evaluating how to get the best return on their investments. At the same time, they want immediate and convenient access to that money. In our view, allowing customers direct access to the money in their money market mutual funds, without the need to make phone calls, bank transfers, dealing with another party, et cetera, not only provides a competitive alternative to the consumer, but it also allows a more efficient alternative. This is one of the reasons why we feel that membership in both the Canadian Payments Association and Interac goes hand in hand. (Blake C. Goldring October 6, 1998).
However, the Committee was cautioned by one life insurance company officer not to over emphasise the benefits that would flow from providing broader access to the CPA. This witness noted that:
Access to the payments system is held up by some companies as a great objective. I think it is a bit of a Pyrrhic victory. The trust companies had access to the payments system and were not able to make successful businesses out of it. … It is sort of a necessary, although not [ a] sufficient, condition to build a good financial services business. You do need access at some point, but just having access will not make you into a successful financial services business. I do not think too much weight ought to be given to that.
They advance the notion that access to the payments system will make life insurance companies competitive with the chartered banks. I think that building a business out of access to the payments system is a non-starter. It is like having access to the Trans-Canada Highway. You do not build a business by being allowed to drive on the highway. That is basically what the payments system is. It simply allows you to move money around the country and retain money on deposit. I do not think you can build a business out of that, but the implication is that, somehow, that is a great advantage to the industry. (Raymond McFeeters, October 6, 1998).
Most expressed concern about the prudential oversight of new members.
The board of the Canadian Payments Association has never had a problem with additional access. It is under what terms and conditions. It is not under equal terms and conditions, it is under equitable terms and conditions. The responsibility that we have as a board is prudential. … My concern is that organisations entering the payments system should be somewhat regulated. There has to be some area of at least liquidity backup that you can honour your payments at the end of the day. (Wayne Nygren October 28, 1998).
Some argued that the payments system is a public utility and therefore that access costs should not be substantial.
The payments system is a public utility. I do not think the cost for entry should be much greater than it is if you want to put a new driveway onto the street. It is a public utility and it serves customers well to have more companies plugged into the payments system because that expands the ranges of services that they can provide to customers. You should not have to pay other than marginal costs to get into the system. (William A. Black, October 21, 1998).
There is some common ground in this debate. There is general agreement on the necessity to maintain prudential safeguards. This means that entry into the CPA will be restricted to those that are regulated for solvency and liquidity. The CPA concurs.
Both the task force report and the discussion paper put out by the Department of Finance suggest that criteria for deciding on access for various types of institutions should focus on the following points: Regulation and supervisory oversight, access to liquidity support, appropriate legal framework in the sense that laws governing the new participants should be compatible with payments system activity and, lastly, operational and technical competency to participate. (Robert M. Hammond, October 23, 1998).
Investment dealers appear to agree:
We strongly support the proposal that non-deposit-taking institutions should join the Canadian payments system, provided they meet … reasonable criteria for solvency, liquidity and regulation, and that our member firms should be eligible for membership in the Canadian Payments System. (Joseph Oliver, November 2, 1998).
Access may be first on the reform agenda, but governance of the CPA is also a priority. To some, the CPA’s governing board must be completely reconfigured:
Make no mistake, the CPA is and will be run by the major banks with the present situation. They have the votes, which are based on transaction volume. They pay the bills and they have the resources to participate in the endless meetings that take place to discuss changes they do not want to implement. They engage in public relations activities such as the so-called stakeholders advisory committee. … There is no representation in this body from those who actually pay for the cost of clearing, that is businesses and the consumers. The problem with the CPA is fundamental. Its purpose is solely to regulate a system that affects every Canadian individual and business. However, the regulators are effectively the five major banks. It believes it is a law-making body but is answerable only to the direct clearers. … There must be fundamental change in the regulatory process if there is ever to be meaningful competition in financial services. We must be able to go before an independent board to plead our case for changes. (W.H. Loewen, October 6, 1998).
CPA members acknowledge the need to reconstitute a new board:
The two areas we are looking at are the access and corporate governance … presently, we have a board of 11 … there are five chartered banks, five non-banks and the Bank of Canada is the Chair. … [ A] critical area to us of whether we get independent directors, how many independent directors we get, where does the consumers association or the merchants association or the brokerage or the mutual fund industry all come into this. They all want access to the Payments Association. … [ A] s long as we can set up some rules and regulations, some prudence that they are able to honour their commitments. (Wayne Nygren, October 28, 1998).
But how one reconstitutes the board cannot be determined in isolation of other governance issues.
The Department of Finance paper recommended that the stakeholder advisory council be a legislated requirement … expanding the Board of Directors to include independent directors; in other words, directors who were not chosen by our members. … One option … for improving public policy oversight is to create a type of oversight body. Perhaps the Bank of Canada or perhaps at the Department of Finance … In any event, the proposal is that this government body would be required to review and approve all CPA by-laws and rules before they come into force. The task force did not go that far. It recommended instead that the Minister of Finance rather than the Governor-in-Council have the power to approve the CPA by-laws, but it also recommended that the Minister have the power to review or revise CPA rules and to revoke any new rule or revision when the Minister determines it to be contrary to the public interest. (Robert M. Hammond, October 23, 1998).
The CPA indicated its preference:
Given the great number of CPA rules, we have hundreds of rules and most of them being very technical in nature, and given the need for the CPA to be able to respond to emerging issues quickly, the task force approach would clearly be more efficient than requiring all the rules to be approved in advance by a government oversight body. … The second reason we like the task force approach is that it would place the responsibility and the accountability for enacting rules that are consistent with our legislative mandate, including the public policy objectives, squarely on the shoulders of the board, where we feel the responsibility should be. (Robert M. Hammond, October 23, 1998).
Furthermore, there must be a better criterion than that of activity level for determining who can be a direct clearer in the system. While most would recognise this simple rule as a surrogate for economic efficiency given that there are economies of scale in clearing payment instruments, no witness offered an alternative basis for establishing direct clearer status other than to say:
There needs to be a certain number of groupings. With today’s technology, perhaps you can have many hundreds of direct clearers. Certainly there should be a lot more than there are right now. A direct clearer that serves a particular industry would perhaps be a first step. Definitely, there should be many more direct clearers. (W.H. Loewen, October 6, 1998).
Conclusions
There are two immediate issues related to the CPA that must be resolved: (1) membership and its expansion, and (2) jurisdiction and responsibility over CPA by-laws. In terms of the first issue, it is clear that the expansion of participants beyond deposit-taking institutions is preferable given the developments leading to a single financial services marketplace. It would be preferable that new CPA members be subject to similar, but not necessarily identical, solvency and liquidity oversight and regulation.
Should any of these new participants also wish to become and qualify as a direct clearer, they would be expected to bear similar collateral obligations as existing direct clearers. This requirement is particularly important because Canadians are accustomed to a system of clearance and settlement of cheques and debit and credit instruments within a 24-hour period. The effectiveness of this system should not be diminished with an expanded CPA. Hence, the Committee concurs with the Task Force that the Minister of Finance should set the criteria for solvency, liquidity, and regulatory and legal frameworks.
In terms of the second issue, the Committee has indicated its preference for regulation of the CPA in the public interest. This would include ministerial oversight and direction on the by-laws of the CPA. The Committee, therefore, supports Task Force recommendations to this effect.
2. Interac and Other Financial Networks
Background
The Task Force concluded that maximising the competitive potential of existing players would require that there be open access on reasonable terms to other networks such as Interac. But given the size of the country and our relatively small population, we are unlikely to have competing networks as is the case in other countries. In such a situation, the Task Force advises the government to monitor carefully whether existing and prospective networks facilitate competition.
The Task Force also favoured measures that would broaden the functionality of the Interac system to allow deposits to be made to any deposit-taking institution through any ATM, exactly as cash can now be withdrawn through any ATM.
Task Force Recommendations
16) The Minister of Finance should monitor the operations of all networks in Canada to ensure that they are operated in a manner designed to enhance competition in financial services and competitive equity among financial services providers. If significant anti-competitive practices are found, legislation should be considered to ensure network access to all competitors on reasonable terms and conditions, and with fair compensation to network sponsors.
17) The members of Interac should take the necessary steps so that the Interac network is fully functional to permit the network to be used for as many functions as the technology permits, including the making of deposits through any ATM to any participating deposit-taking institution.
Views of Witnesses
Some witnesses to the Committee’s hearings saw the Interac ATM network as a natural extension of the CPA network.
Although the broader definition of the payments systems includes both the CPA and Interac, the task force recommendation does not specifically deal with Interac membership for our … or other money market mutual funds. This is a crucial element to providing our customers convenience and ease of access to their accounts. Access to Interac is critical. We need transaction-based entry fees into the Interac system that are level; we do not want to be blocked at the door by high fees that are different for different members. We want deposits accepted by Interac automated tellers that are not propriety to the institution which owns the machine, and the ability to utilise our own debit and credit the cards.
Without addressing Interac as well as the Canadian payments system, consumers will not be able to have direct access to their funds, and membership in the CPA will not provide the benefits intended by our submission and the MacKay Task Force. We need full and equal membership, without any bank, other than the Bank of Canada, guarding the gate, just as the task force recommends, in order to provide the customers we serve with the same secure and convenient access to their funds as bank customers currently enjoy. (Jim Hunter, October 6, 1998).
Full functionality would include: (1) a client being able to transfer money from one account of a financial institution to an account of another financial institution, and (2) depositing cash and other financial instruments to one’s account while using another financial institution’s ATM. These network functions were seen as an important convenience factor for the consumer. The removal of this proprietary barrier to effective competition in deposit-taking is also viewed as a critical factor for economic efficiency of the financial sector. It was argued that Interac should take the necessary steps to bring about seamless money transfers, at least for withdrawals and deposits, between financial institutions.
There are invisible pillars. We keep talking about breaking down the four pillars of the financial services industry. The invisible pillars are that you cannot move money between institutions. You cannot transfer because someone will not turn on the switch. … We got to basically using ATMs between one institution and another and the world did not end. I am sure we can say the same for deposits. … We should be able to transfer money back and forth between linked accounts in this country. It is a convenience and service to consumers. The transfer can be done with security and control in a prudent manner. (Arkadi Kuhlmann, November 5, 1998).
The Interac Association expressed reservations about the simplicity of accomplishing this.
The solution in recommendation 17 is only one way of addressing service to consumers and it is a costly and complex solution. It is not a simple flick of a switch. It requires considerable investment in both equipment and operational changes. This is the case because of the decentralised architecture of the system. Each participant contributes its own machines and supplies its own servicing of those machines. The only common thread of the network is the inter-member network software and operating standards for shared withdrawal. All machines are owned and operated by individual members. They meet some common technical specifications, but they are otherwise independent and distinct, offering different services. …
Before members invest in new technology to facilitate new functions, they need to be sure that it is the best way to meet the consumers today and tomorrow. A paper-based solution may not be the best way to meet the most innovative and forward-looking approach to broadening access to the network. It also might not be the most cost-effective approach. It seems to us that this recommendation prejudges the solution, without marshalling the expertise or resources necessary to consider alternative approaches. The Interac Association has a significantly enlarged membership of diverse participants, some large and some small, some ATM-based, some more interested in the growth of technologies. Whatever solution is found needs to be evaluated in light of these diverse interests and emerging technologies. (Letter to Chairman of the Standing Senate Committee on Banking, Trade and Commerce, November 12, 1998)
The Committee was told that this type of of argument has been used before; that monopolist telephone companies had for decades (indeed, for most of the last century) claimed that different proprietary call-switching networks were not compatible and could not be linked.
The greatest barrier to entry in the field of deposit taking and, therefore, full service retail banking, since the early part of this century has been that of branching. The capital cost of building a branch network is enormous and the payoff long in coming. Full functionality would provide each new entrant with an instant 19,000 new locations to offer their services, thereby ensuring that other players, however large, would continue to face intense competitive pressures in all regions of the nation.
What we are advocating is that the Interac system be run as a utility, which is pricing the same for everybody. The analogy I use is … the telephone industry. It was difficult to allow competition at the level of the household because if somebody has already put the phone lines in your house it is very difficult to get a second and third to come and also put telephone lines in your house. … Think of the ATM system as the same thing, … think of the ATM system as the local lines and make that equally accessible to everybody at a charge which just pays for the system, not one which becomes punitive, and you will get a lot more competition.(Youssef A. Nasr, October 29, 1998).
Conclusions
Given the importance of financial networks to competition in the financial services sector, the Committee supports the Task Force recommendations designed to monitor and enhance this competition.
Background
Federally incorporated deposit-taking institutions were excluded from the insurance business in Canada until 1992, with the exception of selling a limited range of products, such as creditor life insurance, that had historically been viewed as incidental to banking. The most developed bancassurance activity in Canada before 1992 was in Quebec, where affiliates of the caisses populaires were permitted to distribute insurance through the branches of the caisses. Credit unions, in a number of provinces, also own insurance brokerage companies. In 1992, the Bank Act was amended to allow deposit-taking institutions to sell insurance through subsidiaries and they have subsequently taken advantage of this change through new incorporations and acquisitions of fairly small companies.
According to a study done for the Task Forces
From an economic standpoint, banks are particularly well positioned to capture share in life insurance. By leveraging their customer bases and branch networks, banks can achieve more than double the productivity of career agents. This greater efficiency coupled with lower commission payments to their salesforce, is reflected in banks’ low marginal acquisition costs of new policies. In Italy, for example, the cost structure of the bank channel is significantly lower than that of either career agents or financial advisors. This is due, in part, to banks’ stronger ability to turn leads into sales. (Task Force Report, Background Paper #1, p. 39).
The Task Force argues that, based on the available evidence, the existing distribution channels will not disappear when insurance is distributed through branches of deposit-taking institutions. While there will be some consolidation, other forces already at work are causing consolidation throughout the insurance industry.
Finally, the Task Force notes that a number of provinces have regimes that prohibit employees of deposit-taking institutions from obtaining insurance licences and suggests that model code, such as that in Illinois or Quebec, could achieve uniform standards across the country for licensing and consumer protection issues. Such a model code, coupled with a system of mutual recognition among the provinces, would address the concerns raised regarding multiple and inconsistent insurance regulatory regimes across the country.
Task Force Recommendations
18)Subject to the adoption of appropriate privacy and tied selling regimes, federally regulated deposit-taking institutions should be permitted to retail insurance through their branches and to use their customer information files to assist in retailing insurance.
(a) Deposit-taking institutions with less than $5 billion in shareholders’ equity should be permitted to retail insurance through their branches and to use their customer information files to assist in retailing insurance, as soon as legislation in respect of privacy and tied selling is in place.
(c)All other companies should have access to the new powers on January 1, 2002.
19) Employees of deposit-taking institutions who are engaged in the sale of insurance should comply with applicable provincial requirements with respect to the education and licensing of insurance salespersons, so long as such requirements are non-discriminatory.
20) The insurance and deposit-taking sectors should work with the provinces to develop a model code for licensing and consumer protection issues arising from the sale of insurance at branches of deposit-taking institutions.
Views of Witnesses
Some supported deposit-taking institutions being able to sell insurance in their branches.
Our vision for the industry is focused on our customers. We want to offer them the greatest possible range of choices, multiple access to products and services, low costs and good value. Along with consumer choice and benefits, we believe consumers deserve respect and information. … We applied the Task Force recommendations to allow consumers to buy insurance through branches of a deposit-taking institution and to receive information tailored to their needs. The consumer benefits driving this policy recommendation are three-fold: lower distribution costs, enhanced service delivery, and improved access to insurance for more people. (Dunbar Russel, November 4, 1998).
If you look at any research we have, 67 per cent of Canadians said if they have a choice, they would like to be given the option to buy insurance in a branch because it is convenient. These people that sell insurance have to be licensed professionals. If they do not conduct themselves in a professional manner, they lose their license. Same thing as you do with a financial planner. (Holger Kluge, November 3, 1998).
Others argued against extending this power to deposit taking institutions.
What … will happen if banks sell insurance directly from their branches? I suggest they will be handed an open invitation into the private life of every Canadian who has ever opened a bank account, bought a home, applied for a loan or invested in a retirement plan. Banks have amassed and have access to a bounty of confidential information about your credit, medical, employment and personal history. They will be free to use it to their commercial advantage and with impunity. A bank may consider such information when accessing the risk profile of a potential customer. Without access to the same information pool, insurers are being invited to sell or go bankrupt. Banks are provided sensitive personal information for specific purposes. (George L. Cooke, October 5, 1998).
Some pointed to the resource disparity between deposit-takers and non-deposit-takers.
We had absolutely no objection to the chartered banks buying a life insurance company or starting one, which the law permits. They come into the business on the same basis as we come in. What we did not think was level was their having access to this unbelievably powerful database that would be almost impossible to compete with. … We are not lenders. We do not clear the cheques. The bank knows where the money goes. The bank not only knows how much, but exactly where it is going. The bank knows if you are buying a mutual fund from Investors Group because they see the cheque. The bank knows, if you are in small business, that you have your group insurance with Great-West Life and it knows how much it costs you every month. Is that a level playing field if you can do that? (Jim Burns, November 5, 1998).
This competitive advantage, they argue, would inevitably result in less competition.
We believe that implementation of the proposal to allow banks to sell insurance using bank customer information through their branches would result in an erosion of consumer choice, decreased competition, fewer products being offered and reduction of the advice distribution channel. Insurance cannot now, nor is it proposed that they be allowed to, take deposits. Insurers can participate in the deposit-taking industry by owning a bank. We believe that banks should participate in the insurance industry in the same way ¾ by owning an insurance company, as they are currently allowed to do. (Raymond McFeeters, October 6, 1998).
Deposit-taking institutions noted that life insurance companies would be given access to the payments system, allowing them to, in effect, take deposits. In the short run, this privilege would minimise the economic disparity between the two types of institutions but, in the long run, would completely eliminate all these concerns of inequity.
It is clearly in the interests of the consumer to level the playing field in the area of who can provide what service to consumers and on what terms. Using consumer preferences and needs as its guide, and bolstered by substantial and impartial research, the task force has recommended the removal of the current restrictions preventing federal deposit-taking institutions from retailing a full range of insurance products through their branch networks and offering lease financing services for light vehicles. The task force not only concluded that consumers will benefit from more choice and lower cost in insurance and automobile leasing, but has also cautioned that to deny choice in these areas would be "contrary to the public interest." It is unclear, however, why the task force does not feel the same degree of urgency in providing consumers with the benefits of greater competition in insurance-retailing and lease-financing areas as it does in urging broader access to the payments system. Further, if appropriate consumer safeguards are in place, why should consumer access to these products be delayed? (Raymond J. Protti, September 29, 1998).
P&C insurers expressed no interest in access to the payments system. They argued:
First, that the property and casualty industry was distinct. The task force accepted this proposition in its report, but it ignored it completely in its analysis and conclusions. Second, that the bank branch retailing of property and casualty products will raise serious privacy and coercive tied selling issues. They accepted that proposition but wrongly, in our view, believed that these issues can be addressed satisfactorily through legislation. … The report suggests that concerns about privacy can be addressed by adopting Quebec’s Bill 188. I suggest that this is a losing undertaking ¾ it takes us down the road of confusing and time consuming Byzantine regulations that are ultimately detrimental to consumers. (George L. Cooke, October 5, 1998).
In turn, insurance agents argue:
I believe that these actions, combined with the MacKay report’s polling data, speak loudly to those who have long denied that tied selling exists in the financial services marketplace. The task force reported being surprised at the number of Canadians who reported that they felt that a loan or a mortgage might not have been approved unless another product was purchased from the same institution. One in six Canadians and one in four self-employed Canadians felt that over the past three years one of their loans or mortgages may not be approved unless another product, such as insurance, was purchased from their institution. (Robert Thibaudeau, September 30, 1998).
The insurance companies add:
Our feeling is that the banks will use the current customer information to select a niche market of better-than-average insurance customers ¾ customers who have low claim records and above-quality properties. The less desirable risks will not be targeted by the banks, and therefore these consumers will be left with no alternative as to where they can purchase their insurance coverage. PEI Mutual, along with Canadian mutuals in general, has always been, and will continue to be, a fair player in the marketing of our insurance product. Identifying and insuring the best risks and leaving the rest has never been a high priority for our company. Our position is that we are an insurance company for the public at large, not for just a select few. (Terry Shea, October 20, 1998).
Insurance brokers predict that:
There is … a serious potential for cross-subsidisation, that is, one business line subsidising another business line in the overall interest of achieving market share, whether in auto leasing, auto insurance, home mortgages or home insurance and so on. The possibility of cross-subsidisation increases the more lines of business there are. … Surely public policy demands that the actual security of the banks be as transparent as possible. We have seen instances in the last 20 years where bankers have failed or have come close to failing in their duty where they strayed away from the primary focus, which is the security of their depositors. In the broader sense, this is an issue Parliament should be concerned with. (Fred Hyndman, October 21, 1998).
Some banks conceded this possibility for commodity-type insurance like P&C insurance, but not for differentiated products such as life insurance:
I will give you an educated guess. I think it will be less consequential for the life insurance industry, perhaps, than for the property and casualty industry. Life insurance is fundamentally a wealth management business. The reality is that the banks are losing market share to face-to-face forces in the wealth management business. They are not gaining market share. It is not clear to me that putting life insurance in the branches would be as devastating. Property and casualty tends to be more a product bought and not sold. It is more of a commodity product, which is why it is sold over the direct bank more easily. It could well be more devastating to property and casualty than to life insurance. (Ed Clark, October 7, 1998).
One witness described the Quebec situation in which the Desjardins Movement is able to distribute insurance products:
Our premise is quite simple. We are looking at our main competitor in Quebec, the Desjardins Movement, which distributes life insurance and general insurance. It has done so with quite some success, having brought downward pressure to bear on premiums all across Quebec because its operations are more systematic and seamless. It has demonstrated that by taking a systematic approach to the distribution of insurance, it is possible to provide consumers with lower premiums as well as more efficient claims settlement systems. That is the premise for our saying to the rest of the world that we are one of the only countries where insurance-selling banks are seen as futuristic. They are already a reality everywhere else, although I must admit not always a success. (Léon Courville, September 29, 1998).
and
The insurance area is obviously controversial, and our position is that MacKay seems to have come up with a reasonable idea. I can understand why the National Bank, given the market in which they are operating, regards this as a very important area, because essentially their main competitor is able to sell insurance in the branches. Similarly, we are the only major, non-bank financial institution that is not able to access its customer base. If we left federal jurisdiction, we would be able to do so. That seems to be an unusual regime to impose on us. (Ed Clark, October 7, 1998).
Deposit-taking insurance companies argue that if all these claims of abusive business practices and pending disaster to the industry were true, then we would observe them in jurisdictions where insurance is being sold in branches.
[ B] ecause of the growing market, the Task Force has discredited the notion that opening up the insurance competition in Canada would inevitably lead to massive job losses by brokers and others. International and Quebec experiences clearly demonstrate that a number of different distributors can exist side-by-side and continue to thrive. There has been little market disruption as a result of the European bancassurance activities.
A good example is Quebec. The Task Force observed there that insurance agents, brokers and companies continue to be strong competitors despite insurance retailing by deposit-taking institutions for the last decade. In fact, in the decade following the entry of the Caisses Desjardins into property and casualty insurance, the number of licensed P&C insurance brokers in Quebec has remained relatively stable, declining by 216 licensed brokers. That is on a total sample of 5,000. At the same time, employment at the Caisses related to insurance has tripled to 1625 positions. (Dunbar Russel, November 4, 1998).
Finally the banks argued that:
We have the advantage of being able to offer products to our customers in a more systematic fashion, which means that they have less shopping to do, receive better prices and benefit from the stimulation this provides. The more choices we offer consumers, the better off they will be. And the more competitors there are, the more likely it is that the market will evolve along those lines. The system for distributing insurance could be improved. Credit unions, banks and financial institutions operating in other countries have already proven that. (Léon Courville, September 29, 1998).
Conclusions
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.
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 with 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.
4. Light Vehicle Lease Financing
Background
Federally incorporated financial institutions (banks, trusts and insurance companies) are not presently allowed to lease light vehicles, either directly or through subsidiaries. In the 1980 revisions of the Bank Act, the vehicle prohibition threshold was established at 21 tonnes. However, credit unions and caisses populaires, which are governed by provincial legislation, are able to lease vehicles in all provinces except Newfoundland and New Brunswick. Trust companies that are provincially incorporated also have leasing powers in most provinces.
The Task Force viewed this debate in the context of the impact of new competitors on existing players rather than on consumers. The Task Force concluded that the only way in which consumers would not benefit from the entry of new competitors is: (1) if the new entrants were able to dominate the market and then engage in anti-competitive pricing; or (2) if the new entrants were to engage in coercive tied selling or abuse of personal information. In this way, these negatives could possibly outweigh the positive aspects of greater choice and price competition.
The Task Force considered all the arguments advanced by the stakeholders on this issue and concluded that, on balance, the benefits of greater consumer choice in automobile leasing substantially outweigh the disruption that may take place in the dealer marketplace. Accordingly, the Task Force proposed that sections 417 and 464 of the Bank Act and the parallel sections of the Trust and Loan Companies Act and Insurance Companies Acts should be amended to remove the current prohibition on the leasing of vehicles of less than 21 tonnes.
Task Force Recommendations
21) Subject to the adoption of appropriate privacy and tied selling regimes, federally regulated deposit-taking institutions and life insurance companies should be permitted to lease light vehicles, including automobiles, to consumers.
(a) Deposit-taking institutions and life insurance companies with less than $5 billion in shareholders’ equity should be permitted to lease light vehicles as soon as legislation in respect of privacy and tied selling is in place.
(b) All other companies should have access to the new power on January 1, 2002.
Views of Witnesses
Witnesses in favour of the Task Force recommendation argued:
We believe the banks should be allowed to be in that business. We think it … will result in more competitive terms which will benefit the consumers … if banks want to do it, and they have the balance sheets to be able to provide cheaper cost of funds, I wish them well. (David F. Banks, November 4, 1998).
They cited independent surveys showing that consumers support their entry into the auto-leasing market:
The survey also saw in MacKay was I think it is 77 per cent of Canadians said they would like to have the choice among insurance companies, banks, and so on, to make their insurance purchases. I could go into auto leasing in the same way. But I think that there is a compelling case in the sense it is more compelling than auto leasing because the rates are higher, 1.2 per cent higher than in the U.S. where banks are allowed to auto lease. (Charles Baillie, November 2, 1998).
On the other side of this debate are the leasing arms of the automobile manufacturers and automobile retail dealers.
The automotive industry’s long-standing opposition to bank entry into vehicle leasing is well-known. This opposition extends from the manufacturer through to the dealer. We believe that if banks are allowed to enter into this market, there will be a long-term reduction in competition, a lessening of consumer choice, an increase in leasing costs, adverse impacts for automobile dealers operating in virtually every community across this country and disruption of the automotive industry as a whole. (Maureen Kempston Darkes,, November 2, 1998).
They base these conclusions on the following arguments:
Now, this is a very bleak scenario for what is now a very healthy and productive industry. We believe that bank entry into auto leasing would bring about these results for six reasons.
First, leasing is not the equivalent of lending. Current restrictions on banks recognised this distinction. Leasing involves vehicle ownership, which entails responsibility for residual risk and liability risk management. Addressing these issues requires a continuing commitment to the automotive business that banks simply do not have.
Secondly, banks would be able to use their legislated cost of funds advantage to drive competitors out of the market. Moreover, it is not a viable option for finance companies to become a bank in order to compete on a level playing field. The costs of entry into the banking business are exorbitant, as has been previously stated to the Committee by other witnesses.
Thirdly, due to their dominant position in the financial services industry, banks have a history of capturing market share and driving out competitors in new markets through the use of loss leaders. Such a policy is not conducive to long-term support for the auto leasing industry and would be followed by reduced competition, and hence higher prices for the consumer.
Fourthly, if banks were allowed into the leasing market, Canada’s local dealers would be forced to compete with the same deposit-taking institutions who provide them with the majority of their operating credit. This would clearly be a conflict of interest.
Fifthly, vehicle leasing is a critical part of the automobile business, while it is only tangential to the business of banks. Vehicle leases, and particularly rate supported leases as low as zero per cent, a level unheard of for the banks that seldom drop below prime, were developed and popularised by auto manufacturers and their affiliated finance companies as a means of addressing vehicle affordability. This was particularly important during the period from 1988 when sales peaked at 1.5 million units to 1995 when sales fell to less than 1.2 million units. Without leasing, it is entirely possible that the trend of declining sales would have been further protracted with the loss of many more dealerships and jobs across this country. Would banks have a similar commitment to the industry during economic downturns? It is very doubtful. If banks are allowed to enter leasing and drive out competitors, including many smaller dealers, the industry will have fewer tools with which to support sales and economic activity.
Finally, affiliated finance companies are committed to providing support to dealers in various ways other than lease financing, such as wholesale floor plan inventory financing, in-house lease financing, equipment financing, mortgage financing and loans for working capital. They have acted as a lender of last resort for some business dealers whose financing needs have been rejected by banks. (Maureen Kempston Darkes, November 2, 1998).
These criticisms of bank entry into the auto-leasing market were supported by automobile dealers.
The banks have access to our most confidential information, including current lease portfolios, customer renewal dates and lease payment information. To let them compete with small businesses would create a serious conflict of interest. There would be an unfair advantage and one might wonder about tied selling issues at that point, knowing all they do about a consumer’s financial and purchasing background.
In their paper on leasing, … the task force argues basically that if leasing is so competitive, the banks will not be able to dominate or take over. But the bottom line is that the banks, with their size and deep pockets, have the power to dominate the market, and consumers will pay in the end. Similarly, the task force is dead wrong to say … that factory-leasing programs will be the hardest hit, rather than the dealers. Dealer leasing companies will be starved for credit on one hand and undercut on the other as the banks buy short-term market share. Independent-dealer leasing companies will be the first to go. We depend on the banks for our source of capital in order to lease vehicles directly from our own leasing operations, which are very viable, and a very crucial part of our dealerships, especially in economic downturns. They provide a steady flow of business and are not as cyclical as the sales end of things. (Gordon Hoddinott, October 1, 1998).
The banks, however, claim that a lease is just another form of loan and that they do not wish to enter the automobile wholesaling or retailing business.
We have been in leasing since a Bank Act review in the 1970s. We acquired a leasing company back in the 1970s because we were permitted to be in that business. We have not been permitted to do light vehicles, which is unique among other major countries with which we trade. A car lease, for example, is just an alternative to a car loan. We do not want to be in the car manufacturing business or in the car wholesaling business. We simply want to provide financing for our clients. We have been able to do aircraft and ships and heavy vehicles, and so on. It is just another form of financial service, and it is certainly recognised that way in the U.S. (John E. Cleghorn, Chairman & CEO, Royal Bank of Canada, September 29, 1998).
Further, banks make the following claim:
Auto leasing should be allowed by Canadian institutions. Auto leasing is the second largest purchase or lease by the consumer. It is controlled by foreigners. GE Capital, which is bigger than the Royal Bank, can lease cars in Canada but the Royal Bank cannot. I find that incredible and that should be changed. That does not make any sense to me at all. You are preventing your own financial institutions from doing something. I think you could help the consumer because if the Royal Bank can come up with a better lease than GE why should they not be allowed to? (Larry M. Pollock, October 28, 1998).
Conclusion
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 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 lead to lower costs to them.
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 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 which 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 bypassed or prevented from offering the same products that his competitors offer;
- 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/or 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.