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

Issue 15 - Evidence

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OTTAWA, Thursday, May 17, 2001

The Standing Senate Committee on Banking, Trade and Commerce, to which was referred Bill C-8, to establish the Financial Consumer Agency of Canada and to amend certain acts in relation to financial institutions, met this day at 10:00 a.m. to give consideration to the bill.

Senator E. Leo Kolber (Chairman) in the Chair.

[English]

The Chairman: Once again we will hear testimony on Bill C-8, to establish the Financial Consumer Agency of Canada and to amend certain acts in relation to financial institutions.

I am pleased to welcome, by videoconference, Professor John Chant, Department of Economics, Simon Fraser University. Good morning and welcome. Please proceed with your opening statement and then senators will ask you questions.

Professor John Chant, Department of Economics, Simon Fraser University: I have studied Canadian banking for about 40 years. In the 1970s, I was a director of the financial market group at the economic council that produced input for the Bank Act of 1980. I think we were the first people who proposed a distinction between Schedule I and Schedule II banks. I worked several years ago for the MacKay task force.

Flexibility appears to be a watchword in the government's policy toward the financial sector and appropriately so. The financial industry has been changing rapidly and can be expected to change rapidly in ways that we cannot anticipate in the future. The reasons for the changes are clear. The financial industry is an information industry. Even though the pace of change of information technology may itself have slowed, the financial sector is still coming to grips with new information technologies and what they mean for business strategies.

This flexibility of government policy shows up in a variety of ways in the government's package, such as the holding company proposals, the ownership rules and the broadened access to the payment system. Most important in terms of flexibility is that it created a process for dealing with mergers. It established the principle that they are possible, thereby removing the roadblock of the unwritten "big shall not buy big" policy. This is important because mergers may be a viable and even vital business strategy for our banks.

That said, there is a public interest in mergers because of their impact on the state of competition in the financial services sector and because of concerns about safety and soundness of the financial system. These issues have been dealt with through the provision for review of proposed mergers by both the competition and the prudential authorities.I think these reviews, by themselves, are sufficient to protect the public interest in the mergers.

While the change in policy towards mergers is most welcome, I do remain concerned that the mergers may not pass the competition test. The letters from the Competition Bureau to the presidents of the banks in the case of two recent proposals raise a number of concerns. I expect that some of them are anticipated by the banks and can be dealt with readily. Others, especially competition with respect to services offered through branches, will be much more difficult. Banks would be required to divest themselves of numerous branches.

To make sure that this possible vital business strategy can go through, there is a need for a policy to ensure that there is a wide range of possible buyers. The potential buyers now include foreign banks operating through subsidiaries, credit unions and other Canadian institutions. I am not sure whether this roster will be sufficient.

I should like to see a more open approach to the branches of foreign banks. Currently they are limited to developing retail business by the floor on their deposit-taking powers. They cannot take deposits of less than $150,000. These restrictions are important because the Office of the Superintendent of Financial Institutions, OSFI, does not have oversight with respect to their parents. This is an issue for branches but not for subsidiaries because they are an integral and inseparable part of their parents' operations.

I suggest that we expand our approach so as to allow foreign branches into all banking business, retail as well as wholesale. The only way we could do this would be by making foreign authorities responsible for their branches in Canada and making them offer deposit protection to Canadian depositors on the same basis as they do to domestic depositors.

How can we achieve this? We might do this through extending NAFTA by creating a single banking market within NAFTA. Alternatively, we might also do it in a less structured way by negotiating reciprocal agreements with other countries and possibly the EU. These agreements would specify the obligation of foreign authorities with respect to the operations of their banks through branches in Canada. Similarly, the Canadian authorities would have to take on responsibilities for their branches in other countries.

What would be the benefit of such an approach? First, it may possibly expand the number of potential buyers for branches and other businesses of which the merging banks must divest. In addition, it might provide an alternative route for the entry of foreign banks. By its reciprocity feature, it might provide better business opportunities for Canadian banks in foreign markets.

Some may argue that this additional channel is unnecessary, claiming that foreign banks can already do anything through their subsidiaries that this branch proposal offers, but we should not try to second-guess the benefits of different strategies to foreign banks. Possibly the critics are right and maybe we will offer these arrangements and no one will use them, but the costs are small and the approach is consistent with an emphasis on flexibility elsewhere in the government's proposal.

In conclusion, I am worried that viable and even vital business strategies may not be possible under current conditions. We may be faced with the same conflict that we have with respect to the airlines and the booksellers. I would like to avoid the conflict between competition in domestic markets and the ability of our banks to be strong global competitors. It should be a priority to find solutions out of this dilemma.

My proposal, is discussed more fully in a paper that will be published soon by the C.D. Howe Institute.

The Chairman: Thank you, professor.

Senator Meighen: You should have told us where we could buy this book so we could all rush out and get it.

Mr. Chant: I will see that you get it.

Senator Meighen: Make sure we pay full price.

I notice that you have written and published quite extensively on the matter of regulation. While you did not deal in any great detail with that this morning, I have a question about it. Many of the witnesses that have come before us have commented on the large amount of what is left to regulation in this bill. Do you share that view?

Mr. Chant: I have shared it. There are some areas where I think the regulation is necessary and others where I am less convinced, and others where I think that the proposed regulation is not quite as drastic as it sounds.

Let me start with something that I think is very important. The Minister of Finance has been given powers over the CPA with respect to its decision-making. I gather that when they establish a rule, it does not come into effect for 30 days. During the 30-day period the minister's staff has a chance to look it over. I gather that the minister can make directives to the CPA.

I think this is really important because the CPA is our central payment system and at times in the past there have been rules that were unfortunate. Rules that may have been appropriate at one time ceased to be appropriate at another time. Having a review of the rules of the CPA is essential. Even the drastic step of having the minister be able to issue a directive to the CPA is important.

However, there is one area at the other extreme where I think they have gone too far, and that is with respect to the low cost account. The low cost account was an idea that came up when I was working for the task force. Our staff studied the low cost accounts that existed in the United States, and found that five out of the six big American banks had a low cost account that was on better terms than the low cost account that was mandated in the State of New York. That is an area where I think that probably the approach is more than is necessary.

I am a little bit surprised that a regulation or provision that suggests a certain amount of notice be given for a bank branch closure is regarded as excess regulation. I think that the three months is quite a reasonable time for bank closures.

There are some areas where the increased regulation is quite justified, and there are other areas where it may go too far. There is another area where I accept it.

Senator Meighen: On a totally unrelated issue, I want to turn to the 10 per cent to 20 per cent rule, or the 10 to 20 plus 10 rule, I guess. First, I would appreciate any comments you might have on that subject. As one who once thought it was a good idea, I am now sort of having second thoughts. I am not quite sure I know why I thought it was a good idea to start with and why I think now it might not be. Perhaps you can help me clarify my own thinking.

I was under the impression that when the 20 per cent was proposed it was done to enable banks to enter into strategic alliances with other financial institutions. I am left with the view that maybe that will happen but, it is not necessarily something that will happen because there is nothing to stop IBM, Defasco or Teachers' Pension Plan from buying, with the permission of the minister, 20 per cent of one of our chartered banks. That, I would suggest, might not be in the spirit of why we are going from 10 to 20 plus 10. Do you have any comments on that?

Mr. Chant: I have not looked at the details of the Banking Act. I have looked at the summary prepared by the Parliamentary Research Bureau. I think the notion of "strategic" that modifies the ownership arrangements is vital. I can see a lot of motives for someone wanting to invest beyond 20 per cent. Someone might want to invest beyond 20 per cent to get a beachhead in case the ownership provisions are extended even further. I can see a bank becoming worried about that and getting a white knight to extend beyond the 20 per cent to freeze out other people that might come along and challenge the management in control.

To me "strategic" means something to with a business strategy or with forming an alliance. I think that the initiative for a strategic investor going beyond 10 per cent to 20 per cent should come from both from the investor and from the bank, and the strategic dimension should have to be justified. I imagine, if nothing comes of it after awhile, it should be rolled back so that there is a possibility of another strategic alliance. I am worried that once someone passes beyond 10 per cent they freeze out all other possibilities. I think that the approval process will be vital.

I am sorry I do not know what provisions there are in the law with respect to the nature of the approval process.

Senator Meighen: You used the words "freeze out." Is that your judgment of the practical effect of someone owning 20 per cent, let alone 20 plus 10? In theory, you could have two or more owning 20 per cent, could you not?

Mr. Chant: I have not looked at the law in detail. I thought that with the mention of a strategic investor one person would be allowed to move beyond 10 per cent. I am sorry. I should have looked more closely. If a bank forms a strategic alliance with let us say two banks, my understanding is that would be taken care of in the one permission to go beyond the 10 per cent, but I am not sure.

Senator Meighen: You are putting a lot of emphasis on the word "strategic." Are you suggesting the minister should judge whether or not it is a strategic alliance? I do not know how he or she would do that. Is it something that the bank has to judge?

Mr. Chant: Let us go back a step.Again, I should have looked at the proposed laws. I am not sure that the bank has any say. If IBM comes along and if their proposal is strategic, I have to assume that at least half of the strategy comes from the bank. There should be an onus on the bank to say, "This is a strategic investment because we are now going to be a global bank by making an alliance with a European bank. We will be able to do things we were not able to do before."

Perhaps I have attached more significance than I should to the word "strategic", but I would say that any movement above 10 per cent should be justified as strategic to a bank's objectives.

I do not want to speak for the task force, but I think that was the task force's intent. It goes along with the domestic holding company. It allows banks to do things in better ways than they could before.

Senator Poulin: Professor Chant, one of the first points that you raised was the objective of flexibility for our financial institutions. You felt that even more flexibility and more openness is required. I think that I heard you say that. My question is not on the appropriateness or the need for more flexibility and more openness. My question is on the implementation of Bill C-8 - the implementation meaning that this is a change that will be implemented in our country. I am a strong believer in the gradual implementation of change. In other words, I can be accused sometimes of being too prudent.

Is there anything in Bill C-8 that would prevent our government or a future government from adding changes after appropriate evaluation of the consequences of the implementation of Bill C-8 in its current structure with the regulation that will follow?

Mr. Chant: In other words, have we put in roadblocks to future flexibility, in a sense? I do not think so. For example, the holding company proposal is completely in line with your philosophy. Banks do carry out businesses that do not need much regulation. The holding company proposal is the beginning of an attempt to see what we could do in the future.

The prudential authorities, quite rightly, were concerned about whether we will lose control of vital aspects of the banking system. The holding company approach allows experimentation with putting this part of the banks into a holding company and subjecting it to lighter regulation. We would be able to say down the road that it worked for that activity and it was obvious that it did not need much regulation. Over time, experience may tell us that we must stay where we are and not go any further. Experience might tell us that there are a number of aspects of the banks' activities that can be put into holding companies, about which OSFI need not worry. The proposal appears to be an envelope approach that will provide for greater or lesser scope in the future as we move forward.

I view the 20 per cent ownership rule, as you heard earlier, quite narrowly, but perhaps in the future people will be able to view it more broadly and there may be more possibilities. The weight that I put on the word "strategic" will not be worried about in the future. It is an approach that fits with your philosophy.

It is early in the morning, but I cannot see areas where we might be blocking things for the future. I have gone to many other countries and told them about Canada's ten-year and five-year review process. It means a large amount of work for you people and others, but it is vital to provide us with a banking system and a financial system that evolve with the changing world. I am not worried about inflexibility. I think that we have a good balance.

Senator Tkachuk: I would like to turn to the area of competition. We had the credit unions and co-ops before us over the last number of weeks and the credit unions yesterday. Their concern was that there were impediments, or at least, that the bill did not clarify their ability to move into the banking business in the way that they felt that their corporate structure would allow them to do.

This morning, you raised issues about the impediments put forward to branch banking, which is really the retail end. We have lots of competition from people getting into the business end of banking but the retail end of branch banking is where some of our problems will be.

The two major players, that we hoped would provide competition in case of mergers, say that Bill C-8 does not give them the flexibility to move forward in this direction. If this is so, how will the Competition Bureau justify mergers today that they did not justify before the bill?

Mr. Chant: That is the biggest question that we face. I have not been able to put my mind around the proposals for credit unions in the way that they have. It would be unfortunate if the bill does not allow them to become a more national system. The task force did have the possibility for co-operatively owned banks in its proposals.

I am concerned about what would happen if the Competition Bureau went through bank mergers again. There have been some changes. Some new types of financial institutions have grown up that may have solved some of the issues, but they have not solved them all. The disposal of branches is the biggest issue. My paper for the C. D. Howe Institute had a section called "Who Could We Turn To?" I was quite pessimistic that the credit unions could absorb many branches. I am somewhat pessimistic about the roster of foreign banks. I made a suggestion about how we might open it up to a wider range of branches.

I wish that I could understand the proposals better with respect to the credit unions because I think that they will not be the entire answer. Dealing with the Competition Bureau's concern, we must look at an accumulation of possible answers rather than one answer for the new competitor. It would be unfortunate if the credit unions do not have the scope that they feel they could manage.

I am sorry if that was not very concrete.

Senator Tkachuk: The bill lends itself to that very point. It does not clarify and does not jump into opportunities for both foreign branch banking and co-op and credit union banking to take over branches or to provide competition to the big five, which may become the big three or the big two and one half.

If an attempt were started today to put together your idea of an arrangement like NAFTA or an arrangement with European countries to allow the home insurer of the bank to insure the deposit, how long do you think it would take before this kind of agreement, if everything went reasonably well, could take place?

Mr. Chant: I would guess, if it went very well, it would take three years. I cannot see it as something that will take place in six months.

Senator Kroft: I have two questions, one general and one specific. The specific question deals with the effect of the provisions of Bill C-8 in keeping the two major demutualized insurance companies separate as widely held entities and not available for takeover by the banks. I would appreciate your comment on this attempt to keep those pillars independent, at least for the time being.

Mr. Chant: This fits in well with what I have been talking about and the concerns expressed in the last question. One might ask why one would worry about the insurance companies being independent. The insurance companies are losing their independence elsewhere in the world. If we cannot find ourselves an appropriate solution for the banking sector, I do not think we want to lose the insurance companies. If we get ourselves into the situation we appear to be in with the booksellers or the airlines, then I would want to wait until we found a satisfactory solution for the banks, allowing them to pursue their strategies at the same time as ensuring domestic competition, before I would do anything with the demutualized insurance companies.

Senator Kroft: You would have some optimism about their ability to play a meaningful role. I think your task force talked about them becoming, effectively, banks. You began to call them banks.

Mr. Chant: I have guarded optimism, but I think we need to preserve and allow scope for the things that we have left - coming back to the previous questions - the credit union system and the demutualized insurance companies.

Senator Kroft: We have had a remarkable consensus revealed among those who have appeared before us. One of my colleagues referred to it as a love-in yesterday. Looking at the whole process as you have, from the task force forward, what is your view of the consensus that appears to have been built? There have been a few watchdog type agencies that have thrown up cautions, but the major players before us have shown general approval for the bill and said not to touch it, not to amend it and to pass it as fast as we possibly can. Do you see this development as a healthy one?

Mr. Chant: The direction of the bill is right. Many of the concerns I have raised are the concerns the minister will have when dealing with merger proposals or perhaps indicating what the conditions will be when he considers merger proposals. The general direction of the bill and its flexibility part are important. The financial system moves quickly and we cannot anticipate where it is moving. These provisions are very good.

I am not sure I am qualified to be a participant in the love-in, but I am not going say they are wrong.

Senator Kelleher: Notwithstanding the love-in espoused by Senator Kroft, the Canadian Bankers Association, CBA, when it appeared before us yesterday, still expressed regret - I will put it that way - at being closed out of insurance and auto leasing. What are your views about that? If you agree they should be shut out, could you give us your reasons why you think that is reasonable? If you disagree, could you tell us why you disagree?

Mr. Chant: I tend to agree with the CBA. Competition in financial services is important and the distinction between financial services is changing. The ability to retail insurance through branches is a logical next step associated with this change.

With respect to automobile leasing, bankers are all around automobile leasing, from every direction. They have arrangements by which they can come close to automobile leasing. They can lease everything right down to automobiles. The terms of their automobile leases would add to the competition for consumers and businesses. I would agree with CBA's regret.

Senator Kelleher: Given your answer and possibly the need to do further things in the future, where do we go from here? One could say no sooner do we get this bill passed than we may have to look ahead because of the fluid situation in the financial community. Perhaps we will have to start almost immediately with a review. Do you think we should stop and pause for several years to let the new legislation take effect?

Mr. Chant: You will not have a very long pause because of the five-year provision. You probably will be examining it earlier than you intend because I believe when merger proposals come up we will see we have not got ourselves out of the bind yet. We will have to find ways to get out of the bind. Perhaps the ways to get out of the bind are to revisit the credit union views that you heard yesterday and to revisit the role of foreign banks. I am not sure the banks would want their mergers being held over for another five years, but if the Competition Bureau looked at the mergers next year, it might find it has a more optimistic approach to report than it did before. However, many things had to be done to satisfy it the last time.

Senator Angus: I want to go over a few points. I presented a speech in the Senate at second reading of this bill. In that speech I indicated my reluctant approval. My concern is that, based on the evidence that was brought to Parliament during the MacKay task force and the subsequent hearings on those findings, there is general agreement that the bill does not provide a broad vision of Canada's direction in the financial services industry. Even though it has been characterized as framework legislation, I fail to see the framework of a policy direction. Rather, I see a hodgepodge of technical amendments. Do you share that view, professor?

Mr. Chant: It would be a fearful task to be commissioned by the Senate to give a broad vision of the direction in which the Canadian banking system is moving. I am sure that I would disappoint you. Actually, I might give you a wonderful vision, but in five years time you would be disappointed and point out to me that I had omitted to tell you about this and about that.

A framework that financial institutions can adapt to the changing circumstances is the best that we can do. One danger with a vision is that it is possible for it to be too specific. I think that this framework provides two-thirds of what we need to allow our banking system to develop into a strong, international industry.

The ownership change allows them the flexibility to work out arrangements with others. The holding company allows them to sort out their businesses according to the need for regulation. The framework, in terms of their national structure, is about the best that we can do.

On the other hand, we fall short in consideration of the slate of competitors that will be there when the next merger proposal comes. I proposed a way for the medium term by which foreign banks might become a greater competitive presence, and might become potential buyers of the services that the banks must divest themselves of. My suggestion is not the complete story, but just a piece for dealing with the future.

With respect to the mergers, we have ourselves in a major bind, and we have to think of productive ways to get ourselves out of that bind. I am a hard marker to students, but when you say that we do not have a vision, that sounds like you are giving it a C or a C-plus. I would be more optimistic and give it a B-plus. That is not bad. It has been done as well as one could in the vision direction by providing a framework.

Senator Angus: That answer is helpful. We have been told, rightly or wrongly, by many of the institutions and their leaders, that they do not like the bill, but they want it. I characterize that as a Hobson's choice. If you do not like it, why do you not like it? At least let us try and improve it for you. On the other hand, you really need it now, if you are going to keep up and participate in the global game. Obviously we would like to facilitate that goal. I am encouraged by your answer.

In reading the legislation, the guidelines and the process for approving mergers, this bill will be a deterrent, in a way, to mergers in Canada. Would you agree with that? Can one reasonably draw that conclusion?

Mr. Chant: I said in my statement that I would be quite content to have the Competition Bureau and OSFI be the sole inputs to the minister.

Senator Angus: Would there be no ministerial discretion?

Mr. Chant: There would be ministerial discretion, but with those organizations as the sole inputs. The message in the Competition Bureau statement would be quite clear and the message in the OSFI statement would also be quite clear. Let them deal with it.

The Competition Bureau's criteria, or standards, will be difficult to solve. Those two organizations deal with safety and soundness, and competition and financial services. It may be that the call is close enough between them that one would want to allow ministerial discretion. I am certain that, when the minister gets the reports from the Competition Bureau and OSFI, they may have to set out provisions for the merger to proceed. Some ministerial discretion would be necessary there.

Senator Angus: Having listened to information and having read quite a bit about it, I am beginning to form the view that we should be careful in Canada. We have a unique banking system, and we should be careful not to mess it up. It is wrong for people to suggest that, in the U.S. and in other countries, with whom we do business, you can go ahead and merge and then obtain the approval after the fact. Certainly, as a business person, that would be much easier and it makes more sense because it appears to be a more friendly environment for the evolution of our industry in the global marketplace.

On the other hand, a witness said that you cannot compare apples to oranges. This is Canada with our geographical particularities and our small number of developed institutions. We are unique and that uniqueness requires a special environment. We cannot be compared to other countries with whom we do business. I am quite persuaded by that. I should like your view on that.

To an American, a British or a Dutch person, Canada may seem to be a maze of regulations and political controversy. It may seem to them that the cost of doing business here would be more than they could ever make doing business here. As a result they might decide not to make the effort.

Mr. Chant: I agree with what you said about apples and oranges when comparing us with the States and the approval process. There is a movement in the United States toward a banking system such as we have. Mergers are of less concern in the States now because banks that operated in one region are getting together with banks that have operated in another region and the impact on any particular market may be very small. It is just putting together the start of a national bank.

Senator Angus: It is a convergence.

Mr. Chant: We are the apples and they are the oranges. I do not think any parallels to the United States are warranted. The United States is different from us.

I enjoyed this difference for many years when I went to other countries to talk about the Canadian banking system because they did not want experts from the United States. This difference will disappear over time as the American banking system becomes more like ours.

We ought to look at our own circumstances. The merger review from OSFI and the Competition Bureau is quite appropriate.

Senator Angus: That is very helpful.

To conclude, yesterday we had the witnesses from the ING Bank of Canada which portrayed itself as a direct or virtual bank. It was quite an interesting model, in fact. The witnesses indicated that ING Bank of Canada is in the retail field and is the only competitor doing basically the same thing as the CIBC President's Choice Financial initiative.

They expressed considerable disappointment with the bill. In fact, they are the only bankers that have come here and candidly said that they did not like the bill because there is little in the legislation that creates a more level playing field or that exposes the traditional larger banks to more international competition in a way that may bring benefits to Canadian consumers of banking products. Nearly all the so-called "measures" to faster, greater domestic competition do not apply to ING or to other small or big foreign players who might want to come into Canada. Most of the existing hurdles that new entrants like ING must jump over still remain in place, notwithstanding Bill C-8.

The ING representative itemized the hurdles. He said that there is an onerous regulatory environment. He explained that the red tape is much more onerous here than in Holland. He noted that if ING complied fully with the regulatory regime in the Netherlands, it should be good enough for us. He went into a few good examples.

He then talked about the capital requirements, the capital tax, other tax burdens, the CBIC deposit insurance premiums and the current closed nature of the Canadian payments system. He allowed that, as a result of negotiations and in an enlightened attitude at Canadian Payments Association, CPA, this last hurdle in effect was being obviated. That is a good thing.

I told him that we were here to improve the bill, if necessary. I asked if there were an area in which we could improve the bill, if there were some amendment we could bring to help fix his problem.

Mr. Chant: This is along the line of my statement in that if we get assurances from their regulators and they are covered by a level of deposit insurance that satisfies us, which is an open question, foreign banks should be able to enter the retail business. If they fail, we would have a commitment from the Dutch regulators that Canadians would be protected by deposit insurance to the same degree as the Dutch.

In saying that, one might wonder whether we would allow let a country in that offers only $500 deposit insurance. Perhaps we would not. Perhaps we want to set a minimal standard that one must have a sound regulatory regime that meets capital requirements and has acceptable deposit insurance. If its authorities guarantee it and if Canadian banks are allowed into that country on the same basis, it would be quite fine for a foreign bank to operate in the retail business as a branch.

As I said, I will ensure that you get copies of my study for the CD Howe Institute when it comes out soon. I will clean up my initial statement and fax that to Mr. Robert later today. I think that it touches on this.

I had not realized that ING had made such a statement. I heard comment on my paper that foreign banks should be allowed to operate in Canada in certain ways and why would they need more ways. I think that it is probably a mistake to try to second-guess the arrangements by which foreign banks would want to operate in Canada. As long as we ensure that we have the prudential safeguards, then I think we should consider that possibility.

Senator Angus: Perhaps, Chairman, we could ask the clerk to send Professor Chant a copy of the brief from ING. It does list some interesting objections that are within the spirit and the intention of Bill C-8, which is liberalize and to make it easier for legitimate competitors to operate here. This is an area where we should do everything that we can.

Senator Tkachuk: This point was raised by the answer given to Senator Angus. The bill is described as an Act to establish the Financial Consumer Agency of Canada and to amend certain acts in relation to financial institutions.It is an appropriate description.

I know that you rated it a B-plus bill. Who am I to argue with a professor?

Beyond the holding company and ministerial discretion, which is what governs everything else including the 20 per cent rule and, it seems, almost every part of the bill, what was done in the bill that provided a new framework for competition, that solved the process of mergers or that allowed small players like the credit unions and foreign banks, which you earlier said have impediments, to get into the banking game? What has this bill accomplished in a major way?

There are many technical things, but what major thing did the bill accomplish?

Mr. Chant: When we look back on it 10 years from now we will find that the holding companies did offer Canadian financial institutions greater flexibility to manage their affairs and that certain financial services would be provided more competitively than before. I am less clear on this, but we may find that banks have taken up the opportunity to get strategic investors under the 20 per cent stipulation and will have found ways to increase their global presence through alliances rather than doing it all themselves.

This will be an outlet for some banks. I am less optimistic about that. Making it clear that the big shall not buy big is no longer hanging over mergers and that has been useful. I do find that the shortcoming that greater provision for foreign banks was not made.

The bill provides a framework. I do not know the details of the credit union complaints, so I cannot speak to them. I did speak to the foreign bank complaint. I gave the B-plus rating in terms of the vision. It is very difficult to form a vision, and the bill did provide flexibility in different ways.

It is hard for me to imagine other ways that are necessary. I wish that I had heard the complaints of the credit union so I could speak to them more fully.

The Chairman: Thank you, professor. You have been very kind and helpful.

The next witnesses will be from the Competition Bureau, Industry Canada.

We welcome Konrad von Finckenstein, Commissioner of Competition, Richard Annan, Assistant Deputy Commissioner of Competition and Gerry Birks, Competition Law Officer. Good morning. Please proceed with your opening statement.

Mr. Konrad von Finckenstein, Commissioner of Competition, Competition Bureau, Industry Canada: Thank you for inviting us and giving us an opportunity to comment on the financial services legislation.

There are two main changes to the act that arise out of the new legislation. The first is proposed section 29.2, which relates to information sharing. Under the new legislation, the Commissioner will have the authority to communicate information that is specifically requested in writing by the Minister of Finance. This new section of the Competition Act will allow the commissioner to provide information collected, received or generated in the context of a merger. For his part, the Minister of Finance must certify that the information will only be used for the purpose of making a decision in respect of a merger or proposed merger.

This differs from the previous practice where the commissioner was prohibited, under section 29 of the Competition Act, from providing any confidential information.

The other section of the Competition Act that is amended by the legislation relates to paragraph 94.(b) of the act. The existing provision provides that the competition tribunal shall not make an order in respect of a merger under the Bank Act, the Trust and Loan Companies Act or the Insurance Companies Act that the Minister of Finance had certified is in the best interests of the financial system in Canada. This section has now been amended to take into account the new power of the Minister of Finance to impose terms and conditions on such mergers.

These amendments are technical in nature and complimentary to the new merger review process introduced by the legislation.

[Translation]

As for other elements of the new legislation, their objective is to allow domestically based financial institutions to become large enough to compete internationally while maintaining an acceptable degree of domestic competition. In my view a number of the proposed changes will have a positive impact on competition in the financial services sector.

First, the new legislation modifies the widely held ownership definition. Under this amendment the 10 per cent limit on individual shareholdings is increased up to 20 per cent for voting shares and 30 per cent for non-voting shares. This should make it easier for financial sector companies to engage in strategic alliances either domestically or abroad. Such alliances should make it easier for our domestic institutions to achieve the size and strength necessary to improve their competitive position abroad.

[English]

Second, the new holding company regime provides a structure to unite banks, insurance companies and mutual funds under one banner. These structures will allow banks the organizational flexibility to best complete in the international arena.

Third, the more liberal ownership rules will make the formation of smaller community-based banks much easier and could help in the formation of a strong second tier of financial institutions that can, in certain instances compete with the large banks.

[Translation]

Finally, expanding access to the payments system for insurance companies, securities dealers and mutual funds could provide for more competition for deposit-like services, and provide Canadian consumers with useful alternatives for these products.

In addition, there will be a new merger review process as described in the Merger Review Guidelines. Although they have no direct impact on the way the Competition Bureau reviews a proposed merger, these Guidelines will be useful for the merging parties in that they clearly identify the steps to be taken to get a decision. The Merger Review Guidelines do not, however, prevent the banks from proposing concrete remedies to potential competition issues before the analysis and decision process has been completed.

[English]

As a final comment, I would like to note that the proposed legislation would not have a substantive impact on how the Competition Bureau would perform its analysis, if and when confronted with mergers in the financial sector. As in 1998, the Bureau will follow the process laid out in the bank merger enforcement guidelines issued by the Bureau.

The only difference will be in the context of the analysis of mergers where efficiencies are claimed by the merging parties. As a result of the recent Federal Court of Appeal decision in the Superior Propane case, the Bureau will apply the principles set out in the court decision. The sections of the merger enforcement guidelines and the bank merger guidelines dealing with efficiencies are being rewritten in order to reflect the Court of Appeal judgment. When measuring the trade-off between efficiencies gained versus the anti-competitive impact of a merger, the Bureau will now consider a broader range of competitive effects consistent with the general purposes clause of the Competition Act, and particularly how the efficiencies benefit Canadian consumers.

We will be glad to answer your questions.

Senator Angus: I think that the last time you were here we were considering whether to change your name from director to Commissioner. How is it going as Commissioner?

Mr. von Finckenstein: The work has remained the same. As always, it has been a fascinating job. There is never a dull moment.

Senator Angus: I am interested in the last part of your testimony. It has been a while since I read the report. I think that I did have an opportunity to review excerpts of the report from your Bureau on the proposed merger of the Royal Bank and the BMO and the CIBC and Toronto Dominion.

My recollection is that you found that those would not be good for Canada from a competition point of view? Am I correct?

Mr. von Finckenstein: We specified that the mergers as structured would lead to substantial lessening of competition. We then pointed out that there were certain solutions that might be attempted in order to remedy those anti-competitive effects. As you know, we never got to that stage because the Minister of Finance, on the basis of our report and the report of OSFI, decided that proceeding with the mergers would not be of national interest.

Senator Angus: On the basis of your report, indeed. You say in your statement that you:

...would like to note that the proposed legislation will not have a substantive impact on how the Competition Bureau would perform its analysis if and/or when confronted with mergers in the financial sector going forward after the implementation of this act.

I take it that refers to process or procedure, even though the word "substantive" is there. There are new policies and new rules, so would I be right that you could now come to a different conclusion?

Mr. von Finckenstein: The word "substantive" is there to mean that the provisions of the Competition Act dealing with mergers have not been changed. We will apply exactly the same process, the same analytical process, take the same issues in consideration and come to a conclusion based on the facts presented to us. Now, I have no idea if and when a merger will be presented to us, nor what type of merger it might be. Obviously, the conclusion that we reached three years ago may no longer be pertinent. That will depend on what changes have taken place in the industry, the specific merger put forward and the specific remedies proposed.

All I am trying to indicate is that this act makes it easier for us to exchange information with the Minister of Finance. We had that problem with the last one.. In effect, when the banks gave us information, we could not share it with Ministry of Finance. We had to tell the ministry to get the information on their own because by law, we were prohibited from giving the information to them. Now, if the Minister of Finance asks for information and informs me that it will be used only for a specified purpose, I have the capacity to give him that information. And, more importantly, not only am I able to provide him with the information, but with the analysis that we made on the basis of that information.

Senator Angus: That is helpful.

Business people like to see things in black and white. People think that in our past Canada's policy was to be against bank mergers. For example, the Competition Bureau found that if they were tried, they would lessen competition and this would not bring about any significant benefit to Canada. This act changes that. Now, the Minister of Finance is trying to put out the sense that yes, Canada is in favour of mergers. However, in order to merge banks the investor will have to go through this new process. That new process will include dealing with OSFI and the Competition Bureau and this very committee and the House of Commons Finance committee. We will all have a role to play in the process.

I understand from your answer, assuming there have been no other major changes out there in terms of the competitive environment, that if a merger were put before you today it would get basically the same mark, a C-minus.

Mr. von Finckenstein: Senator, I do not quite agree with your characterization of what happened in 1998. Take the specific merger of the Bank of Montreal and the Royal Bank, for example. We found, in the various lines of businesses that the banks were in, three problem areas. The first problem area was in branch banking and more specifically in the chequing and savings accounts. The second area was in the credit card business. The third area was the full service brokerage where the banks handled the trade and also gave advice to the investor. We suggested that if the merger were to proceed, these problem areas would have to be addressed and remedies would have to be negotiated.

The process now is the same as it was then. You need a double approval. You need approval from the Competition Bureau, and you need approval from the Minister of Finance. The Minister of Finance has made it quite clear that he will not overrule the Competition Bureau, so, if they have problems, then they will have to be addressed through remedies. If a merger now comes forward we will review it to see if there are common business that the partners are involved in and if there are any areas where there will be a substantial lessening of competition. We will take that information to both the banks and to the Minister of Finance.

In the event that the Minister of Finance responds that these are not in the national interest the then the investors must see first, the Competition Bureau, and second, the Minister of Finance concerning his issues of national importance other than competition. At that point, the negotiations will take place separately. The investors will deal with us on the competition issue and with The Minister of Finance on the issues that he highlights. At the end of the negotiations there may or may not be a resolution and a merger.

Now built into the process, as you rightly point out, is consideration by this committee and by its counterpart in the House of Commons. You will be adding your views to the mix.

The ultimate decision rests with the Minister of Finance to approve or not. However, the precondition to any approval now, as it was in 1998, is that the issues identified by the Competition Bureau have to be resolved.

Senator Angus: One of the main issues that you pointed out in your report on those two specific mergers was the risk in retail banking. In our studies, we have learned that there may not be many people interested in getting into retail banking. The foreign banks are not particularly interested in coming in here and buying up retail branches of the Bank of Montreal or the Royal Bank et cetera. They would rather get into the big money such as wholesale and commercial banking. Even with the credit unions and Caisse Populaires, we understand that there might not be, notwithstanding new incentives that might be put in place by this bill or otherwise, a rush to fill a potential void.

Assuming for the moment that our findings are correct, is it a reasonable conclusion for me to derive from your evidence, that as long as that situation exists, it will be pretty tough in Canada to allow a consolidation in our major banks? I think the phrase used in England was a second tier of retail banks to come into the fray.

Mr. von Finckenstein: I find it difficult to accept your assumption that there are no purchasers for retail branches. When we did the merger in 1998, there were several contacts we had for both domestic and foreign banks. They were both interested in picking up branches. It depends where they are located and how many they are as a critical mass. Does it fit to their existing strategic plans, or do they already have presence in Canada to the Canadian presence?

As you know, since then we have had the merger of Toronto Dominion and Canada Trust. We made the merging parties sell 13 branches. There was no problem of disposing with those branches. I have trouble accepting the assumption that retail branches cannot be sold. The sales of retail branches would very much depend on how many there are and where they are located. Price is an issue as well as how the banks would fit into the purchaser's global plans.

Senator Angus: Thank you.

Senator Setlakwe: Commissioner, you mentioned that more liberal ownership rules will make the formation of smaller community-based banks much easier. They could compete with the larger banks. Do you think that will happen? Could you elaborate on whether you think these regional banks, if they are formed, will generate additional venture capital regionally?

Mr. von Finckenstein: I cannot answer that question. I have no idea what will happen. All of this is framework legislation. All you are doing is setting the stage and making it possible for such developments to happen. Obviously, the Department of Finance did this after consultation with existing small-tier players. These are clearly moves that will help.

Will anyone actually take advantage of these? Will there be a movement to exploit these measures to the fullest? I do not know. I can describe the measures and why, from an objective point, they should foster competition. Whether they will actually be used, there is no way to answer that.

Mr. Gerry Birks, Competition Law Officer, Competition Bureau, Industry Canada: I think the senators understand that you are referring to the capital requirements being reduced from $10 million to $5 million. You are referring to the ownership regime whereby, under $1 billion, banks can be privately held.

We think both those measures could prove useful in the long run to enable local regional banks to become more effective. We do not we believe necessarily that they would become full-service banks like Canadian banks are. They may focus on niches, but this is our hope for building up the second tier in Canada, something that obviously we do not have right now.

The Chairman: We appreciate there is great scepticism about that.

Mr. von Finckenstein: I would not go so far as to say scepticism. I am not in the prognosis business.

The Chairman: I am just remarking on what Senator Angus said. Most banks we have heard from do not want to come here and run retail branches. However, we take seriously what you said.

Senator Oliver: Commissioner, the witness who appeared before you is Professor John Chant from the Department of Economics at Simon Fraser University. He was asked some general questions about his opinion of Bill C-8 and how it will help the financial services sector. On three occasions in his remarks he said that for banks that want to restructure certainly some can enter into a strategic relationship if they can buy 20 per cent, but he doubted that the mergers would pass through the Competition Bureau's tests. He said that on three occasions.

You today have said that, as in 1998, the Competition Bureau will follow the process laid out in the bank merger enforcement guidelines. My first question is obvious then. Bill C-8 has nothing in it to change or alter the bank merger enforcement guidelines.

Mr. von Finckenstein: No, there is nothing.

Senator Oliver: Second, you referred to a recent Federal Court of Appeals decision in the Superior Propane case which will apply to new merger guidelines. I have not read the case and I do not know the case. How do the principles in that case change the way you will interpret new proposed mergers from banks?

Mr. von Finckenstein: Under the Competition Act, we examine a merger and try to ascertain if there are any anti-competitive effects and second, whether the merger will lead to a substantial lessening of competition. Third, if so, does the provision, which states a merger may still be approved if the anti-competitive effects are outweighed by the efficiencies generated by the merger, apply. That provision had never been tested until the Superior Propane case which involved the merger of two national chains of propane distributors. There is no question that a lot of efficiencies result by merging two national chains.

We took the position in that case, which was finally upheld by the Court of Appeal, that it is not just a question of efficiencies generated, but you must consider that the company will make more money and the shareholders will benefit. You have to show the other effects. You must show that the merger will benefit the country as a whole and that there will be a flow-through to consumers basically. Everyone must be better off, not just the shareholders of the company.

The Court of Appeal said exactly that. The Competition Act has a purpose clause stating that the act exists to create a competitive system, to maintain it, to give benefits to small business, to consumers, et cetera. You are not simply required, as the court initially said, to calculate whether there are efficiencies. The purpose of the Competition Act is not to create efficiencies and nothing else. We took violent objection to that opinion and we argued in the Court of Appeal.

Going forward to banks, if there is a merger between two banks that undoubtedly would generate a lot of efficiencies. All I am saying in this statement now and publicly is that, yes, we will look for those elements but we will not decide based solely on efficiencies. There has to be a benefit for consumers as well.

Senator Oliver: In terms of benefit to consumers, you saw a series of problems with the Royal Bank and Bank of Montreal issue - the branch banking problems, savings account problems, full-service brokerage problems and credit card problems. How would banks go about resolving the new consumer tests from the Superior Propane case in relation to those areas?

Mr. von Finckenstein: If banks try to have a merger approved on efficiencies, they obviously would have to somehow demonstrate that it would be in their own best commercial interests to pass those benefits on to consumers rather than keeping them in the company. In effect, they must drive through the efficiencies. The unit price of their product will drop and it will make good economic and business sense to sell that product at a lower price because it will be sold much more widely and the overall profit will increase.

That is assuming that banks would try to justify a bank merger on efficiencies. If the banks assume that we would come to exactly the same conclusion as we did in 1998 - which is highly unlikely because it is now a dynamic market - they would search for divestitures to satisfy the competition regime.

In the TD-Canada Trust merger, we identified the markets and came to an agreement that these are the branches that you must sell. We gave them a time period in which to sell them and gave conditions under which they could be sold. That was done. The same thing would happen here.

When we talk about national banks, we must look at the branches across the country, by municipality and so forth. It is a massive task, but it can be done. It could have been done in 1998.

Senator Oliver: As a final question on Professor Chant, why do you think he said that the mergers may not be able to pass the competition tests?

Mr. von Finckenstein: I am quite surprised. If you read my 1998 letter, I was very careful to say "the mergers as structured" and, as structured, they did not envisage any divestiture or anything except putting together the Royal Bank and the Bank of Montreal, as they then existed. In our view, substantial divestiture of branches was required. The Royal Bank had to sell either Nesbitt Burns or RBC Dominion Securities. The Visa and MasterCard issues had to be addressed.

Was that possible? Could that be done? Would the merger still make financial sense? We never got to those questions because the Minister of Finance, as you know, ruled as he did.

Senator Kroft: I would like to go to another element of potential competition that we would all considering in the case of a merger. When we were holding our hearings on the MacKay report, the major insurance companies appeared before us. That was before the demutualization era. The insurance companies were being included in the payments system then, but we pressed them as to the degree of interest they had in becoming banks as envisaged by the MacKay report. They did not exhibit much enthusiasm.

They were disappointingly unenthusiastic about that kind of role. They were specific in certain wealth management areas, but where some of us saw the potential for major competition coming from those areas, it did not seem to be high on their list.

Nevertheless, steps have been taken to keep them as a major competitive force. They are in the payment system. The independence of the major demutualized companies is being assured under this act. Even from following the media it appears maybe there is a mood change there. They appear to be much more aggressive in a number of ways and, in their new form, to be much more ambitious on a number of fronts.

I am asking you for any observations about the importance of the major insurance companies as independent entities and competitive elements in the financial situation as it may bear on potential bank mergers.

Mr. von Finckenstein: First, I think you said "in this act." It is a policy decision, is it not, that the major companies are being kept separate? It is not the act that prohibits the takeovers. It is the departmental policy.

Senator Kroft: They have to remain widely held. Do they not?

Mr. von Finckenstein: It does not prevent a merger. If the policy changed, you could actually have a merger. It is the policy that is stopping it right now, not a provision of the act.I do not mean to be picky; it is just a technical correction.

Finance markets are evolving very rapidly. All sorts of models are being tried, and one of the big open questions is this: To what extent do you actually need bricks and mortars? You can do financial services over the Internet, and we have only seen the beginning, and it going to take off. Does it change the business models? Banks and insurance companies are based on yesterday. Do we care about that? Are they under attack? We see many merging niche players who are getting into financial services who were never there before.

A perfect an example is UPS, a company that nobody thought of as a financial player, that is now financing many of the transactions for the goods that they transport, et cetera. I mention this as one example.

The insurance companies, like everybody else in this industry, are looking at the changes, and trying to find out where to position themselves. Given their massive size, they undoubtedly have a role to play. Will they go into banking directly, or will they making use of the provisions here so they can, in effect, be members of the payment system? I do not know. I do not have a crystal ball any more than anyone else. I see them as major players in the financial services system.

The nature of the banks and the insurance companies will change. There will be a tendency to concentrate on some lines of business and to shed others. Big conglomerates that are all things to all people will be more difficult to operate. In my view, the insurance companies will play a major role in this process of transformation.

Senator Tkachuk: You raised two points. The first was, raising the 10 per cent limit to 20 per cent and 30 per cent to non-voting shares. Secondly, you discussed the new holding company regime that provides a structure to the banks and insurance companies and mutual funds.

You mention as well, in the first point, that the 20 per cent rule will ferment alliances that will play out on a national stage.

I want you to comment on this rather than answer a direct question because I find it troubling. Both those points, it seems to me, will actually decrease competition in a domestic market, and the justification you use for both of them is that they strengthen our institutions competitive ability in the international market.

What role would the Competition Bureau have in the merger of two banks or two insurance companies? Why do you care what they do in the United States or Europe or the rest of the world? What is the point of that?

Mr. von Finckenstein: I am trying to ensure that we have a domestic competition system. I am also trying to ensure that the impact of that system on the Canadian market, which is what I am responsible for, does not result in a substantial lessening of competition. If, in order for Canadian companies to be strong and successful, it is necessary to have foreign alliances to protect their positions then I will look at those alliances, to see whether they have a substantial lessening of competition.

If a Canadian company creates an alliance with a foreign company and, as a result of that, becomes stronger and better able to compete in Canada, this is something that I would obviously welcome. On the other hand, if the alliance results in a diminution or a substantial lessening of competition in Canada, then we would object to it.

Senator Tkachuk: If a company formed a strategic alliance under the 10 per cent rule, you are talking about forming an alliance with someone here in Canada, not necessarily someone in the United States.

Mr. von Finckenstein: It could be either.

Senator Tkachuk: That would mean an insurance company or another bank or someone else in Canada getting together, which, it would seem to me, would lessen competition. How would that situation work?

Mr. von Finckenstein: If a Canadian bank makes a strategic alliance with an American bank that has no presence in Canada, but it somehow makes the Canadian company a more vigorous competitor in Canada, I would welcome it.

However, if that American bank has a presence in Canada, as quite a few American banks do, and an alliance would lead to a diminution in a certain sector of the banking market where both of these banks are working, then we would have considerable problems with it. We would probably insist on certain remedies. A foreign bank may or may not have an impact on Canada, and that is what we would look at.

Senator Tkachuk: I am not sure if that answered my question. It seems to me that an alliance means one joins with another to make oneself stronger. In the second case, the holding company is providing one banner for insurance companies and mutual funds, along with banks, which would mean there would be less competition locally. Let us just say that happens. You have four points here.

In your concern about ensuring that there is competition, which is the reason the Competition Bureau exists, you mention the small community-based banks and the payment system, but you do not mention foreign banks expanding branch banking, the co-ops or the credit unions. Is there a reason for that?

Mr. von Finckenstein: No. I think those moves are clearly pro-competitive and I applaud them. This legislation is not mine, as you know. It is Bank Act legislation. I am basically doing a cameo appearance here.

I will talk about the two provisions that affect the Competition Act. It will not be a long presentation because I thought that I would look at the highlights of the legislation and then answer your questions. Undoubtedly,, the areas that you have chosen are pro-competitive. They were not mentioned to me, but that does not mean in any way that I do not find them to be useful and desirable.

Senator Furey: Mr. Von Finckenstein, in your opening comments, you highlighted the changes in the act. Are you merely highlighting those changes, or do you have some concerns about the protection in those circumstances?

Mr. von Finckenstein: Section 29 is absolutely essential for our business. In order to assess a merger, you have to have access to the most confidential information that a business has. The costing data, the strategic planning and, basically, their projections as to what will be the benefits of a merger, this is all information that is given to us. Companies will give it to us if they are assured that it will be kept confidential. We rigorously keep it confidential. We will not disclose it under court order, and even if we are forced by court, we will try to plead any privilege or exemption that we can. This is a key element to our being able to do our work.

We realize, in the case of bank mergers, that the Minister of Finance has a bigger role to play than we do. It makes sense to avoid unnecessary duplication and cost by sharing the information with him; and it has been structured that way. We do not have to share, and it is only at the specific request of the minister. The minister must specify that he needs it for the merger and that it will only be used for the merger. We have restricted it as much as possible, so we can ensure companies that the information that they give to us will be kept confidential. If the minister receives information as well, it will only be that which is necessary.

Senator Meighen: At the risk of sounding flippant, it sounds to me as if you are putting your stamp of good housekeeping on alliances, rather than on mergers. Alliances sound like a poor man's merger that would likely slip through your net and not cause the anti-competitive problems. You probably do not want to comment on that.

Mr. von Finckenstein: I will gladly comment on it, if you want me to. An alliance is no different. When there is an alliance, if it means that one company receives a substantial interest in the other, it too falls under the merger provisions of the act. We will submit it to the same rigorous tests that use for any merger; it is the identical test.

Senator Meighen: I cannot help but think that you write approvingly about that. You wrote:

This should make it easier for financial sector companies to engage in strategic alliances either domestically or abroad.

That refers to the increase of 10 per cent to 20 per cent. Continuing, you wrote:

Such alliances should make it easier for our domestic institutions to achieve the size and strength necessary to improve their competitive positions abroad.

That is a goal that some banks have set for themselves. To be fair to you, you have not commented whether that is good, bad or indifferent. You make no distinction except to say that an alliance is more likely than a merger to achieve that end. Am I reading incorrectly?

Mr. von Finckenstein: Yes. I am saying that domestically or abroad, we are concerned with the impact on the Canadian market. The banks, the last time around, said they needed to bulk up so that they could do business abroad. Given the 10 per cent shareholding, there was no way to structure meaningful alliances abroad.

Now the change actually allows them to structure meaningful alliances abroad. Whether they do it is up to them. I am only interested in the impact on the Canadian market. I am making a factual statement that seems to address the comments we made last time.

Senator Meighen: The factual statement that you made is that going to 20 per cent should make it easier for financial sector companies to engage in strategic alliances. Is that based on evidence or is that based on what the banks told us?

Mr. von Finckenstein: If you make a strategic alliance, and your partner wants to have a meaningful percentage in your operations, 20 per cent is larger than 10 per cent, whether it is voting or non-voting. There will be more options available. Will it be used? I do not know.

Senator Meighen: They may have less liquidity, too. I am not convinced, and I wonder if anyone else is convinced, other than the banks, that selling 20 per cent is easier than selling 10 per cent?

The Chairman: Equity accounting is one good reason.

Senator Meighen: That is a good reason.

Senator Kelleher: Broadly speaking, the Canadian system for determining mergers is said to be fairly political in the end result. Whereas, in Britain and in the United States, it is more bureaucratic, in that it is laid out and it does not involve the ministerial or political system. Do you have a preference for one system over the other?

Mr. von Finckenstein: Well, I am not sure. I totally agree with your premise. Bank mergers, because of the importance of the financial sector to the economy, are highly political in all countries. It is a question of whether there is transparency. The process that is before you, and the involvement of this committee and its counterpart in the other place, makes the process extremely transparent.

I do not think that there is anyone who is not in favour of transparency. The question is whether there is a trade-off between transparency and speed. To what extent will the process be slowed down? Have we found the optimum mix of the two, so that we can have mergers in this sector? Yet we have full transparency and we do it in a reasonable time frame. You have seen the guidelines, which suggest that this could all be done in a five-month period. By international standards, that is a fair and reasonable standard.

What you have is an attempt to strike a correct balance, and hopefully, it will prove to be that.

The Chairman: Thank you.

Our last witnesses are from the Canada Deposit Insurance Corporation. Please proceed with your opening statement.

Mr. Ronald N. Robertson, Chairman of the Board, Canada Deposit Insurance Corporation: I appreciate the opportunity to be here. This is my first appearance before this committee since I was appointed Chairman of the CDIC in 1999. Our president and Chief Executive Officer, Mr. Sabourin, has appeared many times before.

I thought it would be helpful, before we talk about the subject matter of your hearing, to make a few remarks about where CDIC currently stands in order to bring you up to date.

Since being created in 1967, we have had 43 failures. The total deposits held by those institutions came to $24 billion. They were held by approximately 2 billion Canadians. Our cost of dealing with those failures was about $4.7 billion, or approximately 20 cents on the dollar.

Our revenue, as I think you all know, comes from premiums paid by our members, not from government appropriations or money from the taxpayer to subsidize our operations. When we are required to meet our obligations to ensure depositors and we must borrow money, we have authority to borrow it from the Consolidated Revenue Fund or from the market. As an agent of Her Majesty the Queen, our obligations to depositors are obligations of the federal government.

Our total borrowings since inception have been about $7.6 billion. We have paid $1.7 billion in interest charges as a cost of borrowing. Our debt peaked at $3.7 billion in 1992, and our deficit reached $1.7 billion in 1995. At fiscal year end 1998-99, our debt and deficit were eliminated and we established a provision for future losses of $400 million. In addition, premiums paid by most members have been reduced by 75 per cent from what they are while we were dealing with our debt and deficit. We now have a surplus of some $450 million. In other words, our financial position is much improved.

On the operations side, there have also been significant developments, which have been, to a major extent, the result of lessons learned from the experiences of the 1980s and 1990s.

CDIC now approves all entrants for deposit insurance. We have developed a comprehensive policy of deposit insurance to which institutions must adhere as a condition of membership. We worked to streamline the application process to ensure that applicants need only file the same information with CDIC and with the Office of the Superintendent of Financial Institutions.

We actively monitor our risks as required by our mandate. We have worked to put in place an environment with important inducements for good corporate governance and sound management by member institutions since it is our belief that well-managed institutions seldom fail.

Our standards of sound business and financial practices are being revised after extensive consultation with stakeholders. We believe they are effective and modern tools for fostering sound business and financial practice - that is for ensuring good corporate governance and sound risk management, all within an effective control environment - at member institutions.

As well, the revisions to our standards and the associated reporting process dovetail with the Bill C-8 proposals and OSFI's risk-focused approach to supervision. Our collective goal is to reduce the burden of regulation where prudently possible and the frequency of reporting will be tied to the risk profile and good management of our members.

Along with the standards, OSFI and CDIC have issued a guide to intervention for federal institutions. It describes the coordination mechanism in place between CDIC and OSFI and the graduated steps we take in response to an institution's particular difficulties.

We have put in place a differential premium system under which CDIC can charge higher premiums to members that demonstrate a higher risk profile. Poorly rated institutions pay eight times the premium rate paid by the best rated members. Differential premiums not only provide a financial incentive to the member, they offer an important early warning to the institution's board, as well as management.

Taken together, the standards, the guide and the differential premium system provide a clear picture to the board and management of any member institution of what we expect and what the consequences could be if they do not manage their institution appropriately.

Internally, we have built up a strong team of risk assessment experts. We do contingency planning, for example, to deal with the possibility of member failure and to fulfil our obligations to ensured depositors.

Today, together with OSFI, we have a wider and better range of intervention tools at our disposal. As I said, we have learned our lessons from the past and our legislation has been amended over a dozen times to better enable us to deal with problems that may arise.

We have excellent working relationships with provincial legislators and supervisors and, if appropriate, cooperate fully in the scope of their examinations and assessing the results.

Our preferred approach is preventive medicine. However, we are ready to intervene if necessary. For example, we can terminate a member's deposit insurance, effectively putting them out of the retail deposit-taking business.

These good times have been an opportunity to put our house in order.

Bill C-8, if passed, promises to shape the future in many ways. There has been extensive consultation regarding its provisions and we are certainly satisfied with the result. We believe consumers will or may benefit from the increased competition that Bill C-8 seeks to foster. However, we recognize, as everyone does, that competition means risk-taking and that along with the winners there may be some losers.

While the proposed legislation before you eases some of the criteria for entry, such as allowing minimum capital requirements for start-up banks, it makes explicit that those proposing to set up a bank must meet the "fit and proper test." Further, sound business plans are necessary, as are people qualified to execute them. In our experience, it is ultimately the management that makes or breaks a financial institution, not initial capital levels.

The proposed legislation also provides more flexibility in how banks structure their affairs - for example, the proposed bank holding companies. Certainly in the past we had difficulties with certain trust companies "holdcos." In most cases, it was poor management of risks, especially those related to real estate - not only in the trust company but also in the non-regulated parent - that created the problem.

Bill C-8 proposes to have the entire bank "holdco" subject to regulatory supervision, albeit in different degrees. That should go a long way to addressing the contagion problems we saw in the past where weakness in the unsupervised parts of the "holdco" spread to the unregulated entity. Under the proposed rules, we should have a much better chance to head off those dangers.

The "holdcos" raise a further issue, one that is not tied to our exposure to loss but that of possible confusion on the part of consumers. If consumers deal with a number of affiliates of a bank holding company, they may not fully understand the nature and providence of the financial products they purchase. Our own research shows that the public is unaware or uncertain whether certain products issued by our members are covered by deposit insurance. We responded by launching, once again, a public awareness and education program to help address this problem.

In that regard, we welcome the creation of the proposed Canadian Financial Consumer Agency of Canada, whose commissioner will be a member of the CDIC board. That commissioner should bring an important perspective to our board discussions.

We look forward to working closely with the consumer association in improving consumer information. That agency will consolidate and strengthen the federal oversight activities and allow it to more effectively safeguard consumer interests in the financial sector.

Bill C-8 also provides for another private sector director to be added to our board which will maintain the existing balance with the public sectors which we consider important. As I am sure you know, we have four ex officio directors and four private sector directors plus the chairman on the board at the moment. That means it will go up to five and five.

As a final comment on the topic of entry, which is the proposal to allow credit union associations to apply for CDIC membership, we welcome that as a source of possible greater competition and choice for consumers.

As far as we are concerned, we think we are in good shape to deal with the changes envisioned in Bill C-8. We have a much better capability to manage risks and minimize our exposure to loss. In summary, we believe we are much better placed to deal with any problems, real or potential, than was the case 10 years ago.

Senator Tkachuk: Before we go to questions, I would like to move:

That the Committee inform the Honourable Paul Martin, Minister of Finance, that his attendance before the committee is of utmost importance and that we urge him to appear before this Committee on May 30 to discuss Bill C-8.

The Chairman: You know you have a commitment from our leader that either Mr. Peterson or Mr. Martin will show up and they will give testimony.

Senator Meighen: Mr. Peterson told me yesterday that he will appear.

Senator Tkachuk: We understand that fully, but, as you know, our concern was always having Mr. Martin here. We thought that, at this opportunity, perhaps the committee could request that Mr. Martin could appear, rather than Mr. Peterson. That is why we are moving this motion.

Senator Poulin: Senator Tkachuk, I respect your comment and find it very interesting that, on such an important bill, you want to make sure that the Minister of Finance comes here in order to have discussions between him and the whole Banking Committee.

In our past discussions, the leadership gave us the assurance that, according to the schedules of the different ministers involved in this bill, we would definitely get one of the ministers to appear before us. I wonder, do you feel that it would still be appropriate to hear Mr. Peterson? We, as a committee and as individuals, have not checked with the schedules of these ministers. However, we do have the assurance that they will definitely meet with us.

I understand Senator Tkachuk"s objective and I respect it. That notwithstanding, this is the end of a session, and you know what scheduling is like for everyone and for the two chambers. It is pretty hectic these days in both places. We have been informed that we may need additional days of sitting. I can imagine how busy the ministers of the government are at this time of year. I always feel that it is a little like the Christmas season.

I do not know if Senator Wiebe has something to add.

Senator Wiebe: This is a question that should be considered by all members of this committee. I think it is an important issue. We have assurances that Mr. Peterson will be appearing before us. We also know there has been a request made for the minister.

We are in the middle of a process of interviewing some witnesses, which I think is very important. I and I know others certainly have a lot of questions that we would like to ask of these witnesses. If this issue is so important to the honourable senator, why did he not raise it when the last witnesses were here? Why did he not raise it when we started first thing this morning? Why did he not raise it when the second witness was here?

If this is such a key issue, why must we move this motion in the middle of the process of interviewing witnesses who have taken the time out of their busy schedules to come and appear before us?

Senator Tkachuk: It will only take a minute, Senator Wiebe.

Senator Wiebe: I suggest that the urgency of this motion is because the senators on the other side feel that not all members of this committee will have the opportunity to voice their concerns on whether this motion should be passed or not.

As you look around the room, you can see, if a vote was taken strictly on party lines, what the result of that motion would be. May I suggest that may be the reason for an urgent motion being made at this time, rather than being made before we called witnesses and before we called witnesses today. I think it is important that this be put on the record.

A motion like this, while it is important, could have been dealt with earlier in the morning, before we put an embarrassment in front of witnesses that are appearing before us. We as a committee have a responsibility not only to our caucuses, but we also have a responsibility of fairness to the witness who we have asked to appear before us. This is taking a great deal of time out of their schedules. They are prepared to make a presentation regarding this particular bill.

I suggest that we possibly adjourn the debate on this motion and get on with the discussions with the witnesses who are appearing before us. I understand that an adjournment motion is not debatable.

Senator Tkachuk: Are you moving one?

Senator Wiebe: I understand that a vote must be taken on an adjournment motion. I realize that, if I move that particular motion at this time, the results will probably be the same as on the motion itself. I know that other senators will certainly want to make some comments in regards to the motion and I would certainly leave some room for them to have that opportunity, Mr. Chairman.

Senator Tkachuk: Question.

The Chairman: All right. Would you repeat the motion, please?

Senator Tkachuk: I move:

That the Committee inform the Honourable Paul Martin, Minister of Finance, that his attendance before the committee is of utmost importance and that we urge him to appear before this Committee on May 30 to discuss Bill C-8.

The Chairman: I understand that I have the first vote. I vote against it.

All those in favour?

All those against?

The vote is tied, therefore the motion is defeated.

Senator Meighen: Mr. Robertson, thank you for your patience.

I want to ask you about your risk assessment and how that process occurs. Some of the very small players in our financial landscape, such as ING Direct, and President's Choice Financial, according to my information, will be paying higher premiums than the large banks. I assume that is based on the risk assessment.

To what extent do you take into consideration the risk profile of the parent companies?

Mr. Robertson: I will ask Mr. Saint-Pierre to explain to you how that works. It should not be taken as a given that a bigger institution will be in our first category and that a smaller one will not be. I do not want to get into the details. I do not think I should, but there are small institutions that are in the first category as well. In fact, certain small institutions rank very well in that first category.

It is not a given, as I say, that size or lack of size precludes you from being in the first category as opposed to being in a lower category. Having said that, perhaps Mr. Saint-Pierre can explain how it works because that bears on the answer to your question.

Mr. Guy Saint-Pierre, Senior Vice-President, Insurance and Risk Assessment, Canadian Deposit Insurance Corporation: Our system of differential premium is based on four categories and on a 100-point score: 60 points assigned to financial ratio of the member institution and another 25 assigned based on the rating received from the supervisor. In the case of that bank it would be OSFI. Another ten points are assigned for following the CDIC standard of sound business practices and another five points are assigned for other matters relating to the member institution.

As I said, the first 60 points are based on financial ratios. We do not have much discretion. That is based on the results of the members. Those ratios relate to capital adequacy, profitability, asset concentration, performing assets and efficiencies. Those are quite universal ratios, and certainly it is up to the institution to be performing and to get as many points as possible in that area.

The rating of OSFI is done using the Camel rating code, which is well known in the supervisory field, and it is done on a one-to-five basis. Certainly we do respect the rating of the OSFI people, the superintendent, and we have nothing to say in that regard at CDIC.

The other 10 points are on following standards. If they do not follow standards in certain areas, they will not get full marks. We give time to correct the standards when they are not followed, and the other marks relate to other matters that may affect the members and it is only five points.

Senator Meighen: You may well have answered my question.

Mr. Jean Pierre Sabourin, President and Chief Executive Officer, Canada Deposit Insurance Corporation: If I may add two points, as part of the differential premium system, we allow new entrants to be in category one for almost two years to give them an opportunity to build their businesses et cetera. In that regard, new entrants are not rated or assessed through a differential premium system for over two years.

The other comment that my colleagues forgot to mention is that, while the premiums have been high in the past, as our chairman explained, we had a large deficit. We have now built up a surplus. The premiums were reduced by 75 per cent last year, therefore, they are substantially reduced. They are reviewed on an annual basis by our board based on the circumstances and the environment.

Senator Meighen: I did not understand the first point you made. New entrants are automatically placed in the first tier?

Mr. Robertson: In the first two years, yes.

Senator Meighen: Regardless of their standing?

Mr. Sabourin:Yes.

Senator Meighen: Regardless of their financial standing?

Mr. Sabourin: Our view is that they have started up, therefore a number of the ratios do not apply. It would be unfair to apply them. In the first two years they are put in the first risk category and that provides them an opportunity to build their business. Of course, we are always looking at the issues of how they manage the risk and the soundness of their business plans and the implementation of their business plans that they provided to us at the start of their business.

Senator Meighen: You are nice fellows. You certainly are very generous for the first two years.

Perhaps you answered this and I missed the answer. What weighting, if any, do you give to the financial situation of a parent?

Mr. Robertson: Subject to correction, my understanding is that does not get into the calculation. To try to do that would raise all sorts of complications because neither we nor OSFI, of course, rate the parent. To determine the value or worthiness of the parent's backing would get us into a potentially difficult area.

The essential point, from our point of view, is to try to have safe and sound, efficient and effective Canadian deposit-taking institutions. I think that I am correct, Mr. Saint-Pierre, that the parent, as a particular institution, is not brought into account in the differential premium system, which is focusing on, amongst other things, the risk profile of the local operation.

Senator Meighen: Thank you, that is very helpful.

I was not here yesterday when ING-Banking testified. Maybe one of my colleagues can pick up on it, but my understanding was that they, for obvious reasons, are rather keen that their parent's financial situation be taken into consideration. I suppose the only way you could do it would be to rely on a home regulator.

Mr. Robertson: That would get you into a number of invidious different situations where we were trying to say that the institution from country X, regulated by regulators in X, is great. We do not think very much of the regulatory regime in country Y so, however they rank it, that is a territory into which we would prefer not to venture.

Senator Meighen: I think we are getting into it in other spheres, but I understand your reluctance.

Mr. Sabourin: The important aspect is that we use differential premiums and look at the institution by itself. Obviously the performance of that institution and the level of its capital, et cetera, are separate subsidiaries. How they operate their affairs and their businesses in Canada is important.

Senator Meighen: If the parent were a domestic institution, would that change any of your responses?

Mr. Saint-Pierre: If the parent were a bank, we do assign all members in the group that are members of CDIC the categories of the parent. If we have a member that is the TD Bank, as an example, and we also have members that are TD Mortgage and so on, then TD Mortgage will be assigned the same category as the one of its parent.

Senator Meighen: What if the parent is not a member?

Mr. Saint-Pierre: If the parent is not a member, we do not take that into account.

Senator Poulin: As a senator from Northern Ontario, one of our concerns has always been - and I am speaking for the people who spoke to me about Bill C-8 in its former life in the former Parliament - that the small business people who are in insurance and in auto leasing would lose out with the new restructuring of the financial system in Canada. Do you feel that small businesses all over the north should still be concerned after reading Bill C-8?

Mr. Robertson: I will confess that your question catches me somewhat by surprise. We have been looking at this, naturally, from the point of view of a depositing insurer, interested in safety and soundness. That issue really does not fall within our purview. Perhaps my colleagues can be more helpful. I would like to be helpful, but I am not at all sure that we can be very helpful.

Senator Poulin: I was wondering if you could give us an objective point of view on a question that has been raised to other witnesses, but if you do not want to fall outside what I call the "driving line" that is all right.

Mr. Robertson: I am not afraid of falling outside driving lines; I am a bad golfer. To be blunt, I have not given that subject the kind of thought to give you a proper answer.

Senator Angus: We have had many discussions, about CDIC, its constitution and the matters of co-insurance and a plethora of things over the last 10 years. We welcome the wise input that we receive from you and your officials.

Mr. Robertson, you mentioned governance in your opening remarks. Last night I was looking through some of the materials that were delivered to our offices yesterday about the CDIC. I knew that changes had taken place. I was curious to see who was on the board now. I could not find that in the material. It may not be there or maybe I missed it.

Mr. Robertson: I would be happy to run through that, if you wish. The board consists of four ex officio members: the Deputy Minister of Finance, or his or her alternate; the Governor of the Bank of Canada, or his or her alternate; the Superintendent of Financial Institutions, or his or her alternate; and under Bill C-8, another senior officer of the OSFI office. Those are the four ex officio directors.

The four private sector members include, at the moment, Colin P. MacDonald from Calgary; Tracey Bakkeli, from Regina; Garfield Emerson, from Toronto; and Viateur Bergeron, from Hull, and I am the chairman.

Senator Angus: There will be five private sector representatives in the future; is that correct?

Mr. Robertson: Under this bill, there will be the commissioner and another private sector director.

Senator Angus: Do you have monthly board meetings?

Mr. Robertson: No, we do not have to meet monthly, fortunately. We meet six or seven times a year and if there is a need for interim meetings, then we meet more often.

Senator Angus: Another thing that interested me in your opening remarks, was in reference to the holding companies that are contemplated under Bill C-8. Will this avoid the contagion that was inherent in the old system? You do qualify it by saying, if there is a weakness among some of the non-regulated entities in the group that it could spread.

I would like to have a more explicit example of what can happen, and what you refer to as contagion. I think I know, but I would like to have that a little more fleshed out, please.

Mr. Robertson: Perhaps the simplest example is certain companies in the past. We have been learning from the mistakes and the experiences of the past. A simple example would be where a trust company lends on real estate, up to its permitted percentage, but then elsewhere in the trust company holding company regime, someone is providing the remaining gap between, let us say, 75 per cent and 100 per cent. That someone is financed by other institutions that provide the money. This is when problems develop. The problems very often become more difficult at the institution that is financing the 25 per cent which is the more risky part of the development. They start to get into trouble. They start to try to find means to perhaps pull more out of the regulated institution.

We take a dim view of that, that the regulated institution should not have more pulled out of it. The contagion is spreading from the person who has taken the riskier part of the financing to the entity that we are directly involved with.

Senator Angus: We have been given the example of the Royal Trust situation. Is that analogous to what happened there? That was in the Brascan Holding Company and was a regulated entity.

Mr. Robertson: It would be prudent for me not to get into specifics such as Royal Trust.

Senator Angus: Are there any specific ones that you could mention?

Mr. Robertson: Mr. Sabourin has been through the wars. I became chairman in 1999. I have certainly had experience at CDIC. I was director during part of the bad times, if I can put it that way. Mr. Sabourin can give you some examples as well.

Mr. Sabourin: We have a number of examples: Standard Trust, Standard Trustco, Central Guaranty and Central Guaranty Trustco are examples where the biggest problem was not in the regulated entity but in the parent. The parent got into trouble and needed to access large dividendsand other management fees, et cetera.That affected the regulated entity.

The biggest problem at that time was that the supervisors were not supervising the holding companies. There was no way of knowing what was happening.

Senator Angus: Using Central as an example, how would that not have happened under Bill C-8?

Mr. Sabourin: The supervisors will now look at those institutions to assess the risk. As it was explained, they are changing their assessment of their examination process to a risk-based approach. They look at institutions and affiliates and conglomerates and look at the issues of risk. They will focus and drill down in those specific areas.

Bill C-8 provides a different process and a different examination. These changes are based on lessons learned.

Senator Angus: My last question has to do with the evidence we heard yesterday from the ING. I am not sure if you were here this morning. I asked our witnesses about the four or five hurdles an investor has to jump in order to get into the Canadian financial institution business. Small foreign banks was the example.

The chap from ING Bank of Canada talked about the excessive regulatory environment here and gave some specific examples. He talked about the capital tax and other taxation issues. Then he talked about the CDIC deposit insurance premiums. This was alluded to in Senator Meighen's questioning, and he said that certain benefits were not resolved with this legislation.

In other words, certain benefits which philosophically and from a policy point of view, are government-designed to induce more competition to come into the scene here in Canada. However, we heard that these benefits will not necessarily flow with Bill C-8 because, in the case of the CDIC deposit insurance premiums, the benefit is available to their major competitors, but not to ING because of its short length of tenure in Canada. That means they cannot meet specific criteria and has no relation to its ability to pay.

We heard that the level of premium a bank pays is dependent upon a formula of many variables and many of those variables are difficult if not impossible for ING to achieve, and we heard the example of five years to average profit.

In other words, they are in their first month. Under the present rule, they must wait for five years before they see a profit.

Mr. Robertson: No, with respect, that is incorrect.

Mr. Sabourin: Under the legislation, we have confidentiality provisions that restrict speaking about specific institutions. Therefore, I will generalize, instead of dealing with the institution to which you refer.

The differential premium is based on a 100 per cent score. To be in the one category, you have to get 80 points. There are 20 points left. Therefore, the 80 points can be obtained from different areas. Profitability is only one.

Senator Oliver: How is it weighted, though?

Mr. Sabourin: It is five points out of the 100. There is a lot of different criteria.

In reference to the cost of deposit insurance, we should point out that while there is a cost to providing deposit insurance there is also a benefit to institutions of having deposits insured by CDIC. That is important for new entrants because, obviously, having deposit insurance ensures that customers will have no difficulty dealing with them. Therefore, new entrants will attract depositors because people will not be concerned about the insurability of their deposits. There is a benefit.

I should also point out that we put the differential premium system in place in Canada about two years ago. We put the system in place with two years of transition time. We were adjusting the scores to give the institutions time to adapt to the new system. We are very confident that the system is working very well. In fact, the FDIC, the large U.S. deposit insurance corporation, is re-vamping its risk-based approach and is going to use much of our system.

Others are emulating what we have put in place in Canada. Again, the cost of deposit insurance is borne by member institutions and their clients, not by taxpayers.

Senator Angus: I think your system is a good one and was not for a moment suggesting it was not.

One of the policy elements of this bill is to try to streamline the process and to introduce new players into Canada.

Mr. Robertson: For a new player, and particularly for a modest-sized player, deposit insurance is of critical importance to their acceptability as safe and sound places. Although a certain organization in another country may be very successful, depositors may have no knowledge about it. However, they do know that CDIC is an agency of the Government of Canada and, therefore, their deposits are safe.

Senator Angus: I think you are saying that although it might be a minor inhibitor in terms of timing, it is a good thing; it is prudential.

Mr. Robertson: Exactly.

Mr. Sabourin: Also, as we pointed out, we give the start-ups two years. As well, it is fine to say that institutions can lose money, however, they cannot lose money indefinitely. There is a point where they have to make a decision if confronted with a bottomless pit.

Senator Angus: They call in the receiver.

The committee adjourned.

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