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

Issue 27 - Evidence - Afternoon sitting

OTTAWA, Thursday, September 29, 1998

The Standing Senate Committee on Banking, Trade and Commerce met this day at 5:05 p.m. to examine the state of the financial system in Canada (Task Force on the Future of the Canadian Financial Services Sector).

Senator Michael Kirby (Chairman) in the Chair.


The Chairman: Senators, with us this evening are the Chairman and Chief Executive Officer of the Royal Bank of Canada, Mr. John Cleghorn, and Léon Courville, President and Chief Operating Officer of National Bank of Canada.

Mr. Cleghorn, we are delighted to have you with us this evening. For the next couple of months, we will be focusing on the report of the MacKay Task Force on the Future of the Canadian Financial Services Sector, our purpose being to report to the government by December 1 on our reaction to the report. Our focus is not, you will be delighted to know, on the merger issue but on the broader public policy questions.

I understand that you have an opening statement, after which we will turn to questions. From talking to our members earlier today, I know that we have a number of quite sophisticated policy questions to ask you.

Thank you for taking the time to be here. We really appreciate it.

Mr. John E. Cleghorn, Chairman and Chief Executive Officer, Royal Bank of Canada: Thank you, Mr. Chairman. I am grateful for this timely opportunity to discuss with you our response to the MacKay task force report. I look forward to a dialogue with you after my remarks. Your input will be vital to the government's deliberations about the future of the financial services industry and indeed the country.

It is clear to me that since the Porter commission report more than three decades ago, Harold MacKay and his task force have conducted the most thorough review of all the issues facing our industry and its crucial importance for all Canadians. It presents a powerful, sensible blueprint for Canada to have a creative, innovative, flexible and competitive new financial services arena for the 21st century.

I echoed these comments last week when I appeared before the House of Commons Finance Committee.

The report provides clear recognition that change is accelerating. Change is upon us, whether it is driven by globalization, customer demands, new competitors or new technology. The last words of the highlights of the report say it all. They read as follows:

The changes are inexorable and we cannot ignore them or pretend they do not exist. For financial institutions, their customers and public policy, reliance on the status quo is no option.

I could not agree more.

These forces are reflected in the changing needs and preferences of our customers. I will illustrate with a number of examples.

Fifteen years ago at the Royal Bank, 90 per cent of routine banking transactions were conducted in branches. Ten years ago, 50 per cent were conducted through branches and 50 per cent through automated banking machines. Today, less than 15 per cent of transactions are done through our branch network, with more than 85 per cent being done electronically through ABMs, telephone banking and PC banking. To underscore the shrinkage in the cheque business, the two major suppliers in Canada announced today that they are merging. Paper transactions have been on the decline in Canada since 1988.

The Royal Bank introduced telephone banking in 1995. In the first year of operation, our call centres received 4.8 million calls. Three years later, that number will increase to 43 million.

Debit cards did not exist five years ago. In 1997, debit card transactions represented 34 per cent of our total transactions. This represents 22 million transactions a month.

Between 1990 and 1996, the mutual fund market grew 750 per cent while personal deposits grew at a rate of only 16 per cent. On a dollar basis, between 1991 and 1996, the average annual increase in mutual funds has been approximately triple the average annual increase in personal deposits. Assuming the same rate of relative savings and rates of growth, the amount of Canadian savings held in mutual funds will surpass that held in personal deposits in a few years. This is already the case in the United States.

These all reflect irreversible trends shaping the financial services industry at the institutional level around the world, and this leads me to suggest a vision of where we are headed.

First, the consolidation and rationalization in North American banking has been going on for some time and will continue. It is being propelled by the need for greater efficiency, scale, scope, escalating technology requirements and deregulation. This trend is leading to huge market capitalizations among U.S. banks, which provides them with considerable clout to grow through acquisitions, an important source of competitiveness while our industry is consolidating.

The gap in market capitalization between the Royal Bank and the average of the top 15 U.S. banks was under $3 billion in 1993. Today it is $23 billion.

Second, globalization will have a lasting impact on Canadian financial institutions in ways not yet imagined. For example, the task force report notes that the globalization of wholesale banking has resulted in the disappearance of U.K. investment banks, even though London remains a major international financial centre. While the globalization of retail banking is in its infancy, the survival of Canadian retail banks as full-service players is not guaranteed, if action is not taken soon.

Third, increasingly there will be divergence between the strategies of different Canadian banks as each selects directions based on its core competencies. Some of this is already apparent in the differences among Canadian banks with respect to their strategies and the business segments and markets that they are pursuing. These differences will widen. What may make sense for one bank or financial institution may not for another.

Fourth, meeting the changing demands of customers for a mix of service delivery mechanisms poses real challenges. While most customers have embraced the electronic delivery channels, such as ABMs, telephone and PC banking, today they still want the option of face-to-face branch access. This is currently leading to costly duplication. In five to ten years, with better use of technology and better understanding of customer needs, we will be able to better meet diverse customer preferences more efficiently. Finally, Canadian banks also need to respond to the increasing expectations of Canadians that financial services firms should provide tangible support for communities and pursue more community customer partnerships.

These are some of the directions shaping our industry. They pose major challenges and the task force recognizes their importance. There are important broad themes in the proposals that are in harmony with the challenges we face, and which I strongly endorse. The most powerful theme is that, in any reform, the interests of the consumer should be paramount. In order to meet this important test of serving the consumer interest, the task force recognizes that the best approach is to have a vibrant, open and competitive financial services industry within a sound prudential framework.

The report makes a number of recommendations to benefit consumers, such as consumer protection safeguards, redress mechanisms, convenience of access and meeting the needs of small businesses and communities. We concur with all of these and welcome their application to all financial institutions.

In particular, we agree with the task force that Canadians believe banks have greater public responsibilities than other businesses and that they also expect banks to play leadership roles in their communities. At the Royal Bank, we are proud of our record of community involvement and endorse the recommendation by the task force that all federally regulated deposit institutions and life insurance companies be required to file a community accountability statement with the Minister of Finance.

In supporting this community accountability statement concept, we are ready to help build an open, inclusive and transparent consultation process with various community groups to collaboratively develop a score card of accountability, with respect to community expectations.

In the next few minutes, I should like to focus my comments on two broad sets of other recommendations. One set aims at enhancing competition, creating an environment where there are numerous players, domestic and foreign. The second set attempts to ensure that they operate within an efficient, effective and flexible regulatory system.

The Royal Bank has always supported measures to increase competition and I should like to enumerate some of the report's major positive recommendations in this area, which we support. Ownership policy governing financial institutions is clearly an important factor in determining the degree of competition. The report's proposals relating to this provide a pragmatic and sensible direction. The wide ownership rules faced by Canada's Schedule I banks have had the twin objectives of ensuring a separation between commerce and finance and ensuring domestic control. While these may well be justified government objectives, there have been four undesirable consequences. The report attempts to correct these.

First, by applying only to banks, the policy is open to being undermined by the non-bank sector. In addressing this issue, the report proposes extending the wide ownership rules to all financial institutions, not just banks.

Second, since ownership rules may act as barriers for new bank start-ups, as it is practically difficult to have dispersed ownership in small institutions, the report provides for exceptions to the rule for small institutions.

Third, since the strict 10 per cent rule may limit the use of bank shares for a merger and acquisitions strategy, where the partner may not be as widely held as a Canadian bank, the report suggests that the 10 per cent limit be allowed to rise to 20 per cent, with ministerial discretion.

Finally, since the ownership regime prevents outright takeovers, it can be a barrier to effective foreign competition. In addressing this, the report recommends allowing outright takeovers of widely held, large institutions by large, widely held foreign institutions under exceptional circumstances, where it is clearly in the interest of Canadians to do so.

In the area of organizational flexibility, we welcome the report's proposals to give banks and other financial institutions the option of structuring themselves under a federally regulated financial holding company, if they wish. This will provide individual institutions with the flexibility to organize their corporate structure, as they deem most appropriate within a sound prudential framework.

On mergers, the Royal Bank is in full agreement with the report's conclusions that mergers among institutions are a viable business strategy and should not be prohibited outright. We also fully support the report's proposals for the case-by-case merger review process.

On greater openness to foreign competition, we welcome the proposals to permit foreign bank branching and other related proposals to encourage cross-border lending by foreign banks that may not wish to establish a physical presence in Canada.

We support the initiatives to enhance domestic competition. In addition to the changes to ownership policy, which will encourage more new bank start-ups, there are proposals to enable credit unions to operate nationally and compete more effectively.

On the payment system, we welcome the proposals to broaden access to insurance companies and others institutions that meet criteria relating to their solvency, liquidity and regulatory and legal frameworks.

Similarly, on leasing and retail distribution of insurance, we are pleased with the proposals to do away with these restrictions. Consumers stand to benefit from the greater competition that adoption of all of these proposals will bring to the market-place.

The task force recognizes that a competitive financial services industry must also have a sound regulatory framework and it makes a number of recommendations. The task force suggests strengthening the role of OSFI, clarifying the role of CDIC and harmonizing compensation programs for depositors with those for policy holders. They aim to streamline regulatory effectiveness, making it flexible and responsive to market forces without compromising prudential concerns. We are in agreement with these aims.

In providing government with a clear path into the next century, the task force report cautions that time is of the essence. It urges that the debate be focused and the action be timely. It points out that to delay is to deny opportunities that could be realized and the challenges facing us will be harder to manage.

I share this view competely.

The task force also notes the need for Canadian financial institutions to consider their strategies in response to the challenges they face. In order to meet new and potential competitors, they must consider how best to position themselves. In this environment, the report clearly points out that there is considerable need for flexibility; flexibility on the part of institutions to be nimble and to adapt as market realities demand, and flexibility on the part of policy makers to allow them to do so. In our case, we have determined that a merger with the Bank of Montreal is the most appropriate response for our institution.

There will obviously be some tough choices and difficult decisions to be made, but I believe that if the government adopts the recommendations of this watershed report, Canadians will be the clear winners. This will ensure the continuation of a strong Canadian financial services sector, providing more competition, leading to a wider choice, better pricing and quality, and increased consumer protection.

The Chairman: Thank you very much, Mr. Cleghorn. I have a question about the future as you have described it on page 2 of your statement. My question is essentially one of timing.

You identified five different trends on that page, but I do not get a sense of the time frame. For example, if you look at globalization, yes, it is happening. I do not know whether the globalization issue becomes a crisis issue for Canadian banks today or in 1999 or in 2005, to pick arbitrary numbers. Yes, there has been some consolidation and rationalization going on in the U.S. banking system, but that is in part as a result of legislative change that has allowed the creation of national banks rather than merely state or regional banks. When I look at the trends, I say, yes, there are a lot of changes happening, but I do not have a feel for when these changes ultimately start to have a significant impact on Canadian banks.

Mr. Cleghorn: Let us use, as an example, mutual funds. I commented on that in my opening remarks. Mutual funds have been the fastest growing area of financial services. They represent the greatest shift that is taking place on the balance sheet of banks. Most Canadian banks today are active in the wholesale deposit-raising market to finance their portfolios because of the disintermediation that has been taking place on the deposit side.

If you look strictly at banks, which is your point, in the latest RRSP season, mutual funds passed bank deposits.

The Chairman: In light of what has happened to the market since the last RRSP season, it will be curious to see what happens in January and February of next year. This does not deny your argument. I say that as a speculative comment.

Mr. Cleghorn: You can look at 1990 to 1996, and of course there were corrections in 1991 and 1994 along the way. The point is that in the United States the mutual funds have passed all deposits. We expect that to happen in Canada in the next several years.

If you take a look at the players, you have two large, world-scale mutual fund providers operating here, among others. The assets held by Canadians in Templeton and Fidelity now exceed those held by each of the five chartered banks and Canada Trust. I am suggesting that they are doing pretty well. This last year, Fidelity was the fastest growing provider, in absolute dollar amount, in Canada.

Mr. Cleghorn: That is correct. They have been at it for a while, but in terms of being active, they started about the same time as the banks, back in the middle of the last decade. That would be an example of what I am talking about.

Another example would be credit cards. We are seeing now the monolines who have covered the U.S. and are now looking northward for a new market to cover. I think that the task force goes into some rather interesting examples of what has happened in other countries, and so on, with their penetration. There have been articles in the paper about it recently. Here you have MBNA, Capital One, and Bank One announcing they are coming here. These are large North American players that use technology, such as call centres and so on. They can operate in Canada just as they do in California, which has the same size of economy and population. It will be our call centres against their call centres. That will be the difference down the road.

The Chairman: You seem to be saying that the future is now, in the sense that the future you described is here, not five or 10 years away.

Mr. Cleghorn: Yes. If you take the U.K. investment banks, you know how quickly they disappeared. That did not take very long.

Senator Meighen: Welcome, Mr. Cleghorn. It is nice to see you again.

I am sure that Mr. MacKay, if he were here, would be overjoyed to read your report. It is not often that a task force chairman would receive such blanket endorsation of their recommendations. I am sure there are some things in the report that cause you disquiet -- or maybe there are not.

Given how you indicated you think the future will unravel in the financial services sector industry, starting now and in the years to come, is there any aspect of the MacKay report that causes you grave concern? For example, it has been suggested by some that, on the one hand, MacKay says, "Let us open things up and remove the shackles of regulation." On the other hand, he seems to come up with a number of recommendations for precisely that, regulation, whether in the consumer area or elsewhere. Does that cause you any problem at all?

Mr. Cleghorn: No, because I view this as a recommendation for opening up what appears to be a logjam. It seems to be fair to start with the consumer and ensure that there is wide competition but that there are also protections for the consumer. When this task force started, the level of debate was whether banks would be in car leasing or insurance, not the whole issue of financial services and the inroads of technology and the new kinds of competitors. Frankly, Canada has some barriers for entry that need to be opened up. It has been cited in international studies. We operate in the North American environment. Our bank's assumption has been that there will be open competition and that it will get here somehow, whether it comes through the Internet or right over the border. It happens in many areas of our business now. We had to be prepared for it. This report goes a long way to recognizing what those forces are, but it starts with the consumer.

My own industry has a problem in gaining public support for a lot of its initiatives, and although it does many of the things mentioned here, there is a credibility problem. If an infrastructure can be put in place that will satisfy the public interest, we are prepared to accept that. On the other hand, we look south of the border and we certainly want to be on both sides of the border in personal, commercial and wealth management. We are in the process of acquiring a small Internet bank out of Atlanta, Georgia. We had to meet requirements there in terms of proving our public impact and the positive nature of our arrival.

The Bank of Montreal has certainly faced that with the Harris acquisition and any other acquisitions that they have gone through.

What is recommended here is a made-in-Canada solution that can adopt many of the protections for consumers without having a huge bureaucratic process.

My only concern would be that the report is put in place on a cherry-pick basis. The worst of all worlds would be that we have no flexibility and every competitor in the world coming at us.

Senator Meighen: Do you see the adoption of the MacKay task force recommendations as -- I am not seeking to put words in your mouth at all -- enabling Canada to catch up to the open financial services sector that exists in many other countries, the United States being perhaps the most important one? Do you see it simply as that or, if it is that, are there any reciprocal benefits that we will gain by doing what MacKay is urging us to do?

You cited, for example, your experience in Atlanta. Was the following ever raised with you? "If we want to do the same thing in Canada, it might be more difficult for whatever reason."

Mr. Cleghorn: We are buying a subsidiary. I expect the border on our business to disappear. There are references here to the Internet. The bank we are buying is the first fully functional Internet bank in North America. With that, we expect to be able to operate for our customers wherever they choose. The rules are being written for that kind of electronic commerce today. We want to be there in the early stages because it will be a very important service delivery channel in the not too distant future. For some segments of our customer base, it will be the preferred channel, especially for younger customers. We do not know exactly what the future will be. It only has 17,000 customers and it is not a major investment. The investment will come as we grow forward.

The U.S. experience still has some barriers in terms of convergence of financial services. We have seen that in the case of the Travellers Citibank example. For a small country like ours to remain a leader, we will probably need to be slightly ahead of the curve. Our regulatory processes certainly are. The Australians and the British are adopting the combined regulatory process that we have for banking and insurance, for example.

Senator Meighen: Are you saying that there are still improvements to be made in our regulatory process?

Mr. Cleghorn: There are always improvements that can be made in everything we do. If we have a flexible system, we do not have to wait five or ten years to do them; we can do them as we go and improve with experience.

Senator Meighen: To what extent do you think the MacKay recommendations will prevent what might or might not be a good thing: the possible fragmentation of the financial services industry? I am thinking of what are termed "category killers." Five years down the line, are we likely to see a full-service banking operation, or will we have to go here for credit cards, and here for smart cards, and here for something else? Is the future unfolding clearly in your mind in that regard?

Mr. Cleghorn: You will have a combination of full-service players as well as monolines -- people that pick a niche.

Merrill-Lynch has come back here in a form far bigger than they were when they left in the late 1980s. They are much more of a cross-pillar firm today than they were back then. I would think that they would continue to do so as they seek new revenue opportunities. Whether they will look and sound like a bank, I am not sure, but they will offer many of the same services. With the recommendations here, for example, for broadening the number of players in the payment system, we can see them having many of the same attributes.

Fidelity, for example, is a powerhouse in its own right, a very serious player. In the U.S., they do a variety of activities. I would expect that as their business base grows here, they may choose to broaden their level of activity. Bank One is coming in as a credit card, but it is a full-service bank that is in the process of merging with First Chicago. They may decide to do that.

I saw an ad the other day for Nation's Bank. We will see divisions of financial institutions coming here. We might see them in a complete, full-service capacity if that is what they choose. If they think that the competitive landscape is such that their service is better, they will give it a try. We are certainly seeing it with the monolines today.

Our point is that whatever we decide to be in the future, it must be something that balances our ability to service our customers, deal with the communities in which we are located, and satisfy the needs of our shareholders as well. That will be a fairly flexible future, especially with technology. To think that we can be in all the services that we are in today on both sides of the border might be a good vision, but it might be tough 10 or 15 years out from now when you have specialists there, as well as full-service players.

Senator Meighen: Could you talk for a moment about your vision of the payment system? You supported the opening-up of the system. Would that mean cross-subsidization of the members of the system to an extent, or would there be a separation between the insurance industry looking after its own and the banking industry looking after its own?

Mr. Cleghorn: There, you get into definitions of solvency, liquidity, and strength. Forget the players today, but take a look at what we have. We have a better system than the Americans do. Customers are better served. They get their funds coast to coast literally the same day. If you dilute the system, and the system is not sure whether someone will be there when the cheque clears, they will hold on to it, which is the situation in the States today.

There are various players, and the Bank of Canada will have some say as to the definitions of solvency and security. Comments in the press were made recently by American players. We do not want to back into what they have because it is not in the best interests of the consumer.

Senator Meighen: Do I understand that, assuming questions of solvency and all that can be satisfactorily answered, once you are in the club, you are an equal member of it?

Mr. Cleghorn: Yes, and to go with that, you also have recommendations on deposit insurance. You may have the same administration but separate pools for insurance and banks. That helps to achieve a level of satisfaction by consumers and also the other users.

Senator Callbeck: When you talked about trends shaping the financial services industry, you mentioned that Canadians expect tangible support to communities. You mentioned the community accountability statement. When this committee was in Washington talking to the Federal Reserve Bank, they indicated that their Community Reinvestment Act had been successful. The banks were hesitant at first, but they have come around. The Canadian Bankers Association indicated that they had little difficulty with it, except that they thought it should be extended for the four pillars.

You mentioned this evening that you are behind a community accountability statement. I believe I read press reports where you favour a score card similar to that American reinvestment act.I should like to hear you expand on what you see. What factors will be looked at in that accountability statement? In other words, if this was in force, what could a community expect to see on their statement?

Mr. Cleghorn: When I talk about a community score card, it is something that we want to work up between individual communities. The MacKay task force, rather than laying out exactly the way it should be, lays out certain criteria, with which we would agree. They also say it is not just banks. It will be other people that are in financial services, which is fair.

There is a perception that perhaps banks do not do enough, whereas others might. You will now have a chance. There must be some kind of common score-card, although they do not attempt to do that here, to be able to get a meaningful comparison.

In the States, as I am sure you heard in Washington, that developed as a result of the red-lining process in communities, which was a lending issue. We are talking about a much broader application, as they are here in the MacKay report, where it goes clearly beyond just lending in a community. Canada can learn from the American practices of community reinvestment and can come up with something more modern, based on the practices here and not the kinds of practices there in the 1960s and 1970s that led to the Community Reinvestment Act being legislated. That is something that is applicable to all players.

I would not add too much to what MacKay has already indicated, namely, the various areas that could be covered, but it should be broader than just lending. It would be things such as partnerships in micro-credit, for example. We have some now with Calmeadow, which is considered one of the leaders, if not the leader. I would suggest a visit by Martin Connell to talk about the micro-credit area because it does not just cover cities like Toronto. They are active in Nova Scotia and have had projects out in British Columbia as well. We are a major partner, as is the Bank of Montreal, with CalMeadow. Another area would be in the area of volunteer support, both by the employees and the institution itself.

In looking at scorecards, we found that you might have a different score-card for Toronto than for Charlottetown. It is important that the communities have some say as to what is important in their particular area and what they think should be on a score-card. We are talking about forming a grassroots score-card, as opposed to one that serves everyone from Newfoundland to Vancouver Island.

The Chairman: I presume that the list Mr. Cleghorn is referring to is the list on page 170 of the main report, which lists the items as Mr. MacKay has suggested.

While Senator Callbeck finds that, I will ask a supplementary question. There is a second list in the report on page 117, which talks about public interest criteria vis-à-vis mergers. Senator Callbeck asked you about the criteria for community accountability statements; what are your views on this list? Both lists raise public interest criteria questions and one could envision a combined list of the two of them, somehow.

Mr. Cleghorn: Yes, you could. The public interest criteria for mergers is something that would be considered in the short term, whereas with the score-card for community involvement, you might start with a draft and it might take some time.

The report asks for all players in financial services to draw up a score-card for community support. I have no issue with any of these criteria. The issue is how extensive these public interest meetings would be and over what period of time.

Senator Kenny: When you describe different criteria for different regions, do you also envisage different institutions for each community or would you see a common set of criteria in each community?

Mr. Cleghorn: That might vary depending on what services they are offering. For example, if they are offering investment services, you might have that kind of criteria. If they are involved in lending, there might be others. The trick will be to try to include non-regulated ones, as well, which are increasingly more active, for example, in medium-sized, small-business financing.

Senator Kenny: What you are talking about is a community statement that each institution would make to that community that would form a type of contract or standard or threshold. Would each institution have a different threshold to meet, with which to satisfy the community?

Mr. Cleghorn: As I recall reading, I do not think that they said exactly how it should be.

Senator Kenny: I was asking your views on it.

Mr. Cleghorn: Sorry. It is my view that it depends on the individual institution's involvement in that community, both at the business and the community's levels. I refer to its impact on that community, in other words. It also talks about taxes paid to all levels of government, which is a very good thing to include in the community score-card.

Senator Angus: Mr. Cleghorn, my first question arises from your opening statement. As Senator Meighen pointed out, this appears to be very favourable to the task force report.

On page 2 of your statement, you talk about globalization and you refer to the fact that global retail banking is in its infancy, but the survival of Canadian retail banks as full-service players is not guaranteed unless action is taken soon.

This raises these questions: What kind of action, by whom and what does "soon" mean?

Mr. Cleghorn: I can talk about new areas of service, the way banks are permitted to do things in the States or in the U.K., for example. There are schedules in other countries, which show bank insurance activity and car leasing, for example. Those are two that I would mention.

There is also the ability to follow whatever strategic move you need to follow with each institution, by looking at its future and determining what it needs to do, whether that happens to be mergers or divestitures or concentrating on particular niches.

Right now we have regulatory barriers that prevent additional revenue sources, unlike other countries, and we have barriers that prevent combinations in certain circumstances.

We have other things. We have NAFTA, but we have non-NAFTA counting rules, for example, which have also been mentioned in this report. We have things that are uniquely Canadian but which impede the progress of maintaining the strength in certain industries in our financial services industry that we have been used to.

When the report says, as indeed our bank has said, that the status quo is no longer an option, it is absolutely true. Technology is enabling new competition to come in faster than the old bricks-and-mortar entry of before.

I look at Canada as an interesting market for anyone who wants to do business here. Once they appear to have saturated their own market, they look here, just as they seek to penetrate the U.K. and other countries. They have started and many have been here for a while. We view that as a fact.

I will give you an example of how long it takes to turn your systems against competition. When we joined forces with Royal Trust, it took us four years to combine our term deposit and mutual funds. Four years can be an eternity if you are looking at competition. It took us four years because the first attempt blew up and cost us $10 million. So, systems integration is not foolproof, but it is essential in order to achieve the benefits of technology and to be able to face competition in the future.

Senator Angus: In terms of action that needs to be taken, I understand that you are saying that those uniquely Canadian barriers that are in place need to be removed by government action. Is that a fair simplification?

Mr. Cleghorn: Yes. MacKay recommends all of these new processes in his various appearances and also in the language of the report. We cannot keep our heads in the sand. We should keep our debate focused. Timely action is required if we are to take advantage of some of these changes for the benefit of Canadians, rather than just letting them happen to us.

I share the concern in this report that we do not have forever to debate this, because we will lose advantage.

Senator Angus: I am sure that you know this report well, having spent long weekends absorbing all these background papers. My view is that the report is not without its criticism of the banks, the present major players in our country.

Mr. Cleghorn: Sure.

Senator Angus: In the comments that Mr. MacKay has made ex cathedra after the issuance of the report, he seems to imply that some of you folks have perhaps lacked imagination; that perhaps you have been overprotected and coddled in our system, which has legislated and prevented foreign competition from coming in here for many years. Although our own regulatory system has perhaps been too severe in recent years, a second cause of our falling behind in the global scheme of things has been the failure of the banks to be more imaginative.

I believe he goes so far as to suggest that mergers are not the only answer, and that there are other ways that the banks could do something.

Do you feel his criticisms are fair? What do you think about this?

Mr. Cleghorn: I worked for an American bank for nine years and competed against the Canadians. I was with the Citibank organization, which held the Mercantile Bank of Canada. It was a wholly owned foreign bank. It was owned by the Dutch until the government at the time decided that the Dutch could own 100 per cent, but not Citibank, and put in controls to prevent its growth. It was a good commercial operation. The Canadian public ended up owning approximately 70 per cent of it and then it merged with the National Bank about 10 years after I left because it ran into the downturn of the 1980s.

If you have competition, you will be innovative. We believed and anticipated that more competition would come. We also knew it would take some time to re-equip ourselves to meet competition in the core business areas that we thought we would have to try to be standing in at the end of the day, when the smoke cleared. Our strategy would be different than another bank in Canada that has chosen to build up a presence on Wall Street. We decided to take more of a niche role.

In personal commercial banking, scale does matter. Technology and development costs in the future are cheaper for the person who has the larger customer base to absorb those development and maintenance costs. Someone who has 20 or 30 million customers on the card side will probably have more scale than someone with four or five.

We have seen a similar occurrence with cheques. There is one major provider of cheques on both sides of the border. We expect that we would have to be on both sides of the border if we are to survive as a significant brand some time early in the next century. We would rather be a consolidator than a consolidatee.

Senator Angus: I take it that you are agreeing that up to a point some years ago, these criticisms of Mr. MacKay's were valid ones. But in the last couple of years, you have been playing catch-up ball and feel you have been innovative and strategically on the leading edge.

Mr. Cleghorn: When I say "wealth management," it is a small "W" because our average mutual fund customer has approximately $14,000 invested. The banks were permitted to get into that activity and I believe we are doing a better job than American banks, but there are major financial institutions in the U.S. that are very active in the same business. I mentioned two of them, Templeton Franklin Group and Fidelity.

On the brokerage side, we have now had 10 years of experience with the different cultures of brokerage investment, banking and commercial banking. The American banks are just getting into that. That may be a blanket statement on the part of the MacKay task force, but there are nuances that would indicate that we are better at some things because we have gone through the sound barrier of experience. Certainly, American investors have said the same thing.

Senator Angus: Historically, our banking system in Canada has been based on a strict separation between finance and commerce. The institutions within our banking system have developed and the system is operated on that basis and under the law the way that it is there, subject to the amendments made in 1992. Everything now seems to involve a blending of finance and commerce. Am I correct in that? Do you have any comments?

Mr. Cleghorn: One of the largest unregulated players in the commercial finance field is GE Capital. It is already happening.

We have players in other fields of financial services that are commercial activities. We have a large personal-commercial wealth management organization in Canada today owned by a tobacco company with other interests, Imasco being that holding company.

We have Power Financial, for example, which is a major competitor, a major player with a 7,000-person field force selling anything from insurance to mutual funds to mortgages to personal loans, deposits, and so on. It is already here.

Senator Angus: Am I correct in saying that to re-structure and to modernize the Canadian financial services sector, we must make the changes on new premises? It is no longer necessary to have a division between financial and commercial activities in one institution.

Mr. Cleghorn: You certainly must have regulation that is transparent for any player if the commercial interests are widely held. Again, MacKay addressed this. We certainly have experience in Canada with self-dealing. The regulators are better at it and the accounting profession, through the lawsuits that they have enjoyed, are now more experienced in the field of self-dealing between financial institutions and owners.

We now have not only theoretical areas for improving our regulation in this country, but we also have good practical experience that goes back 15 years, at least for some in this generation.

We can set out good rules and I think our regulators are experienced enough to know it when they see it in terms of the negative aspects.

Senator Angus: You have placed a large emphasis on technology and electronic commerce, as has everyone else who has spoken on this subject. You mentioned that you are in the process of acquiring an Internet bank, the biggest player in the States.

Mr. Cleghorn: It is not big, but it was the first.

Senator Angus: It is the main one. When you talk of ATMs and E-commerce and all of these technological ways to do banking, I have trouble differentiating one bank from another. How do you generate brand loyalty in this new area of electronic banking?

Mr. Cleghorn: For people who are active web users, obviously your web site must be competitive with others. The user friendliness, the rapidity in terms of doing your transactions, the completeness of a package and the ability to use other services, whether it is banking or discount brokerage, and your sense that the financial institution understands and respects you makes it easy for you to deal with it.

There is a mutual effort on the part of the customer in being open with the institution and the institution understanding the information they have and accessing it readily. When someone calls and needs a service quickly, the institution must be able to deal with that request in a timely manner.

There is a tremendous usage of technology on Sunday afternoons and evenings, which is when people generally want to pay bills or inquire about their balances. That is what we see in our telephone banking now. No branch system ever enabled us to do that before.

Senator Joyal: The last time we met, as you pointed out in your presentation, the development of the financial world was unforeseen and, to a point, unforeseeable. What happened in Asia and Russia and partly in South America in the last months of the summer led us to reflect a second time about the implications of globalization. Globalization requires a more open market, a better range of services, more effectiveness in terms of displaying the panoply of what customers can have as financial products. However, at the same time, there are risks. When there is a collapse, waves can be felt throughout the world.

In its opening remarks, the report says that financial conglomerates, often operating in many countries around the world, are becoming more widespread and regulators of such organizations effectively will require new regulatory techniques and approaches based on greater understanding of risk management and greater reliance on effective internal governance processes.

In view of your experience, which is wide and certainly compelling, what do you suggest to us as criteria for the kinds of new regulations and policies we should devise to protect the interests of Canadians generally, in view of the emergence of those financial conglomerates? That, of course, brings Canadians to the point of thinking twice in the context of the reorganization of the financial service market in Canada.

Mr. Cleghorn: You can look at what is here today and at what Canadians are using and perhaps extrapolate a bit. Institutions that are not banks are now providing financial services to Canadians, be it mutual funds, credit cards, or commercial finance. In some cases, regulators can deal with them, as they have with the monoline card companies, because they have established a bank licence. ING is a major multinational bank insurance company out of Holland that is coming in with a direct banking approach. They are using the banking regulations.

The fact that we have a regulator already combined here with insurance and banking helps, because in many cases there may be bank-assurance groups coming in which know what they are doing in insurance as well as in banking.

Again, knowing who these players are is very important. Our regulators are not just sitting north of the 49th parallel. They have a world view and are knowledgeable about what is going on around the world. They have a healthy exchange with regulators in the key trading countries for Canada. We have a much better understanding through the BIS. We have central bankers. We have regulators, such as the Superintendent of Financial Institutions, who get together on a regular basis with their counterparts.

Hedge funds in the United States are not regulated because the people dealing with them have tended to be sophisticated, wealthy individuals, so there was a feeling that perhaps that should not be regulated. I think we should consider how Canadian regulators will react to that. Our experience in recent weeks shows that the private sector has literally came together. I do not know all the details because we are not involved in that floatation process, and I do not know exactly the role of the New York Fed in that. However, as I said, some of the players that are active today have not gone through a full cycle.

As managers of risk, we must take that into account in dealing with them as counterparts. We are a leading player in foreign exchange for our clients and also in trade finance, so to that extent we must have relationships with both banks and financial conglomerates around the world to be able to do that business. We must ensure that it is balanced risk, that it is contained within our own capacity, and that we do not take material risks, because we do not want it to jeopardize the 75 per cent of our business that deals with individuals and small- and medium-sized businesses through the whole process, whether they are investment management, administration or traditional banking. The corporate investment banking side for us is 25 per cent.

We want to ensure that it can serve our businesses, but we do not want to put the rest of our operation at risk. I think that regulators must be able to look through all of us, whether at some point we are permitted to have a holding company structure or continue to have the structure we have today. They must be able to look through it and understand it.

I think Canadian regulators are a good example for others to follow; we need to ensure that our regulators are strong and are able to hire and keep the talent they need in order to stay current with events. If the Japanese authorities had adopted Canadian practice, they would not be having the problems they are facing today.

Senator Joyal: Do you believe that we have an institutional base in our country that is sufficient to address the issues at this point, or should we look beyond that, taking into account the new context in which we are operating?

Mr. Cleghorn: In terms of safety and soundness, I believe we have a strong position to build on. It is much better than it was when we had the LDC crisis and the energy crisis in the 1980s. We learned from that. The improvements have been highlighted here, but it is important to ensure that the talent and the scope of the Office of the Superintendent of Financial Institutions is sufficient to enable it to do the role that is spelled out for it here, meaning a broader role as a financial regulator over more than just the group that is being viewed today.

Senator Joyal: In your comments on the report you did not mention its extensive recommendations on tied selling and the protection of the privacy of customers. Do you agree with the recommendations of the report on those matters?

Mr. Cleghorn: Yes. An important issue for us, both strategically and going forward in terms of building and keeping our customers, is the area of credibility. Clearly, our industry has had a problem with credibility, both in recent years and going back a long way. I do not think the Canadian perception is that much different from the public perception of banks in the United States.

Clearly, if there is to be lots of competition and people will be doing similar business to us and our expectation is that we can broaden our product offering, then there must be clear rules and the consumer must have the confidence that commitments made will be met and that there is some form of independent review of the processes.

We think we have had a good history of meeting the concerns of consumers, but clearly credibility has not kept pace with what we think are leading standards, so it is probably a good idea to adopt the process here so that accusations of tied selling can be put out in the public domain in a transparent way and so that all competitors must meet the same test as banks.

Senator Joyal: Of course, if we were to adopt a set of regulations for financial institutions, it would be for all those under the framework of the objective of the legislation. There is no doubt in our mind on that.

Mr. Cleghorn: On that point, there are 500,000 Canadians directly working in the financial services industry. Of those, 220,000 work in banks. Therefore, 280,000 are working in other areas, be it insurance, brokerage, mutual funds, or whatever. The 220,000 who are working in banks seem to get isolated for some of these issues. It is a customer service issue. It is also a morale issue among employees. Therefore, we would prefer, where possible, to see the other 280,000 employees put on the same reporting basis as the people who work in banks.

It is interesting to note that the 44 per cent breakdown of employees to the total population directly involved in financial services is about the same breakdown of financial assets that banks have in Canada as well, if you include the whole service industry.

Senator Oliver: I should like to read my questions into the record and you can answer them in your own time.

The most compelling statement I heard you make was one Senator Angus referred to. You said that, in terms of globalization, the banking industry is in its infancy, but the survival of Canadian retail banks as full service players is not guaranteed.

I want to talk a bit about the second-tier banks, retail banking and so on.

My first question relates to some statistics contained in the task force report. They said that, according to the World Economic Forum, Canada ranks at the top of 53 countries in bank safety, but places forty-first in terms of the presence of foreign competitors.

Do you believe that we have been too cautious in Canada in terms of allowing real and effective competition in our banking market and, as a result, have failed to develop an effective second tier in financial institutions that would provide more choices to consumers?

Second, do you believe that there is an appetite for foreign branching in Canada? If so, what are the markets, and will foreign banks create a real second-tier banking system in this country, and is that necessary? You have already told us what MBNA, Bank One, Wells Fargo and ING are doing. Will that be the form of the second tier?

Third, in terms of the questions about tied selling and so on, two of your counterparts from CIBC and TD, Bailey and Flood, complained that the MacKay task force recommended too much regulation and that there would be over-regulation in the financial sector with the kinds of regulation recommended for privacy standards, coercive tied selling and regular accountability statements that must be filed. Do you agree with them that that is getting close to being over-regulation?

Mr. Cleghorn: In response to your first question, have we been too cautious, the answer is yes. If we want strong, domestically based-headquartered Canadian financial services companies, we must have a more open environment. Competition at home makes you stronger, wherever business you are doing. Frankly, the Canadian banks have been international in their operations since the last century. Maybe we do not always have the pizzazz of our foreign competitors but I can tell you, from being on the firing line, having worked for an American and Canadian bank and competed with many around the world, Canadians seem to be naturally inclined to financial services and we do it well. Opening up competition will make us that much stronger and more innovative.

On the branching side, there are different ways of coming in. For example, you have Norwest, which acquired Trans-Canada Credit, which is a commercial finance operation that has branches across the country.

Senator Oliver: You bid on that as well, I expect?

Mr. Cleghorn: Not that one. I do not recall that we did on that, but we bid on others; for example, we bid on the credit card operations of Eaton's, and Norwest beat us on that. Recently, there was a need for financing in Stephenville, Newfoundland that I was aware of. It was for approximately $400,000 worth of computer equipment and related software. We were the banker who was asked to bid on it, but a variety of others were asked to bid as well. G.E. Capital, which I do not believe has a branch in Stephenville, was there bidding right down to the wire. It was between us and them in that particular case.

When I was at the Mercantile Bank of Canada, where we had one branch in many of the regions, some in individual cities, we travelled to find the business and we had ways and means of finding anything that was interesting. If you take a look at small business financing today, you will see that the banks represent 50 to 60 per cent of that. That statistic comes from the MacKay task force. The rest is being provided by unregulated financial institutions and government institutions, such as the treasury branches in Alberta and the Business Development Bank.

It is good business out there, whether they use a suitcase or an electronic method of delivering. We see a great growth, for example, in our banking operations of mobile account managers who are using laptops and cellular phones now to operate in the rural communities.

Senator Oliver: Going into people's homes?

Mr. Cleghorn: Exactly. Going to the farm gate and people's homes. They operate out of a centre but they can get in their truck or car and do that. We do that also in remote communities. We also find we are not the only ones going there hunting for business.

It is often difficult to see who the competitors are in a particular community. You look at the set-piece branch and you can identify that, but what about the people who are arriving by train, car, truck or plane? It is hard to measure them on the competitive map, but they are real and they are there and we see them.

I referred before to Power Financial. Power Financial is comprised of 7,000 people now. That figure was quoted by the CEO of Great West Life. Power Financial is a combination of Investors, Great West Life and London life. They are cross-selling services between them for the benefit of their consumers, and for their shareholders too, I presume.

So we need to add to the mobile force in our organization so that we are not just operating from a set-piece, bricks-and-mortar operation. I am suggesting that new competitors will use whatever way they can to get to the market to find out. They may use an office, they may use a particular product or they may use straight cold calls.

Senator Oliver: How do you think institutions such as Chase or Citibank, or Travellers and so on, might come in, looking ahead for five years?

Mr. Cleghorn: It will depend on the market segment and the product. Citibank, for example, won a contract with the federal government in supplying card services. That was an open tender against other financial institutions, including ours. We could not meet that. They are a very active player in private banking and corporate finance in Canada. That is one example. Travellers is already in business here, both from the investment banking side and the insurance side.

Senator Oliver: You have referred on two occasions tonight to CT Financial. I asked Harold MacKay and his task force whether or not the grandfathering was giving an unfair preference to a particular group, and I referred to CT Financial. My specific question was that, even though CT Financial is in the range of the $1 billion to $5 billion market cap, it triggers the 35 per cent $widely held' rule and, according to Harold MacKay, it would not be compelled to dilute its ownership block -- in this case IMASCO's 98 per cent ownership -- even if it subsequently grew to a size that would otherwise require it to be widely held. How do you view this grandfathering? It will not affect you because you are so big, but how will that be fair to other smaller banks in Canada?

Mr. Cleghorn: Retroactive legislation would not be fair.

Senator Oliver: You see nothing wrong with that proposed grandfathering?

Mr. Cleghorn: That is right.

There was another question you had on my views relative to comments made by the other proposed merger of CIBC and the TD.

Senator Oliver: About over-regulation?

Mr. Cleghorn: Yes. I have not seen the nature of their comments. I believe it was done at the time of a press conference relative to MacKay. I hear different things from that proposed merger. I do not wish comment on that. We have made our own comments here.

Senator Oliver: I was not asking the question in conjunction with merger; I was asking it in conjunction with the specific recommendations made by MacKay with respect to bringing in formal regulations or legislating rules with respect to privacy and so on, rather than leaving it to self-regulation.

Mr. Cleghorn: As I mentioned earlier, the difficulty we have had is generating enthusiasm for a commitment from the industry that it will do certain things and live up to them. Today the Bank Act requirement for tied selling for banks has been enacted. I would prefer to see that all providers of the same financial services be subjected to the same rules, because that is only fair. This is an inference that only banks should be dealt with because only banks have a habit of committing coercive tied selling practices.

Senator Oliver: Mr. MacKay suggests that all members of the financial family should be.

Mr. Cleghorn: Exactly. First of all, in terms of strategy, public perception is important; if it is negative, this is a way at least to calm their fears, showing that there will be an independent process to ensure that these issues are dealt with, especially if there are any infractions. The added benefit is that it will no longer be just your friendly banker who is subject to these rules, but every player who is operating these services. You must have that in order to have convergence.

It also takes away the argument, for those who do not like convergence, that the rules should apply to everyone. If that seems to benefit consumers, so be it. With regard to the comments of my competitors, I do not know precisely where they were coming from. Obviously, there will be many details in this and it remains to be seen just how extensive and bureaucratic it might become. However, the recommendations would indicate that this could be done in a cooperative manner. It can be done to the benefit of all without it being a large bureaucratic exercise. I am heartened by that.

Senator Tkachuk: I have a couple of questions about businesses outside the business of banking. Let us start from the premise that the state gives the bank a privilege, and that the banks are the core of financial services in any country. Most people feel that, as the banks go, so goes the country. In return for liquidity support from the central bank, and in return for the state telling us that these are good companies and we should deposit our money with them, the banks extend credit.

It seems to me that over the last couple of decades, the banks have been getting into other business outside of extending credit. They have been getting into the brokerage industry, and now you want to get into leasing. You are already in the insurance industry. What share of the profits of, say, the Royal Bank, would be made up of what would be non-traditional banking business?

Mr. Cleghorn: That would be a difficult question to answer in precise terms, because some of our services have evolved. For example, 20 years ago in so-called traditional banking, you did not have daily interest on your accounts because you could not do it without the computer systems. Those came in in the 1970s. Banks were not, for example, into mortgages until the late 1960s and only grew that business through the 1970s. Banks have evolved.

The thing that was different between Canadian banks and, say, American banks was that you kept trust activities and banks separate for some reason. It goes back to the last century.

Banking has evolved. For example, banks were not lenders to individuals. They could not do car loans, for example. They were not permitted to be in that business. Over time, this has evolved and they have become competitive. But, again, Canada has not been unique in this. This is something that has evolved over time.

Our customers have evolved. When I worked for Citibank, I remember seeing a forecast done in the mid-1960s of the decline of free balances to be kept in banks -- deposits, in other words. As those declined, because companies and individuals wanted to get a better return on their deposits, there would be disintermediation. In other words, the same deposits that were there would not be able to fund loans. So companies that traditionally borrowed only from banks started to go to the capital markets. But it was not banks that asked them to do that. It happened because the capital market came along and provided a deeper, in many cases cheaper, form of financing that was more competitive.

In the case of consumers moving to mutual funds, this has been gradually happening with the changing demographics of our country. People are more aware of other opportunities.

I think there has been an evolution. There has been competition formed on virtually every product line on a regular basis as the Bank Act and other forms of legislation have been reviewed.

In the 1980s we went through a period of tremendous shakeout after a highly inflationary period, and that shook out some of our smaller players. As a matter of fact, in terms of bank failures, there was the Home Bank and two small banks, the Canadian Commercial Bank and the Northland Bank in the west; they failed, and that was it. At the same time, there were 17,000 bank failures in the United States. The Canadian experience was fairly good.

This is not something that the banks whined about and asked for. This was something that evolved over time as our customers literally found other ways of doing things. The growth of the investment banking community has taken place because of the growth of the capital markets, the growth of the globalization of funds, and the opening up of borders so that foreign exchange flows. The flow of money is not restricted. It is a much more global environment today in capital markets than it was, say, 15 years ago.

Senator Tkachuk: Would you say that more than half of your profits now at the Royal Bank are being generated by your other financial service business, or would it be more than that?

Mr. Cleghorn: It is hard to say, because we are more active today than we were 15 years ago in venture capital and in different forms of risk lending within our small business sector. We have a lot more in the area of investment advice that we offer through our bank branches today to our clients. We have jobs in our technology field that did not exist five or 10 years ago. We have jobs in our branches that did not exist five or 10 years ago, because the nature of the service offering is different, and yet that is done in a traditional bank environment with a banker talking to a customer. It happens also that in addition to very sophisticated term deposits, GICs, and so on, they will also talk to the customer about mutual funds.

I could look at each service offering that we have today and tell you that it is not as traditional as it used to be. There are variations on each theme. There are complexities today in our product line that I would not say are traditional. They have become available because of technology.

Senator Tkachuk: Traditionally, people put money in banks, and banks have a pledge to extend credit to people in return for the right to take the deposits. The banks are going into other businesses, such as the investment business and the leasing business, and other kinds of financial services outside of extending credit. That would make the amount of cash available to extend credit less, would it not? Or are you generating enough profits out of the other businesses to make credit more available?

Mr. Cleghorn: You mention leasing. We have been in leasing since a Bank Act review in the 1970s. We acquired a leasing company back in the 1970s because we were permitted to be in that business. We have not been permitted to do light vehicles, which is unique among other major countries with which we trade. A car lease, for example, is just an alternative to a car loan. We do not want to be in the car manufacturing business or in the car wholesaling business. We simply want to provide financing for our clients. We have been able to do aircraft and ships and heavy vehicles, and so on. It is just another form of financial service, and it is certainly recognized that way in the U.S.

Financial services have evolved. Personal and commercial banking represent 60 per cent of what we do, but a lot of the products there are not necessarily traditional, nor are the methods of delivering those services. In other words, they are offered by telephone today and by debit card. They are also offered now by PC, which you could not do before the technology became available. We then have the services under investment management, such as our discount brokerage, which was a start-up business for us.

So it is all technology-driven now, and another example is mutual funds. We were permitted to distribute mutual funds a long time ago but we could not own a mutual fund company. We were permitted to do that back in the 1980s along with other financial services institutions. We decided it was going to be a major endeavour for us, and it was one of the reasons why we wanted to join forces with Royal Trust, because they were also a leader in that business.

I mentioned our brokerage business. That is an important part of our business because we are seeing a migration from bank deposits. Bank deposits in the system shrank in 1997 because they were going into other forms of activity, yet our loan side was growing, in personal loans and small business loans and mortgages.

Today there is something called securitization. If you do not have enough funds, you can securitize mortgage receivables or credit card receivables into the investing community. That has really just started in Canada in the last handful of years. In fact, we can raise money offshore and swap it into Canadian dollars to help fund our Canadian loan base.

In addition to banks, there is a variety of competitors in each one of these services. In terms of our being just a traditional banking provider, I do not actually know what services those would be, or what a traditional offer would be, just through the branch network.

Senator Tkachuk:Why would people pay three or four times the interest rate on a credit card unless there was a failure of the banking system to provide credit to people? If they could get credit at 6 per cent, why would they pay 24 per cent?

Mr. Cleghorn: Or 29 per cent to a retailer?

Senator Tkachuk: The credit card business grew, and then the banks got into the credit card business. I cannot believe that the banks cannot compete for personal loans with the leases. I do not understand it. It is cheaper to buy than to lease. Why is leasing growing to such an extent? Should the banks look at themselves and ask if it is possibly because they are not packaging traditional forms of credit in a way that would allow people to buy the car rather than to have the bank buy the car and then lease it, which is what you would be doing?

Mr. Cleghorn: The difference to someone who is leasing versus buying and then taking out a loan is cash flow. They simply look at the cash flow and say the cash flow for a car lease will be less than if they were to buy it.

Credit cards are still predominantly a payment vehicle. The average credit card loan is $1.5 million. The larger personal loans are done as mortgages and so on. The credit card loans have not grown that much on average, and over 50 per cent of our customers pay them off within the stipulated period. They are really a payment vehicle and a convenience.

Senator Tkachuk: You say you are in the leasing business. I know we have the strangest situation where what you can lease is based on weight, but what kind of vehicles do you lease now? I believe I heard Mr. MacKay say Caterpillars and heavy equipment.

Mr. Cleghorn: That is right.

Senator Tkachuk: What is the residual at the end of the lease? Is it 5, 10 or 15 per cent?

Mr. Cleghorn: That will vary depending on the nature of the equipment. Essentially, we are doing financial leases. A small part of our business would involve residual risk.

Senator Tkachuk: In the automobile business, to be competitive, you will have residual risk that will be quite substantial.

Mr. Cleghorn: Yes, and there is a market for that. You must be competitive based on accepted valuations in the market-place.

Senator Tkachuk: Where will you get your car expertise?

Mr. Cleghorn: We will have our financing expertise. We do not intend to build cars or keep them. There are large auction houses where cars are sold. I would expect that that would still be done by those who are active in that business.

Senator Tkachuk: When you lease a car for a customer as fringe leasing -- or in any kind of leasing business of personal items -- at the end of four years you have to guess or take a bet as to what that car will be worth in order to finance that automobile. Therefore, you have to know what you are doing when it comes to the car business, let alone the lease business, because you have to know what the end product will be or you will lose your depositors' money.

Mr. Cleghorn: I think we would have to understand that.

Senator Tkachuk: What will happen to all those cars?

Mr. Cleghorn: It is the same thing when we do an aircraft lease. We have to understand the aircraft. We have to understand the equipment that we lease today.

Senator Tkachuk: You also said you have low residuals there. In the car business, as I understand the leasing business, the residuals are quite substantial. They are based on a four-year lease with a substantial amount of cash left at the other end of the table.

Mr. Cleghorn: There are market practices to follow; you have to be competitive in that business. It works in the States, and I think it will work here. If there is competition, the customer will benefit.

Senator St. Germain: I should like to dwell a bit on retail insurance and auto leasing. Traditionally, you have been protected to a degree that has allowed you to generate huge profits and grow to the size you have. There is a substantial fear among the small automobile dealers leasing automobiles today and the small retail insurance agencies that they will take an awful hit when you come into the market, because of your distribution and the branches you have right across the country.

Can you deal with this in such a way as to allay those fears? Did I hear you say that there should be a transitional period of grandfathering into the market-place from your perspective? How do we answer this?

The greatest number of questions that I am likely to hear on this particular aspect will be from the insurance agents of Canada who cover the insurance agencies and the automobile dealers who are presently in this leasing business. They see you as a huge threat to their industry and they are afraid that job losses and other traumas will occur. I am sure that is why some of the political parties in this country have raised a hue and cry; they feel they cannot simply let you do what you are planning on doing and ignore the report. What is your comment on that?

Mr. Cleghorn: In 1990, 5 per cent of cars were financed by leases; now it is close to 50 per cent. About 80 per cent of that financing is done by the big auto manufacturers, Ford, Chrysler, Mercedes, and General Motors. That is information of which I am aware, and it is also in the report.

Other countries are offering a broader range of competition. In the United States, Ford Credit and General Motors Acceptance are competing against credit unions and banks. In fact, credit unions have a very large part of the car leasing market in the U.S., as I understand it, so they are already used to that. It will not be anything new for them.

Consolidation is taking place in the dealership industry prior to our arrival, if you will, in the car leasing side. Rationalization is already going on in this business. They do permit or suggest a transition period for that to take place first, certainly for large players such as ourselves.

On the insurance side, we have an insurance arm, which we have been building up gradually through small acquisitions. We have in excess of 1,500 employees who all worked for insurance companies before they joined us. We acquired Mutual of Omaha and 600 agents to be part of our group. We wanted to acquire London Life. We saw revenue synergies. We did not have much in the way of cost overlap, so the bulk of those employees would stay within our group in order for us to be a player in insurance. We will have to hire many people both on the sales side and on the administration side. Our chief executive officer of our insurance division was the former chief operating officer of Met Life Canada. We are offering jobs for people who want to come to work for us and help us build up our insurance operations.

There are examples in the Province of Quebec where the major deposit-taking institution in the province, the Caisses populaires Desjardins, has been offering insurance to its customers since the 1980s, with success. It has not destroyed the insurance industry. Canada is unique in keeping its banks out of distributing insurance, and that is highlighted in the report.

Really, the question is: Do you agree with competition? Do you agree that the rules will be the same for every one? Tied selling was an issue that had been raised by the insurance lobby in the past, and it was indicated that we are not in the communities in the same way that others are.

I think the community score-card will help to put everyone on the same footing in terms of what we are all contributing to small communities as well as to large ones. As long as that process is transparent, then on the competition side we think all players should be able to offer their services.

Another point here is that the insurance industry can get into banking and get into the payments business, and so on. As far as the insurance industry is concerned, half of what they do in addition to pure insurance is investment management or wealth management. In other words, we are converging into each other's area and it is hard to tell the difference between products today or the companies that are offering them. That is all highlighted in the MacKay report. There will be a transition period for both car leasing and insurance, and it is the same period of time.

Senator Kelleher: Mr. Cleghorn, during our travels last year to Europe, Britain and the United States, it became obvious that Canada was not exactly a leader in the financial field with respect to holding companies. Finally, now, Canada appears to be taking a look at that aspect of the financial business. The MacKay report has outlined some recommendations that would permit holding companies in the financial area.

Can we have some comments from you as to your personal opinion about the adequacies of this report? Do you feel that the MacKay report has gone far enough? Is it a good first step? Should they have gone further? How well do you think they will work?

Mr. Cleghorn: I read the background paper on it, which you have to do in order to understand their thinking, and I found some good evidence there of the usefulness of, and the alternatives to, holding companies. It is like mergers. Some organizations will see the usefulness of having one because it enables them to join forces with financial services, but services that are unrelated to their banking activities. That is to say, it permits you to have different cultures. It might enable you to have different brands under a holding company structure. That would be the main advantage for a Canadian company that wants to be in a business on both sides of the border where it is important to keep brands in different markets or for different types of financial services; but you could have a unifying corporate name, if you want to call it that, for the holding company.

The advantage is that it is there for flexible corporate considerations. As long as the regulator can look through the various activities, the holding company should be transparent. If the regulator wants to take a look at what is happening, it should be able to do so. We have seen the disastrous effect of holding companies not being able to be reviewed by the regulator in past times here in some of the trust companies. As long as it is transparent, it could be a useful, flexible process for the corporate sector.

In the U.K., on the other hand, there were cases where it was not necessary and they were able to adopt other processes. However, it is like anything else; if it is important to the company to operate on two sides of the border, to have different cultures and to keep its banking separate from its finance company, it would be useful; or, for instance, if it is a different bank that is being acquired, it would be useful.

Senator Kelleher: My last question deals with taxation. I think it is fair to say that banks have felt to some degree that the taxation field is somewhat weighted against them. MacKay is making recommendations in his report for certain amendments to the tax regime as it applies to banks. Can you give us a few comments on to whether you feel these are adequate? Do they go far enough? How do you feel this will affect the banks?

Mr. Cleghorn: The various constituencies that you must address and be successful with, if you are to survive in the future, are those that we have talked about, namely, customers, consumers, communities, employees and shareholders. We have not spent that much time talking about shareholders here, but 75 per cent of our owners are Canadians, both institutions and individuals.

As we compare ourselves with top performing financial institutions in the U.K, the U.S. and Australia, we want to be able to compete in the top quartile. Whether it is for quality of service or performance for shareholders, you must try to aim high in your performance standards. Financial institutions that have not performed well for their shareholders over time, either for safety reasons or just because of poor performance, have not survived; they have been taken over in the long run.

With regard to taxation, comparing Canadian banks with those of other countries, a study by KPMG that compared Canada with the United States and Britain, showed that when you added all taxes and levies, we were at about 68 per cent, the U.S. banks were at almost 50 per cent, and Britain was at 45 per cent. A study done by the University of Toronto indicated that financial services is the highest taxed sector in Canada and banks within that sector are the highest taxed. I think there is evidence to support what MacKay has said there as well.

There is a sense that the banks are making enough profits that they are fair game for taxation. Ultimately, however, it is a matter of cost structure. Capital taxes are perverse because we are trying to build capital. We are required to do so by our regulators, both domestic and international, and we compete for credit ratings on the strength of our institutions. However, the stronger we make ourselves, the more tax we attract in the capital tax area. It is not shown as a net income item, but is shown as part of our cost structure. When we compare our efficiency ratios with those of U.S. and British banks, we have a much higher proportion of levies and taxes such as capital taxes. Our deposit insurance premiums are a lot higher than they are in the United States for comparable players and our capital taxes are included in our cost line. That is one of the reasons why Canadian banks are more expensive in terms of cost revenue comparisons with U.S. and U.K. banks.

People may look at our earnings and conclude that they are good enough and it is fair game to extract a high level of taxation from us, but they might recall that some of the banks did not make any money at all in 1992-93. One must look at earnings over a full cycle, and the recent years have been the good part of the cycle.

I want to address a comment that was made earlier about smaller players. In the past, we have had smaller players in secondary financial institutions. Unfortunately, many of them were wiped out in different downturns <#0107> some in the downturn of the 1980s and others in the downturn of the 1990s. About 23 per cent of my alma mater is still owned by Citibank, which effected a merger with the National Bank eight or nine years after I left them in the mid-1980s because of the downturn of the 1980s. Had we been the Royal Bank of Alberta, I would not be sitting here today because our institution would be gone; had we been the Royal Bank of Saskatchewan, the same thing would have happened. However, because we are a diverse organization with a business that is diverse across the country and in other parts of the world, we survived the downturns of the 1980s and the 1990s and we are stronger for it.

One of the advantages mentioned in the report is that a larger organization can also diversify its risk base. Frankly, diversification of risk is probably the only way to win in the future, because it is very hard to predict the future.

I would encourage broader-based secondary institutions. The report, which recommends that we have credit unions going across provincial borders, makes sense. They will face the same issues as our larger players face in terms of technology, scale, and so on, in going forward.

The Chairman: Thank you very much, Mr. Cleghorn. Given how long you have been here, I will not ask you to answer my questions now, because they will require some thinking on your part before you can answer them, but I would like you to send us a note on them.

First, you have come out in favour of the federally regulated financial holding company model proposed in the task force report. It would be helpful if you would give us a note that explained your position, because some of us are not clear on this question. That is to say, we do not necessarily see the advantages of the holding company or what can be achieved by the holding company route that cannot be achieved by a parent subsidiary route. In other words, from a corporate standpoint, what are the advantages of the holding company?

My second question reflects my deep personal suspicions. I want you to know that that is underlying the question. I notice that in commenting on the payments system, you were in accord with the task force in stating that you are in favour of broadening the payments system to other companies that meet criteria related to their solvency, liquidity, regulatory and legal frameworks.

Perhaps I ask this because of the attitude of the banks during the fight with the Competition Bureau over Interac and because of private discussions during that prolonged fight of several years over the fact that a lot of conditions were suggested by the existing players. The justification for imposing them was that they were solvency conditions, which I think most objective observers would not have thought were solvency conditions but were just an attempt to use solvency as an excuse to make it a barrier to entry.

I would like you to think about those criteria. My suspicion is inherently that, if the drive of public policy is to open up the payments system, one should not end up in a situation where that is the policy but where the detailed route, in effect, does not open up the payments system but becomes an implicit barrier to entry.

Coming to my third question, you have responded to the quotation that several of us picked up at page 2 of your statement regarding the lack of guarantee of survival for Canadian retail banks as full-service players.

You also quoted some of the activities of Northwest Financial in the U.S. As you know, the CEO of that company has been quoted as calling his outlets stores, not branches, which makes me think of the retail business. Let us look at what has happened to retail department stores. Department stores used to sell more things. Now most do not sell heavy kitchen appliances, and many do not even sell TVs.

I understand why you care about this, but as a consumer why do I care if I have a full-service business or not? In the retail business, I now go to an appliance store to buy a fridge or a stove. I go to an electronic outlet to buy a television set. A lot of your rationale tonight has been built around the desirability of a genuine, complete, full-service, across-the-board operation.

If you look at what has happened in the retail business, I would say that that is not the way to go from the consumer standpoint. I understand why the guys in the business would like to do that. Why should the consumer want that?

Mr. Cleghorn: I agree with your comment. Not every consumer does, but many still do; so we have to be there for them.

When we talk about offices or branches or outlets going forward, we are talking, in some cases, of single-purpose outlets. Some might offer quasi-full service; others will offer full service. It depends on what the population in that area wants.

Some are getting used to seeing financial service types come to their kitchen table in the evenings or on weekends. We must adapt to that. It is evolving and we will evolve with it. Some areas and some customer groups want full service. We have to be there for them. Others are quite happy to deal with financial institutions on a one-off basis.

The Chairman: People used to like department stores, and ultimately there is a segment of the Canadian population who would still prefer to have the old- fashioned department stores. Yet, as you know, they are a rapidly fading breed.

For us then, do we look at a public policy framework that is skewed to the development and the maintenance of full service institutions, or do we look at a public policy framework that is skewed to the development and encouragement of very low-cost boutiques, such as the appliance store and the TV store?

The sets of public policies that drive in those two directions, although I am not sure of this, are probably different though, perhaps significantly different.

In watching the evolution of the retail market in general, I am not at all sure we should be focusing on policies that are designed to provide full service units if we can help the consumer get lower cost by boutique shopping.

Mr. Cleghorn: If it is open competition, you will have players that will want to come in on a single-product-line basis. You are already seeing that now. In some cases we may go into a particular area on a single-product basis as opposed to a full-service basis. If you have pretty open competition, you will have both single-lines and full-service players. You will have a combination.

The Chairman: Public policy should allow both to exist?

Mr. Cleghorn: That is true, if you want to have full competition.

Senator Meighen: The Chairman may not have been in a department store lately, but many of them have boutique operations within the store.

The Chairman: Yes, they operate as franchise operations within the store.

Senators, our next and final witnesses tonight are from the National Bank of Canada.

We prevailed upon Mr. Courville this morning as a representative of the Canadian Bankers Association, so I trust we can be reasonably focussed in our questions and comments to him this evening as president of the bank. He has agreed to open with the question which he ducked this morning: What future does he see and what are the implications of that for strategy?

Mr. Courville, I said you ducked it, but that is an unfair characterization of what you did. You said that the members of the CBA had quite a different view on what constituted the appropriate future or the possible futures and, therefore, there was no industry position. I did not mean "ducked" in a bad sense, but it might be helpful if we understood your own view of the future as a going-in position tonight. Please proceed.


Mr. Léon Courville, President and Chief Operating Officer, National Bank of Canada: I would like to take about eight to ten minutes to describe the National Bank's position with respect to mergers and talk a little bit about the future of the financial services industry, as we see it. In two or three days time, we will be sending you a paper that addresses these issues. Tonight's discussion will be an opportunity to provide some details.

The National Bank of Canada is the sixth largest bank in Canada, making it the smallest of the major chartered banks. It operates in Canada and in Quebec. Sixty per cent of its assets are in Quebec. That means that 30 per cent of its assets are located outside Quebec, some in Canada -- specifically Ontario and Western Canada -- some in the United States and a small portion in Asia. It was much more last year. We were able to avoid the storm.

We are engaged in retail and personal banking primarily, as well as being a commercial bank. If we had to choose only one activity, we would be first and foremost a commercial bank.

We represent approximately 7 per cent of the Canadian banking system based on capital, whereas in terms of overall commercial lending, to both large firms and small- and medium-sized businesses, we represent between 13 and 14 per cent of the market. Because we do not deal with the largest corporations, we believe our assets in the small business sector are over-weighted compared with other Canadian banks, despite the fact that our operations are concentrated in Quebec.

We are a diversified retail and commercial bank in the sense that we engage in all currently allowed banking operations. We believe that the concept of integrated financial services -- not necessarily one-stop shopping -- is an asset for Canada and an intrinsic part of the structure of the Canadian financial services industry.

I would also point that we are more familiar with competition than the other banks. The primary recipient of personal deposits in Quebec is the Mouvement Desjardins, which holds 40 per cent of the market. It receives tax, legal, regulatory and deposit insurance benefits unavailable to us and has a broader range of activities. Yet we are still able to hold our own.

You have raised a number of questions with respect to international expansion. In a way, that is linked to globalization. I just want to say that many of the National Bank's activities are international in scope because of our considerable involvement in the commercial banking sector.

Alcan and Bell Canada do not need banks in order to be active abroad. However, small- and medium-sized enterprises that engage in import/export activities with Asia or South America need a banker for letters of credit, international payments, and so forth.

At the National Bank, we closely monitor the requirements of our clients as far as their commercial operations are concerned. That is how we have been able to build an international department whose raison d'être is the need for commercial links with interests abroad in order to meet the needs of our small business clients. That has taken us to Asia, where we opened an office in Hong Kong. We have also set up shop in Korea and China.

In Europe, we have a rather special way of doing business. We had been operating a branch office in Paris with 100 employees for some time, but that was not enough. We could never satisfy our clients, whether we are talking about the footwear, lumber or paper industries. So we decided to form alliances with popular banks in France, as well as a Spanish bank, a German bank, and a group of Italian banks, with whom we have a special relationship and where our clients become their clients when they come here. We have established a solid presence in Europe by doing business with banks that are well-established in their own area of operation, and thus we are able to improve our reach and that of our clients through such alliances.

You talked about technology. I just want to point out that although we may be smallest bank in Canada, we are also the one that initiated the automatic debit system. The very first experience with automatic debit involved the National Bank and Provigo. We were the first bank to link individuals to their banking operations via a computer, even before the Internet became a reality. We developed a new system for our operating accounts. We sold it to a bank that is four times bigger than we are. It took them a while to make up their mind because they could not figure out why it was costing them more than what we were billing them. All this to say that technology does not necessary translate into economies of scale.

We reduced our operating costs by systematically contracting out our computing. In the commercial sector, we sensed, long before the Internet became fashionable, that electronic commerce between businesses -- in other words between large payers and large receivers -- would grow in importance. We are currently carrying out a project in cooperation with Bell Canada, which is now doing business with a large user, the Commission de santé et sécurité au travail du Québec.

The reason I am describing the National Bank's position is to show you that we have our own personality and that we are perfectly capable of realizing our international ambitions with respect to technology.


I will turn to mergers now and discuss why the bank is against the concept. At the outset, we might take advantage of the mergers because there will be a transition period whereby clients who have not chosen the Royal Bank might not like it when they move from the Bank of Montreal to become a Royal Bank client. This one-plus-one does not make two initially; it may eventually.

We are afraid that by reducing the number of banks in Canada, we will have more regulation. Tighter regulation of the banking and financial service industry, and those who have merged and those who have not, will be subject to the same regulations. That is our major apprehension.

We do not recognize the rationale for mergers. You might say that it is not our business decision, it is theirs. They say they have become too small. Canadian banks are big and probably too big; it is the country that is too small. It is a fact that we have lost in terms of share of gross domestic product at the world level. Banks are intimately related to the activities within a country.

The benchmark of Canadian banks today has been the American banks, with their huge profits. We have not had the expansion they have had. Had we had it, our rate of return would be commensurate with theirs over the past five years. It was a strong way out of a recession in Canada. We just got out of it and are probably getting back into it after we slow down again.

What I hear from the proponents of the merger sounds like protectionism. They complain that they have not won a credit card bid with the government, that Citibank had it. First, National Bank has more credit card business than Citibank and we want the business and we do not lose money with it. Second, why should Citibank do all the business that must be done in Canada? They complain about Fidelity having the biggest mutual fund, but Fidelity was there before any other bank. That is their business. However, should Fidelity have all the mutual fund business? Are they afraid of competition? Do they want to rationalize and cut branches for the purpose of getting on par with these people?

I have the impression that this idea of being more competitive by being more protectionist is not for Canada. If you want to be efficient within your own country, you must pair up with those that are efficient all across the world because they are potential competitors for you. If you do not, your cost structure will be higher and eventually Canada will suffer for it. Canadian consumers need an efficient and productive banking system. One bank in Canada would be terrific for a couple of years. Afterwards, it would become stable. But seriously, neither one, nor two, nor three are probably enough. We are getting close to being three.

More fundamentally, Canada has inherited a system where scope economies are an alternative to scale. All banks in Canada have adopted a universal banking model system. They do everything that the Bank Act asks them to do and they would like to do more.

Scope is important. With the same client, we do many things at the same time. Obviously, if you do many things, you cannot be good at everything.

We have scope because the client that does commercial banking can take on your credit card. You know him -- or some of your employees do -- and they can sell him a car. You do not have to use mailings. You just know that Senator Kirby has a commercial loan and perhaps he would like this credit card.

Scope economies are to the advantage of the Canadian banks. To somehow bring in the scale issue will mean that we will have a divergence in terms of public policy. There will always be somebody in some activity that does only that, and he or she will be better. Scope economies are the bread and butter of Canadian banks.

When the National Bank puts a debit card machine into a store in Quebec, the customer that goes through, one time out of two, is a National Bank customer. We debit his account. Then we take the money out of a National Bank account but we credit the National Bank account under the name of the store. This is what scope is about.

Also, the interrelation between individual and commercial sides, and the products asociated with each one is a major strength of the financial industry in Canada. Like the MacKay report, I think this is why we are efficient, compared to the U.S.

With regard to the MacKay report, we must recognize that it is quite comprehensive. We are satisfied with some of the issues it has raised, especially with respect to favouring customers in general and increasing competition. We note that this has been their major goal and we recognize that some of the things we have said in the past are probably going that way, especially in the areas of insurance and leasing, because our main competitor in Quebec does that.

When Mr. MacKay came to see us, we told him that it is the job of the federal government to harmonize legislation, and that there is a vacuum there. You either do in Rome as the Romans do, or you tell the Romans not to do what they do. We have a problem with that, and it is getting more severe.

I was asked this morning whether we should have an overall review of regulations or whether we should do it on a piecemeal basis. I believe that anything that increases competition and the reach of customers toward financial institutions should be the subject of more immediate enactment of legislation.

With respect to small and medium-sized businesses, we applaud the MacKay report's recommendation to assure the quality of information available to public policy makers and the public in general. We recognize that there has been a vacuum in that regard. The National Bank and others do a much better job of that than is recognized. Forcing us to provide data will be a good way of furthering the debate and making it more transparent.

You have discussed taxes. We want to add one thing. Our company in Quebec is not taxed the same way as we are. They do not pay capital tax because they are not supposed to have capital. That is the way a cooperative is supposed to work. We do not like it, of course.They do the same thing we do, although they do not do it the same way. We do not see why we should be treated differently.

The provincial government got it partly right. The federal government is still laggard on this. However, in general we recognize the thrust of the MacKay report -- that a capital tax on a financial institution is a perverse tax. We might eliminate both the political and the fundamental problem by getting rid of the capital tax and installing a better tax system.

Finally, in the MacKay report we have been singled out as a financial institution between one and five in terms of net worth. Therefore, below $5 billion we will have quicker access to insurance and quicker access to leasing. Also, we will be provided with a structure of capital as well as ownership that is different from that of others. There are some steps to be taken and I must say that at this time the National Bank has no position on this.

We would like to mention, however, that with the mergers looming, we would like to have this added flexibility proposed, because at one point we will have to make a decision on this issue. Today, the flexible structure that is proposed, both in terms of structuring the bank and structuring the ownership, could be useful eventually, depending upon how events unfold.

Finally, we think that the report goes some way toward increasing the spectre of additional regulation, not only in terms of a so-called broad approach to regulations, but also in terms of particular regulations on this and that. We mentioned that this morning, and I was using more diplomatic words then. This breaks the equilibrium that we have had up to now. It also puts the minister's discretionary powers in more places than it used to be.

You have to think twice because we have that in Canada in other regulatory mechanisms. The CRTC, for example, can appeal to cabinet. If I were a member of cabinet, I would not like to overturn a decision taken by people who have studied the documents. I would not want to be the final judge and be subject to political pressure after a business decision is made under the general scope of regulations.


When I was a university professor, I predicted that branches would disappear within ten years. But it is been more than ten years now, and they are still around. At the National Bank, we recognize that we do not have enough branches and that the ones we have are too big. We have too much square footage and not enough branches. We are working on projects that involve supermarkets. One senator is well aware of our ambitions with respect to post offices. These are still only at the planning stage, but I would like to see them become a reality one day.

There is now a wide diversity of banking systems available. Community branches play an extremely important role, particularly at certain times. Alternative systems are increasingly used, including automatic debit, bank machines and ATMs, and individuals are constantly moving from place to place.

It should be noted that it is very difficult for us to say today which system will ultimately prevail over the others. We have increased consumer choice and consumers themselves are now choosing the market niches that offer the services they want most.

The biggest problem is insuring appropriate pricing. If counter service costs more than providing service through ATMs, pricing has to be appropriate. Then we let the market or consumers decide. We are under pressure to increase the number of branches. And we would like to have more of these points of sale.

At the commercial banking level, there will be closer ties to small business clients. There is no doubt that in the past, this market was seen to be somewhat homogeneous. We at the National Bank distinguished ourselves by devolving our credit authorities to the regions and resisting credit centralization, even paying for this approach in terms of higher losses. In banking, if there's one area where we add economic value to society as a whole, it is certainly the small business loans sector.

At the corporate level, they have external auditors and their own financial analysts. We produce information about a client, we "mine" that information and we follow up on it. A banker who knows his customers, is aware of their plans and can also make a decision -- because this is a decision made by one human being about another human being -- once all the financial statements have been produced. Let us just say as far as we are concerned, banking is all about small business loans. It is the area that adds the most value to banking services.

As far as the other areas are concerned, we have witnessed a real explosion in terms not only of markets becoming extremely fluid, but of corporate loans, international partnering and fairly rapid changes in nationality as far as the players are concerned.

It is a fluid market where people exchange loans and where clients can maintain a presence and be known just about anywhere. It is possible for a bank in Luxembourg or Austria to hold securities in a client firm listed on the Montreal or Toronto Stock Exchange that doesn't have large sales. You simply can't legislate that sort of thing. We should not be trying to work things so that all loans and market offerings or issues be carried out in Canada.

Senator Angus: You are not a politician, although quite frankly, you seemed to be this morning; tonight is different though. We very much appreciate your comments on the proposed mergers and the MacKay report.


We talked this morning about ownership rules, regulatory framework, as well as some of the other public interest issues raised by Mr. MacKay. We did not cover the subject of size.

Our committee has travelled to other countries and talked to regulators, bankers and all the players in the systems. The question comes up time and time again: How important is size? For example, in a domestic market, is it important to be large to succeed? I suspect your answer might be no, given your own position.

In the international markets, is it important for a major country in the OECD, such as Canada, to have a bank ranked in the world's top 20? This issue of size seems to permeate the whole debate.

Mr. Courville: Yes, you are right, senator, it does permeate the whole debate. To some extent, the proposed mergers are left out of the issue of the structure of the financial industry, or at least they have provoked some kind of attention away from other aspects.

I tend to fall on the side that says that size does not matter. I do not apply it necessarily in banking, but I apply it mostly elsewhere. Speaking as a former professor of economics, if you take the Fortune 500 and look at profitability and size, they do not match. The biggest companies are not the most profitable. If size is important, why are the biggest banks not the most profitable?

When you rank the banks in the U.S. or Europe, you will see that as profitability goes up, size goes down. Why is that? If you had economies of scale, it should be the other way around. The only country for which it is to the contrary is Japan. You lose less the bigger you are. We will provide you with that information.

We have done studies as well because it is a big concern to us. Where will we find the minimum size -- at $25 billion, $50 billion, $75 billion? It seems that the minimum size at which the economies of scale disappear and become flat is $40 billion. It was at one time a bit higher than that.

In the domestic market, I do not believe that size matters. This is well illustrated in the U.S. The third or fifth largest bank in the U.S., in Cincinnati, Ohio, has $22 billion in assests and is the bank with the highest PE ratio in rate of growth of earnings. It has not increased in size that much over the past five years.

As far as the issue of the international market, are there many international banks in the world? We can name five, probably at most. They are truly international banks and have been at it for 300 years. Citicorp Travellers is probably an international bank, but the others are not. They are national banks with a strong presence here and there, but they are not recognized. Even Deutsche Bank is not an international bank as such. It has international activities but you would not say that it is a flagship in Canada for German banking, or in the U.S., for that matter.

Senator Angus: How about the Hong Kong and Shanghai Bank?

Mr. Courville: Yes, that is the other one. We only need count them on one hand. That is not bad but it has come through time and patience. It has not come through national policies subsidizing these banks to go that way. It was part of a concerted effort that lasted through the years. Even if we wanted one, can we promote one successfully without endangering its own mission? I am not sure.

Senator Angus: You were here this morning when we got into the question of a second tier in retail banking in Canada, apart from, say, seven or eight banks that we have here now. It has been said that we do not have a strong second tier in this area, notwithstanding les caisses in Quebec and the credit unions in some other provinces. Is it a fact that we are weak in this area? If so, why, in your opinion, is it so?

Mr. Courville: We wished to promote a second tier by promoting trust companies, especially in the past 15 years. As I said this morning, they were constrained and it led to their failure. The Quebec market is different from the rest of Canada because the caisses populaires have approximately 40 per cent of the retail market. Then there is the National Bank with probably 20 per cent to 22 per cent. The others in some ways are second tier because at 10 per cent, you can categorize yourself as being second tier. They were able to survive and I suspect they make money because they are still there.

In the rest of the country there has been more homogeneity in terms of banking practices. The trust companies were supposed to be the wedge to change that, but it has not happened.

Senator Angus: They have all disappeared.

Mr. Courville: As I said this morning, I believe that it was a mistake of regulation, of overseeing, with a badly structured deposit insurance, that led to their demise.

Senator Angus: It has intrigued me to see the number of Schedule II banks radically decrease in recent years and the virtual disappearance from Canada of some of the major British banks who were here and who just did not like it. Is this a case of over-regulation again, in your view?

Mr. Courville: Yes. In the past, foreign banks here were not allowed to come as branches. They were required to form their own corporation and the so-called requirements put upon them gave them little opportunity to make money. As foreign banks will come as branches, they will be able to cut their way through a bit differently and we will make it more attractive for them to stay here.

Senator Angus: You have heard the chairman refer to a framework for public policy debate and for dealing with this issue. You made a fascinating point earlier. I had not looked at the issue from that perspective. You were saying that the problem is not that the banks are too small and must get bigger by mergers, but that perhaps they are too big already and that it is the country that is too small. The market here and the demographics and the geographical make-up of Canada are such that we must look at it all perhaps in a different way. Can you elaborate on that? It seems to perhaps be a fundamental principle that we should start from.

Mr. Courville: In most banking systems in the world, except one or two, management is within the confines of the nation where the banks are located. Certainly there are smaller countries than Canada which have more banks -- and by that I mean domestic banks, from the point of view of retail and commercial banking. I am not speaking of corporate investment banking, which is another issue.

Canada has not followed some of these other countries, at least the U.S. This is what probably contributed to the benchmarking being so wide. Had we had growth similar to the U.S. over the past six or seven years, we would have had less difficulty and there would have been less pressure on some of the bigger banks in Canada to be players on a North American basis.

By the way, some of them could have done that. We bought a bank in the U.S. eight years ago. We bought it for $33 million and it gives us profits of about $45 million this year. We bought it when it was cheap over there.

Senator Angus: Like the Bank of Montreal did with Harris Bank.

Mr. Courville: They bought it and then they had to suffer a long time with the demise of the financial system in U.S. We bought a commercial banking unit only.

We do only commercial banking in the States. In fact, although we are the smallest bank in Canada, in the United States the National Bank has the most presence. We are located in 22 U.S. cities. We provide commercial banking services to U.S. enterprises as well as to Canadian businesses establishing themselves in the U.S.

This is a niche. It is called asset-base lending -- riskier loans, for which we charge more than in Canada. I know it is a concern with some of you why we do not charge enough. If you ask the question, I will give the answer eventually.

The Chairman: Can you give us the answer now?

Mr. Courville: Commercial banking in Canada has always been done under a section of the Bank Act, formerly section 188 but now section 432, whereby we would lend a margin of credit operations to commercial clients. We would have, automatically, as a guarantee the assets, receivables and inventory, and we would take account of the recuperation as the failure occurs and that would be it. We would offer more or less homogenous rates. We were not taking into account any risk factors in that lending because it was a bit automatic.

When we do asset-base lending in the U.S., first we measure the risk of the loan. We now do it in Canada, and I will get to that later. We measure the risk and price accordingly. We also monitor the receivables and the inventory. We do not wait for the guy to fail before we start monitoring. We have auditors going in on a weekly basis, if it is riskier, or on a monthly basis. We have a lock-box system where we do not authorize the treasurer or the owners of the company to write a cheque unless approved by the bank. Therefore, if, say, the treasurer of a company wants to buy a Jaguar and we do not agree, no money will be forthcoming for that purchase. The treasurer must comply. We monitor the quality of these assets. Therefore, we are able to assess risk and, thus, charge more for risk, for those who enter into riskier operations. However, we also monitor assets, which has never been done in Canada.

We are trying to import that formula into Canada to some extent. There are already a few players here. Nations Bank ran an ad in yesterday's Globe and Mail for $5 million. To Nations Bank, $5 million is nothing. They want to let people know that they are doing asset-based lending. GE Capital is doing it. Congress is doing it. We are starting to do it. Newcourt is doing it as well, but it is more commercial and less asset-based lending than we do.

Think of it. When we start doing that, will we get complaints from members of Parliament and senators that we are charging prime-plus-two to this guy and prime-plus-five to this other guy?

Senator Meighen: Probably, yes.

Senator Angus: They will get used to it.

Mr. Courville: We have developed a system within our bank to measure risk, a risk-rating system. We will be able to provide our commercial account officers with information about the risk level of the company they are dealing with and be able to sell riskier loans, so to speak, and to explain them to customers.

The Chairman: And to politicians.

Mr. Courville: And probably to politicians. I think you understand that fairly easily. We have had to turn down some loans because we were not charging appropriately because we did not have the system to measure risk or the guts to sell it properly. Now we will do it. We have more loan losses now than other banks and because of that we perform less than the other banks. We are in Quebec, where it is riskier. There are more start-ups and therefore more failures, and this has been true for years. We have to charge for risk. It is riskier in Quebec. We would like to get our income-after-loan losses to the same level as other banks, and it is only by charging for risk that we will do that.

Senator Oliver: Do you charge higher fees as well for transactions, in addition to the rates?

Mr. Courville: The rates could be prime-plus, or for a range of services, or initiation fees. We need some profitability statements that go along with the risk.

Senator Oliver: In your asset-based lending in the United States, do you charge fees for credit as well?

Mr. Courville: Yes, you charge fees depending on how much over prime you charge. You have a target of profitability by risk level. Profitability comes from revenue on the spread or from other revenues, such as fees.

Senator Kenny: Mr. Courville, for some reason I get the feeling you have more enthusiasm for your role as President of the National Bank of Canada than you have for your role as President of the Canadian Bankers Association.

Mr. Courville: That is where I get my money.

Senator Kenny: Your principal concern, it seemed to me when you were making your remarks, was that fewer banks meant more regulation. You made that point quite forcefully. I would refer you to page 194 of the report we are examining. Section 4(c) of the report makes it clear that when regulatory requirements come forward, one size does not fit all. In terms of commenting on this report, why are you concerned about more regulation if larger banks are there? We have this proposal before us that says that you would get different treatment.

Mr. Courville: This is with respect to new entrants, by the way, and of quite smaller size. I do not think honestly that we will have such a comprehensive reworking of the Bank Act in such a way as we will have different subsections for different types of banks. We may have a subsection for new entrants for some period of time.

Let me tell you what I meant by regulation. I have met with some people who have expressed to me that they do not like banks to be in the business of car leasing or insurance, for instance. I ask them why. I tell them that some of their constituents would prefer that because there would be more competition for sources of funding. They say, "Well, you are right," but they think that banks are too powerful already. So if you allow mergers, will you allow banks as well to sell insurance and to do leasing? That will be in the balance, I am sure.

If not, I stand to be corrected. I am afraid of that with respect to tied selling, with respect to referrals among insurance companies and traditional bank employees, with respect to community investment, ministerial discretion, and the ombudsman process we discussed this morning. We believe that this will result in a bigger burden and reduce the market-place flexibility in a market where a smaller bank like us has probably more flexibility. I recognize, though, in my comments on the MacKay report, that banks or financial institutions with assets between $1 billion and $5 billion want to speed up the process of leasing powers and insurance power, as well as giving more flexibility on the corporate structure.

I am apprehensive of more regulation. It is natural, as you concentrate the industry, for politicians to put tighter fences around the industry. This is what we apprehend. I stand to be corrected if I am wrong, but you are right in pointing that out. The report goes some way in that regard, but their proposed overall regulatory regime goes a long way. I am suspicious that when it gets down to your report, and that of the House of Commons and the minister, they will weigh some of the powers and new concessions made to the industry and regulate accordingly.

Senator Kenny: Would you not agree that the report suggests, in a corollary way, that as the world evolves regulations cannot keep up with the market-place and therefore corporate governance has to be in place to manage that?

Mr. Courville: Certainly. It is a fact of life. The long-term capital debacle in the U.S. is a good example. You had two Noble Prize winners as partners, in fact the founders, of that, and they are supposed to be bright. Regulation had a problem catching up with them. The imagination of the human mind, in finance especially, is boundless. This is why I prefer to be overseen the way we are in Canada today.

The Office of the Superintendent of Financial Institutions oversees us every year. They learn about our new practices. They train themselves. Sometimes they hire from us. They keep up with our new business venues, and thus they understand better what we do and the constraints under which we operate.

This is a good system. It is not regulation in terms of directives and restrictions; it is regulation that is more managed, in a way. I prefer that kind of regulation, because it both promotes a quicker assessment, by regulatory regime, of how institutions perform and also enables us to present our case in a much more interesting way.

Senator Kenny: You are taking me away from my line of questioning, but I cannot resist.

Mr. Courville: I apologize if I did not understand you.

Senator Kenny: You understood me too well. However, you distracted me while you were doing that.

You have raised the matter of the regulators again, and you have talked about how terrific it is with the regulators. I tend to worry about the fox in the chicken coop when I hear about how nice the regulators are. The message we hear is that the regulators are always a step behind, that they are underpaid, and do not have the resources they need. They cannot compete with folks like you, who can attract the best talent and can move nimbly on ahead of them. I understand, if that is true, why you would like the current system.

Mr. Courville: We are part of an industry. When you are on top of it and one of your important competitors has problems, then you will have serious problems too. That is truer for banking than for anything else. When a grocery store goes bankrupt, it is better for the remaining stores. When an important bank in this country has problems, it is bad for the whole system. The whole system suffers.

That applies even to the small banks, as you will see if you read the Estey report, when we had to take CCB and Northlands. The fact that banks through deposit insurance premiums have to support the failures of trust companies was certainly not something we liked.

We are concerned about inefficient regulation that ensures as much as possible the solvency of financial industry participants. We are all interconnected. This is the toughest thing about banking. We are like worms; we are intertwined. The payments system makes us dependent upon each other.

Senator Kenny: Did I hear your statement correctly that you favoured a legislated "Customers' Bill of Rights" and that you favoured that as the first act that government should take?

Mr. Courville: No. What I said was that anything that increases competition among the participants and that gives immediate benefit to the customer should be implemented.

Senator Kenny: So you are not in favour of a Customers' Bill of Rights.

Mr. Courville: It is more regulation which I said I am afraid of.

Senator Kenny: Are you in favour of a Customers' Bill of Rights?

Mr. Courville: It is tough to be against, you know.

Senator Kenny: I am waiting to hear your answer.

Mr. Courville: I will be diplomatic. If you do not like my answer, you can ask your question again.

I would like the customers to be better off in the sense of more candour, more information with respect to what we do with them, and to ensure that they get a better deal. I am not sure a bill of rights in law will achieve that. More competition will certainly achieve that.

Senator Kenny: You talked about size and technology as not being necessarily linked. You gave us the example, I believe, of the debit card. Is that an exception, sir, that you used because it happened to be one that your firm actually developed, or are you really making the case to this committee that we will not see more technological innovation and development as firms get larger?

Mr. Courville: I will give you other examples, because they work. We are the only bank still doing its own payroll services. It has been out-sourced in the other banks. In fact, the outfit that bought Royal Bank came to us before they went to Royal Bank and offered us something. They wanted the National Bank, and they were probably prepared to pay a bit more because we are French and we operate in French. If they wanted to be in Quebec, they needed a French operation. They offered us only two years' worth of profit. According to the Royal Bank or the TD, they were not making money with payroll services. Why is that? Is it because they are too big or too small? It is not because they are too small, because we are making money with our payroll services.

We are making money with the credit cards that federal employees are using. We were the first ones in the business. We were the first ones in computer-related banking transactions with individuals. We teamed up with SCP, supposedly one of the best software packages in the world for unifying accounting, human resources management, payroll, et cetera. They have come with us, and we are trying to implement that in the medium-sized companies.

As far as I know, we are the only bank involved in electronic commerce in the way of joining payment as well as all documents related to payment electronically, and transmitting that between companies and between companies and government institutions.

I could give you other examples. The problem is that we adjust our strategy to our size and not our size to our strategy. It would be nice to have imaging, but it costs so much that we could not afford it. If we were bigger, we could afford it. That is it. It is a fact of life. All our clients are like that, by the way. They tell us, "Lend us twice as much and we will progress faster. Of course we will have two years of bad earnings." It does not work that way.

Senator Kenny: I am glad this witness was early on the list because, in light of this testimony, we will have fun with the other bank CEOs.


Senator Meighen: You made two very frank presentations in which you clearly presented your views, and we thank you for that. The people watching on television will certainly see a somewhat different image from the one traditionally associated with bankers. Many people continue to believe that bankers generally don't like them and don't share their views.

I would like to come back to two regulatory issues. Senator Kenny asked you a couple of questions about that and was given a good answer.

With respect to competition, you said that in your mind, the possibility of mergers raises the problem of more regulation. Secondly, you said that competition has decreased. Having read the MacKay report, I must admit I am very impressed by the emphasis he places on the need for more competition in the banking sector. He points to a number of approaches that would seem to foster greater competition. What do you see in these comments that would suggest the opposite?

Mr. Courville: Well, in all honesty, the MacKay report seems rather ambiguous on that particular point. There is a desire to promote greater competition, but at the present time, we do not know who the competition is. It is only potential. We have not yet identified who will be building new banks or new cooperatives. We are saying it is allowed. But a bank or a deposit-taking institution is not something that can be put in place quickly. We all know what happens when things move too quickly.

Secondly, the MacKay report states that the Canadian banking system is very efficient. Both its operating costs and prices charged to consumers are lower than in most of the other countries studied. Do you think that by allowing for greater concentration we will be fostering the kind of competition that will make institutions as efficient as they now are? The more we limit the number of players, the less competition and diversity of experience there is. When we develop strategies, we do not try out eight different ones at the same time. We choose one, while our competitors may choose others. But there is usually one that is better than the rest. If that is the case, we will all copy it and make adjustments to what we are doing. But if there are only one or two banks, there will only be two strategies and we will end up with institutions that are less efficient.

Senator Meighen: By reducing the number of Canadian players, you increase -- at least in theory -- the number of foreign players in Canada.

Mr. Courville: Foreign banks come here. Market expansion movements are driven by the current financial cycle. When the economy changes, we will see whether INGs are interested in supporting capital costs before there's any actual return.

Senator Meighen: Wells Fargo has no capital costs.

Mr. Courville: Perhaps their selection is not as good as ours. We will see. There is no doubt they are operating on the periphery. They operate in very specific sectors. I would remind you that the Canadian banking system is based on the universal concept whereby clients gravitate to one or two institutions offering a very wide range of products. That is what has made the Canadian banking system so efficient in terms of payments and operating costs.

Will things change quickly if we reduce the number of partners? I do not think so. Just because the Royal Bank merges with the Bank of Montreal does not mean that starting tomorrow, it will reduce its scope and concentrate on particular market niches where it will be the best in the world. It will keep its Canadian base. At this time the Canadian banking system is benefiting from the consolidation that occurred 60 years ago, the result of which was to leave a small number of banks operating in Canada with a branch network and highly structured entry and delivery points. These are investments that constitute barriers to entry. I cannot see someone setting up a de novo bank tomorrow and having a diversified system such as ours. We have information about a client in relation to a specific product. And we can also sell him another product. For us, that is a tremendous advantage that other financial institutions do not have. They would like to, but will they really be capable of it? I just do not see it happening. More concentration will only restrict us further and when public policy starts reflecting that, we will be regulated even more. That is the most likely scenario, as far as I am concerned. We could spend a lot of time talking about the future.

Senator Meighen: As you suggested earlier, maybe the National Bank will move quickly and acquire an enormous market share, to the point where you may change your tune three or four years from now.

You referred to a National Bank policy that involves giving more authority to local managers. That is something we've been hearing for many years. You have benefited from such a practice.

In that regard, I have often heard the criticism that local managers get to know their clients only to be transferred out by head office after four or five years. Then when a new local manager comes on the scene and looks at the loans portfolio, he does not know the borrowers. He takes the approach that he should clean up the books before he starts to work with the community. That is when problems arise. Has the National Bank found a solution to that particular challenge?

Mr. Courville: You have touched on a very sensitive issue that is actually one of my greatest concerns and that I am gradually giving up on. The rotation rate of our account managers is much too high. The only ongoing complaint that we receive from clients -- and I meet with them for lunch twice a week and for breakfast once a week -- is that we change our account managers too often. So I have been leading quite a battle on that front, telling everyone that I do not mind losing a battle now and again, but not the war. Yet I have a feeling I am losing the war. I am very familiar with the problem. That does not mean I am giving up. We will find palliative measures that allow us to ensure that two people are familiar with a file and that both are not moved at the same time. Last year, our business clients liked our account managers so much that they actually hired one-fifth of them!

So you see, as soon as one leaves, it is difficult to move someone else because he may be the only person in that other region most familiar with our client base there, and he, too, would end up losing his clients. That makes two groups of clients that are unhappy each time a single manager leaves. So, what you are saying is absolutely true. This kind of constant rotation results in lost information, lower efficiency and decreased marketing performance.

It is the value associated with that manager's knowledge about our client base that is being lost each time. Those costs are enormous and we are waging a real war against this problem. I do not want to lose that war, and the fact is we are going to have to find other ways of addressing the negative consequences of that while the battles are ongoing. But I do not think we will be in a position to solve the problem soon. There are too many factors that contribute to this particular phenomenon. People want to move up. We had a hundred small business files that were very good. When one got bigger, part of that file was transferred to someone else. It is perfectly naturally to want to follow a career path. We are trying to adjust salary brackets so that we can say to people: you will be paid more if you do your current job well, rather than telling them they will be given another job. However, it is difficult to change thirty years of well-established tradition. We have abolished that system, but we find ourselves having to juggle with so many issues at the same time that this is likely to take more time than I thought.

Senator Hervieux-Payette: That may be a solution, but I cannot pass up this opportunity to help you solve a problem that seems to be of great concern to you. I was going to say that you should appoint more women managers. They are more stable. Labour market studies show that they change jobs less often and are more loyal to their employer -- that has been scientifically proven. That would be a start in terms of the bank's future.

Mr. Courville: I should point out that Ms Vachon is a good example of that. We have been promoting people at the bank over the past year, three or four women were affected. They are so good that we have to give them promotions.

Senator Hervieux-Payette: I am not against that. I said to Mr. MacKay yesterday that the manager of Canadian Tire is the most important person in the Canadian Tire organization because he is the one that runs it. So, your branch managers should be seen as the pillars of your banking operation and their compensation should match their performance.

With respect to selling insurance, I have not yet formed an opinion. I still do not know what to think, because it seems to me I have a major conflict of interest if, as a bank customer, I receive advertising inviting me to buy travel insurance from Blue Cross. You are doing that kind of promotion, and you are likely to do even more in future since the fact is my daughter was the one who put the program in place.

So, if you are given permission to sell insurance, do you intend to buy Blue Cross? Is the idea to start a new system, acquire new companies and bring them into your organization? In what way will this allow you to better serve your customers? How will you be able to provide better service than you do currently by linking up with Blue Cross? Will I have access to health insurance with greater coverage at a lower cost? What are the benefits for the consumer, because that is the whole purpose of the report? Consumers and clients should be in a position to receive better service at a better price.

Mr. Courville: Our premise is quite simple. We are looking at our main competitor in Quebec, the Desjardins Movement, which distributes life insurance and general insurance. It has done so with quite some success, having brought downward pressure to bear on premiums all across Quebec because its operations are more systematic and seamless. It has demonstrated that by taking a systematic approach to the distribution of insurance, it is possible to provide consumers with lower premiums as well as more efficient claims settlement systems.

That is the premise for our saying to the rest of the world that we are one of the only countries where insurance-selling banks are seen as futuristic. They are already a reality everywhere else, although I must admit not always a success.

We have the advantage of being able to offer products to our customers in a more systematic fashion, which means that they have less shopping to do, receive better prices and benefit from the stimulation this provides. For example, if you are planning to take a trip, you can buy Blue Cross insurance from the National Bank. You must admit that it is a good thing we are able to provide you with that. You may not even have thought of it. It seems to me we are providing a service to you, the customer, although you are under no obligation to buy that insurance. The more choices we offer consumers, the better off they will be. And the more competitors there are, the more likely it is that the market will evolve along those lines. The system for distributing insurance could be improved. Credit unions, banks and financial institutions operating in other countries have already proven that.

Senator Hervieux-Payette: You have joined your sales forces. The product was developed by an insurance expert who can provide the service through other channels than your own. That specialist will develop another sales formula. In what way will selling the product at the counter directly to customers and making it part of bank operations change the service you are providing to the customer? I see no advantage in it. You can provide access to various services. In fact, through promotions in various areas, customers can buy just about anything -- a hair dryer, VCR, camera, and so forth. This is just a way of stimulating consumption.

A number of automobile dealers in Quebec are clients of yours. These same clients, as businesses, probably finance their inventory through you. Supposing you decide to offer an automobile leasing service in your branches. After four years, if people decide to return the car, what are you going to do with them? You cannot just leave them in a National Bank parking lot. You are going to have to put them back on the market.

First of all, car dealers offer a variety of financing and lease-purchase formulas. Financing is provided through your bank or the individual customer can pay cash. I am referring here to the province of Quebec in particular, but I imagine it is the same all across Canada, in towns where people work in these garages. Generally a car dealer has a lot full of used cars next to his business. So, you will be competing with those car dealers. And what advantage is there for the customer in a bank such as yours offering automobile leasing? Are you going to be offering all makes of cars?

Mr. Courville: As regards insurance, I would like to ask Ms Vachon to make a few comments.

Ms Vachon: Both for insurance and automobile leasing, a multitude of distribution networks as well as increased competition through more uniform regulations -- since institutions would be doing the same thing -- will ultimately ensure that the consumer is the winner.

Insurance is also part of financial planning. Access to advice is increasingly important to individual consumers. In addition to financial planners, there are personal bankers. It simply adds value to that function, if you look at all the tax-related issues for future generations. Given that value added and the ability to advise customers is increasingly important in banking, it is natural for the banks to want to offer a product that consumers see as highly important.

Mr. Courville: As for services for motorists, we will deal with those issues the same way we deal with the others. We have a number of clients who are automobile dealers. We are not like GM and Ford; we do not take them to Hawaii to tell them to be careful of the banks. I have been telling them that they are prisoners of their own company. I tell them their black Chevrolets will sell well only if they offer a financing and leasing service. They are the sole suppliers of all their services. Imagine if the National Bank offered the same product as GM, possibly at a better cost. You will resell your car because we do not want any cars; we have no place to put them. We will resell it for you. Rather than dealing with the captive company, we will provide the financing. I'm sorry for being a little aggressive about this. But when you tell them that, you can sense that you have touched the right chord.

Senator Hervieux-Payette: This is important to us, because we are talking about two additional services. I have a couple of questions about general insurance. There is the matter of people who have passed the General Insurance Brokers Association exams versus those who have studied to become financial advisors. You are going to need pretty skilled and knowledgeable people to do planning. They will have to be both tax and insurance experts. Your people will have to spend quite a bit of time in school in order to acquire that kind of knowledge.

Mr. Courville: Quebec is currently the only province -- and we are now involved in discussions with other Canadian provinces -- where it is possible to take a financial planning course for credit. In Canada, it is felt that the Quebec standards are too rigid. I have told my colleagues from the other banks to be careful, because this could set us apart from everyone else. There is no doubt it is more expensive, but if you want to benefit from good financial planning, it is essential. If anybody can call himself a financial planner, we are bound to have problems. In Quebec, the term "financial planner" covers tax planning, insurance, and so on. It is important that consumers be aware of that, because they very often are not.


Senator Oliver: Mr. Courville, I enjoyed your presentation very much. I appreciated your candour. There is only one area that I want to ask you about. It relates to Canada's current banking system and some of the things that are proposed by the MacKay task force.

One reason we have a great banking system now is that we have soundness and safety. What has made it safe and sound are certain of the regulations that permit OSFI to ensure that it will remain safe and sound.

From reading the task force report I gather there is more regulation, and you have said in your evidence that that is also your impression from reading it. Not only that, but there are several sections in the report and the recommendations that give an awful lot of new discretion to the Minister of Finance. You suggested that that may be a problem, and you cited the CRTC as an example of a regulatory board that may make decisions in relation to telecommunications or broadcasting. When they finish their inquiry, the people who are aggrieved have the right to appeal to cabinet.

I should like you to clarify for this committee, as we prepare to travel across Canada to receive evidence on the task force, whether your personal view as the president and chief executive officer of a major bank is that major problems could arise if this unfettered discretion brings in a new political element and politicizes something that should be just regulatory. Is that a major concern?

Mr. Courville: Yes, because what we define as "public interest" sometimes shifts quickly. Something that appears not to be saleable to Canadians today could be saleable tomorrow. It is not necessarily because people think that something is good that it is good.

We must have clear opinions on the part of people like you. For you it is a tough shot to call in that sense.

We all recognize that, in the end, the government should rule, but I would prefer that to be by broad regulation instead of by a case referred to a minister, where again a whole new process comes into force.

The tradition of regulation in Canada, except for the CRTC, has always been to somehow distance the policy from the regulation and to have competent administrative boards. We have something like that in the financial industry which we would like to promote further and which certainly is competent.

I would think that, by introducing this element, decisions will take longer and we will introduce other elements that I am not sure are necessarily good elements. That is for you to decide. I am apprehensive, because in the past it has not always been speedy or appropriate.

Senator Oliver: In the report, as you know, the committee has recommended, on its own, an arm's-length, independent board of directors for OSFI. Then there would be someone, other than government, off whom OSFI could bounce certain strategic ideas. What do you think of that proposal?

Mr. Courville: It is a good idea. It has worked well in other countries. The CDIC, as well, could bring in people with expertise and market intelligence, with knowledge about institutions. That would certainly give the superintendent some background information as well as counsel that he probably needs. It would be easier for him to make his case in front of his peers.

Senator Oliver: Are you also suggesting that a strengthened advisory board for the Superintendent of Financial Institutions may take away the need to have so much discretion left to the Minister of Finance? Would you take it that far?

Mr. Courville: I am not able to say. Certainly, it is one avenue to investigate.

Senator Oliver: As to the make-up of this board of directors to advise OSFI, do you think it should be comprised of ad hoc members, such as the Governor of the Bank of Canada and other senior bureaucrats? Should they all be from the business and finance community?

Mr. Courville: They should come from all walks of life. I have not thought about it. I hate to respond quickly, but if you take on, say, the Governor of the Bank of Canada, is he not at the same time a judge and a future party? The roles of supervision and of lender of support are different. They could coordinate, obviously. However, at some point, the OFSI must define its own strategy with respect to monitoring employees and salaries. Someone mentioned that.

Probably in today's world, especially for certain types of expertise such as technology and market, the people you must hire in these areas earn a lot more money than the typical average banker. Therefore, in order to interest them to work for OSFI, you would probably have to pay more than the typical pay scale that you have in government.

If there is an outside board, these things will be going through easier.


Senator Joyal: We have been told by representatives of the Royal Bank and other banks who are in favour of the merger that one of the reasons why they support that option is the appearance on the Canadian market of a form of outside competition that challenges their ability to maintain control over the Canadian market and, in particular, in the case of small business, the example of Wells Fargo is often cited. How can two financial institutions that have access to such experienced economists have such opposite readings of the threat that foreign competition poses here in Canada? How can the consumer or taxpayer determine which is right? You represent a smaller company compared to the four other banks asking the government to approve their merger. How can they tell us that this competition is not terminal? It is there but we can work around it. We can handle it. There is no reason to make fundamental changes to the way financial services are currently provided here in Canada. How can the Canadian Bankers Association reconcile its views with that interpretation of current market conditions?

Mr. Courville: Well, economists are not the best people to answer that kind of question. We hired one of my former students who told us, after reading the documents, that what you are saying makes a lot of sense.

Ms Vachon: At first glance, it is not so much the reading that is different but the solutions that are called for. I think we all have the same reading of the situation. Competition is clearly on the rise in Canada. This increased competition is in very specific market segments, whether we are talking about Wells Fargo or MBNA. They are operating in very specific, very effective market segments because they are very big players who benefit from economies of scale. If there were reduced competition in Canada as a result of bank mergers, would the Canadian banks be big enough to hold their own against even bigger players? Well, what is important is how you respond to that competition.

It is also important to remember that mergers could be a positive step forward whereas a loss of competition would mean more regulation or different strategies. The response is different. It is possible to be both a universal bank, and a bank that operates in certain niche markets outside. The size argument is not something we see as a credible strategy for dealing effectively with competition.

Mr. Courville: In fact, if you listen to what those proposing the mergers are actually saying, it is important to remember that you do not know what their ultimate strategy is. All you hear is that they have some concerns, that there is a threat there and that their survival is not guaranteed. But it is not a matter of survival. It might be more accurate to say that their profitability is not guaranteed. I do not think their survival is threatened. The Royal Bank remains a major bank and the Bank of Montreal, even though it may be small, is still the 25th largest bank in North America, whereas we represent only one-fortieth of the overall market. You do not know what their strategy is. They have another purpose in doing this.

Senator Joyal: Your interpretation of the situation is that foreign competition will continue to be a fact of life and will affect specific niche markets or products. You mention, Mr. Courville, that the Hongkong Bank of Canada -- or any other ING, for that matter -- is not going to set up a branch banking operation tomorrow morning that would place it in direct competition with the National Bank either in Quebec or elsewhere in Canada. I don't think that is what the market is heading towards. The way compartmentalization is occurring now suggests that foreign offerings are related to specific services and aimed at specific market segments.

Ms Vachon: Yes.

Senator Joyal: So, if we are interested in looking at how we should redefine the rules with respect to competition, do we not have to come down in favour of consolidating Canadian capacity vis-à-vis specific products, rather than trying to open up the market as much as possible to all foreign competition?

Ms Vachon: I am not sure I understand your question. The point is that if we are looking at all the areas where Canadian institutions are currently operating, the MacKay report clearly recognizes the fact that there will have to be more uniform regulations before institutions will be able to compete on an equal footing.

As has already been mentioned a number of times, because of their history, because of the regulatory system in Canada and because of the reality of Canadian universality, banks in Canada are universal. This has not come about just because institutions developed a strategy to become a universal bank. The fact is that the banks are universal, because of the fact that a regulatory system was implemented here far more quickly than it was in the U.S. and that geographical regulation never took hold here in Canada. What counts most for the banks is to see that regulations apply uniformly to all the players in each of their areas of operation.

Senator Joyal: Do you recognize that there are some financial product lines where Canadian institutions will not be very competitive? People are always setting the example of the credit card contract given to American Express, rather than Visa or Master Card.

Even assuming a consolidation of the entire banking system within an individual bank, it still would not be competitive compared to the product American Express offers. Do you not think that Canadian banks will have to accept that some products, although they may not be available through them, will be available on the international market?

Mr. Courville: In Canada, we have what are called "scope economies," which means that by working with the same client in a number of different ways, we are able to compensate for the economies of scale that others may enjoy. There is no doubt the two will always clash, but I do not think one will prevail over the other. We benefit from scope economies by selling several products to the same clients. Institutions that sell only one product benefit from economies of scale, but not from scope economies. It is one against the other. Having a single bank in Canada does not mean we will have a universal bank capable of being all things to all people or being good at everything. That just is not possible.

Senator Joyal: Supposing the government were to go along with the merger. What does the MacKay report say about the kind of institution that would allow you to maintain your market positioning, given that the ground rules would be fundamentally changed?

Mr. Courville: First of all, there will be a relaxation of certain conditions, particularly with respect to powers, which we will receive more quickly than the other banks. We are being told that banks with sales of less than $5 billion will have an immediate extension, as soon as the time setting has been decided, of their insurance and leasing powers. We will also be in a position to change our corporate structure more easily. Finally, we will even be able to become associated with other financial institutions and form alliances whereby someone else will be able to have a 65 per cent interest in our operation, provided that this arrangement has received approval from the board of directors, the shareholders' meeting and the minister. So, we are being given the flexibility to counter the effects of this merger.

Senator Joyal: Are you currently looking at those options?

Mr. Courville: We are not considering an alliance at this time. When the report was released, even a little before that, we made the board of directors of the bank aware of the issues we were facing. Although it opens up new opportunities, it also raises a number of important existential questions. Indeed, the MacKay report itself poses the question. It will not be possible to avoid these mergers.

There is still room on the ice for players like us. Is the MacKay report satisfactory or sufficient? I do not know. I am just telling you what the MacKay report has done. It will be up to us to decide whether that is adequate or not, and to make the appropriate representations if we feel it is not.

Senator Joyal: What kind of alliance would you be looking at?

Mr. Courville: I am not in a position to answer that question now. It was put to us not so long ago. We are aware of it and we will be working on this further to determine whether it is sufficient and if we feel it is not, we will make the appropriate representations. After that, we will start to think about strategies.


Senator Callbeck: I have a couple of questions that come out of the comments that you made. I was interested in what you had to say about regulations, and your conclusion that the fewer banks there are the more regulations we will have. Are you aware of any other countries where they have had mergers that have meant more regulation?

Mr. Courville: A probable comparison would be with Holland, Australia and New Zealand, where concentration in their banking system occurred. I know you visited some of them.

Senator Callbeck: You mentioned about banks going into post offices. I am not sure whether you are in post offices now or if that is something you are talking about. Do you plan to go in to post offices in areas where you do not have a presence, or are you looking at closing an existing branch in order to go into the post office?

Mr. Courville: No. As I said, we have too many square feet and not enough branches. We would like to reach out in communities further. Sometimes the community cannot justify the presence of two competitors. There are 800 localities in Quebec where the caisses populaires are present. If we were to go there tomorrow, three-quarters of the locations could not be justified. However, if we operated in partnership with a store of some sort, a gas station or a post office, we would blend enough traffic to make it profitable for both. We would also improve the performance of the post office, in the sense that they would be able to cut their costs and keep the post office open.

The Chairman: Mr. Courville, you have done a remarkable job. We appreciate all the time you have spent with us, considering that you started at nine o'clock this morning.

The committee adjourned.