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

Issue 37 - Evidence - Morning Sitting

TORONTO, Tuesday, November 3, 1998

The Standing Senate Committee on Banking, Trade and Commerce met this day at 9:00 a.m. to examine the present state of the financial system in Canada (Task Force on the Future of the Canadian Financial Services Sector).

Senator Michael Kirby (Chairman) in the Chair.


The Chairman: Honourable senators, as we begin our second day of hearings in Toronto on the MacKay report, our first witnesses this morning are from the Association of Schedule II Banks, which most people will think of as "the Association of Foreign Banks." Mr. Stammati, who is the CEO of an Italian bank based in Canada, is the spokesperson for the industry.

Mr. Stammati, I notice you have a fairly long opening statement; my guess is it would take you twenty minutes to read it in its entirety. Do you think you could shorten that a bit so that we have lots of time for questions? If you simply hit the highlights, we can then proceed to ask our questions.

I notice that in the first paragraph of your opening statement you introduce the people who are with you. Knowing who they are is helpful. Would you please proceed.


Mr. Gennaro Stammati, Chairman and Chief Executive Officer, Banca Commerciale Italiana: Mr. Chairman, I wish to thank the committee for allowing us to make this presentation today. I am chairman and CEO of the Banca Commerciale Italiana of Canada. I am also chairman of the Executive Committee of the Association of Schedule II Banks. With me this morning are Mr. Bill Randle, Deputy General Counsel for the Canadian Bankers Association; Mr. Harvie Naglie, president, BT Bank of Canada; Mr. Theo Bark, president, ABN Amro Bank of Canada; and Mr. Jeffrey Graham, barrister and solicitor, Borden & Elliot.

Today, we represent all foreign banks of Canada that are members of the Canadian Bankers Association.


Of course, for me, it would be much easier to speak Italian. In any case, my presentation, I understand, will be translated into French.

Having said that, I should now like to introduce to you Mr. Theo Bark, président, Banque ABN Amro.

First of all, honourable senators, I wish to thank the committee for allowing us to comment on the task force report and what we see as the future of Canadian banking and financial services in relation to the comments of the task force. As members of the CBA, we had representatives who actively participated in preparing the presentation made to your committee by the CBA president, Ray Protti, when he appeared before you on September 29, and we strongly support the comments he made about the task force report during his appearance.

If you will allow me, I wish to begin my comments by quoting some excerpts from a recent report on foreign bank branching:

Encouraging the entry of new entrants to the financial services markets will increase the level of competition and improve access to low cost funds for consumers and for small and medium-sized business.

...the government [should] adopt a policy toward forging banks that will offer these institutions the options of running their operations in Canada through a foreign branch, or through a subsidiary, or through both a branch and a subsidiary.

[We] recommend that the Government implement a foreign bank branching policy as quickly as possible.

It would be very reasonable for any one of you to conclude that these quotes are taken from the task force report. While it would be reasonable, it would be wrong. The quote actually comes from the report that was delivered by your committee to the federal government a full two years ago, in October 1996. For that reason, I would thank each one of you for these statements that you made at the time.

Moving quickly to the recommendations of the task force, we would like to underline the frustration and impatience of the foreign bank community with the lack of progress in allowing foreign bank branching. Unfortunately, this example of expectations raised and actions deferred is characteristic of the experience of the foreign bank community in Canada over the last thirty years. As a result, while we applaud the support of Mr. MacKay and his colleagues for foreign bank branching, and note in particular the recommendation of the task force that the federal government move expeditiously to allow foreign banks to operate through branches in Canada, we remain wary.

Much work still lies ahead if the foreign bank community is truly to become a viable and competitive component of the Canadian financial services sector. While the MacKay task force report recommendations would contribute to this process, it is vital that Canadian legislators and regulators stop frustrating the implementation of a more user-friendly environment for foreign banks in Canada.

My written presentation includes a legislative history of foreign banks in Canada, dating back to 1967, including the various causes of frustration. I will leave that to you to read on your own in order to save time, except to say that, despite the problems surrounding the entry and operating requirements for foreign banks, by 1987, 59 foreign bank subsidiaries were operating in Canada. However, as initial optimism and promise has been replaced by disappointment and losses, there has been a steady stream of departures. Today there are only forty foreign banks remaining in Canada.

Let us now look more closely at the task force report's actual recommendations for foreign bank entry and evaluate them in the context of the Canadian experience.

The MacKay report asserts that it is important that the federal government move expeditiously to allow foreign banks to operate through branches as well as subsidiaries in Canada. The operative word here is "expeditiously." The federal government should clearly not delay any further in implementing foreign bank branching. It is almost impossible for a foreign bank to develop and implement a coherent business plan for its Canadian activities when the basic ground rules are constantly anticipated to change but never do. Indeed, it now appears possible that the federal government, despite the strong recommendations of the task force that foreign bank branching be immediately introduced, may not move forward until the issue of domestic bank mergers has been resolved.

We feel that the two matters are completely disconnected. There is no connection between the proposed bank mergers and allowing foreign bank branching. No matter what decision is reached on the proposed mergers, it is clearly sound policy to allow foreign banks to operate in Canada as direct branches of their parent institutions. All sectors of the financial and business community as well as the major political parties, media, and general public strongly support direct branching by foreign banks and acknowledge that it will be very beneficial to Canada and Canadians. There is general recognition that permitting direct branching by foreign banks will increase competition within the financial services industry in Canada. All Canadians will benefit from a more competitive banking sector. Accordingly, the federal government should move, this fall, to implement the necessary legislative changes to allow direct branching.

I should like to touch now on the matter of taxation. You will find attached to the presentation some schedules specifically dealing with taxation; they are quite technical, and again I will leave them for you to read over later.

While we believe that allowing foreign bank branching will improve competition in the financial services industry, we are concerned that the net practical result could simply be the replacement of the word "subsidiary" in the Bank Act with the word "branch." Unless there are significant improvements in the regulatory and taxation requirements on foreign banks, the competitive benefits of foreign bank branching will be seriously undermined.

The task force recommends that, where a subsidiary or branch of a foreign bank does not engage in activities that give rise to prudential concerns, the lightest possible regulations should apply. This is but one of the many examples of common sense and wisdom that characterize the MacKay report. The task force realized that, if foreign banks are simply permitted to operate as branches in Canada without, at the same time, dismantling the burdensome regulatory and fiscal framework now in place, then it will do little to change the current situation. Creating a new entry regime where foreign bank branches are subject to almost the same regulatory structures as foreign banks subsidiaries will not, and should not be expected to, revitalize the financial sector. Avoiding this outcome will require Canadian legislators, bureaucrats and regulators to pursue a more open, permissive and market-driven approach.

The task force explicitly rejected the notion that the interests of consumers or the efficient functioning of the Canadian economy are served by imposing prudential regulation on foreign competitors simply to "level the playing field." In the task force's words, "prudential regulation should not be used where it is not required." As the task force notes correctly, the primary objectives should be greater competition and the interests of the consumer.

As far as the tax issues are concerned, there are four points that the government should really concentrate its attention on: the conversion of a foreign bank subsidiary to a branch; the determination of branch interest expenses; the calculation of tax with respect to interest paid to the parent bank; and the determination of branch equity base for the purpose of capital taxes. For the benefit of committee members, we will include the particulars of these points in the addendum that we will deliver to you.

Before concluding, I would simply say that, in addition, the task force has made important recommendations with respect to the elimination of withholding tax on cross-border lending by foreign banks and greater clarity in the cross-border delivering of financial services, other than retail deposit-taking. The Schedule II banks support these recommendations of the MacKay task force as well, with the proviso that the foreign banks that have made an investment in Canada will not be at a competitive disadvantage.


In conclusion, the task force report provides a sound guide to ensure that foreign banks play a more relevant, effective and competitive role in the Canadian financial services sector. We share the task force's vision of a sound, dynamic, innovative and competitive financial services sector and we are asking for your committee's help in obtaining immediate permission for foreign banks to establish branches in Canada, so that we can fully compete.

We hope that our comments will help members of the committee to report on the task force report. My colleagues and I will be very happy to answer any questions you might have.


Honourable senators, my colleagues and I will be glad to respond to your questions according to our specific fields of experience.

The Chairman: Thank you, Mr. Stammati. I wonder if I could just clarify something at the beginning? You used in your presentation the word "branch," without making a distinction between wholesale branches and retail branches, wholesale deposits and retail deposits. As you may recall from the previous work of this committee, we have already made that distinction. Indeed, our report on allowing foreign bank branching was based on identifying only the wholesale branches, not the retail branches. Am I correct in assuming that in your presentation, wherever you write the word "branch," I should read "wholesale branch" and not "retail branch"?

Mr. Stammati: Well, the MacKay committee makes the recommendation that in the financial environment foreign banks will not be allowed to be deposit-taking institutions. The difference is not really in terms of retail or wholesale, but in terms of deposit-taking and other activities.

The Chairman: Well, deposit-taking below a certain amount.

Mr. Stammati: Yes. That I understand. Of course, as you may imagine, we are glad that a step ahead has been made in so many of the particular items; however, I would underline that our banks are deposit-taking institutions in our own country and in other countries of the world, and we hope that one day our banks might be allowed to do deposit-taking activity here. However, in this particular context, we are just referring, as the MacKay committee suggests, to wholesale banks.

I believe that my colleague from Holland is also experiencing a certain situation of this kind and he might be willing to say a word.

Mr. Theo Bark, Président, Banque ABN Amro du Canada: Yes, indeed. On retail banking and wholesale banking, if I am not mistaken, the legislation that would permit foreign banks to enter Canada on the retail side was not taken up in its first draft because of the fact that we were promised -- between brackets, so to speak -- that the legislation would be introduced in 1997. In order to expedite the introduction, the bankers association basically agreed that, if it assisted us just to get those branch statements as early as possible, why not, for the sake of expediency, accept the restriction that really retail deposit-taking would be excluded? So that was not taken up as an issue.

However, along came 1997, and we are now deep into 1998, and nothing has yet happened. Within the CBA we basically came back on the earlier acceptance, between brackets again, of stating that, indeed, retail deposit-taking would be excluded. We now say, "Why not full retail banking?" In Holland, in particular, we have had that same experience. We have always allowed any bank that enters the Holland market to have, forthwith, a full range of activities.

I have, myself, worked in extensive parts of the world -- Asia, Europe and the Middle East -- and I have seen very few instances where banks were restricted. As one example, I can just cite Hong Kong, where banks with sufficient capital were, indeed, allowed to have full branch-banking, but financial institutions which did not necessarily have the financial background -- that is, capital resources -- were only allowed to have status as a financial intermediary, and were only allowed to accept deposits over a certain amount, whereby it was assured that these financial institutions were dealing with professionals. In my view, that is the restriction you should make.

The Chairman: As you know, if foreign banks want to set up subsidiaries rather than branches, they can; the issue is whether or not they can have retail branches without setting up subsidiaries. The issue that this committee dealt with almost two years ago was the complications that that causes for the deposit insurance system: how does one regulate for deposit insurance purposes?

That is what led us at the time to propose the policy which, in fact, your association was quite content with. I was simply trying to clarify in Mr. Stammati's brief that he was not using "branch" in both ways.

In fact, Mr. Bark, the association's position today is where it was in 1997, even though, as you said, you wish it were not. However, you are prepared to live with the narrower definition to avoid the complications that are caused by moving into retail deposit-taking.

Mr. Stammati: We acknowledge that at this very moment we are discussing the matter of wholesale branching, even though, as Mr. Bark said, we still hope that one day that aspect can be enlarged to also include deposit-taking with branches. Of course, we leave that to the committee.


Senator Hervieux-Payette: Mr. Stammati, unlike you, I have not yet caught that virus that will force me to speak English when talking about economic matters. I have questions about two points, even though you do not wish to go into taxation details. There is, on one hand, the provincial capital taxes which make us wonder whether we should eliminate ours. Generally speaking, what are the rules that you perceive as the most harmful, apart from capital taxes? Are there other tax rules that prevent entry of foreign banks in Canada?


Mr. Stammati: That is a very appropriate question. We represent the so-called foreign banks, but there are issues that are common to Schedule I and Schedule II, domestic and foreign. Certainly, the matter of capital taxes is a common issue for both of us, for which we are, of course, showing a united front to make clear that we feel that these are things that should be differently regulated.

However, there are some specific situations that are affecting Schedule II banks. For instance, I just referred to "parent company funding" in the sense that, if an institution, a Schedule II bank in Canada, likes to fund its operation through parent company funding, then in the moment of returning the funds to the parent the company is taxed with a withholding tax. This particular item is of delicate moment, because we feel that when, due to a market situation, there is a credit crunch and the institution has difficulty raising its own funds, then parent company funding is the best and cheapest way of funding the operation.

Charging the withholding tax makes the situation much more difficult. We also contend that the abolition of this withholding tax will make no harm to Canada, because at present it is a tax that is not being charged. So the elimination of this tax will not do anything worse to Canada.

Moreover, these are not funds that are going out of Canada; on the contrary, they are funds that are coming into Canada. So it is an in-flow of capital that will promote even more foreign activity in Canada with investment and support of Canadian activities.


Senator Hervieux-Payette: My second question is this. What is the level of your activities in Canada -- I am talking for example about Dutch as well as Italian banks -- as compared to your activities in the United States? Is entry as difficult for you in the States as it is in Canada? Could you give us examples? One has to consider that there is a measure of consistency in all of North America in economic terms. After all, Americans are our main trading partners and economic distortions are not necessarily very significant between our two systems. Are there rules in the United States that make entry easier? Do your respective banks have a lot of activities there? Do you have any retail services?


Mr. Stammati: Let me answer as follows. The situation in the United States took a different route from that in Canada. Our bank -- and at the moment I speak for my bank particularly, but I believe it is common to other non-U.S. banks -- our bank had no difficulty entering the U.S. market. Also, we were allowed to enter as a branch, and we were allowed to offer our services from coast to coast. Moreover, in a certain way the situation is more favourable to foreign banks than it is to domestic banks.

In the United States, for instance, a California bank in order to operate in New York has to create a particular subsidiary. So foreign banks in a certain way have been receiving more favourable treatment than domestic banks. At least that was the case some years ago, when we entered the market.

Speaking at the moment only for Banque Commerciale Italienne du Canada, I can say that our bank had no difficulty in establishing in the 1960s a branch in New York. We still have that branch. In the 1970s we acquired a U.S. bank that was a very profitable retail operation. Since then we have divested our interest in that operation, but that was for reasons other than the performance of the bank or difficulties in the market; it was purely an investment transaction. In the United States, our operations right now are limited to wholesale operations, but we would have no difficulty at all in entering the retail segment, if we wanted to.

So the difference between Canada and United States is that Canada, for whatever reason, is very protective and does not allow us to operate freely as a branch, but rather imposes on us the rule of the subsidiary. Even with this liberalization, assuming the law is allowed to go through, we will only be granted branches that are limited to wholesale. That, as you can see, is the difference between the two treatments.

If I may, I would personally recommend that Canada expeditiously make a resolution on the foreign banks issue, because there is also the very important matter of reciprocity. At the present time, Canadian banks are allowed to open branches in all industrial countries with no difficulty. On the other hand, foreign banks are not allowed to come into Canada in the same way. I think we need the same treatment on both sides. There are only two countries in the Western World with this particularity, Canada and Mexico. These two countries, in my opinion, should realize that the world is changing dramatically.

Mr. Bark: Australia has to be added. And I think the MacKay report also refers quite often to Australia as being the example where, indeed, Canada should mirror that. In terms of the ABN Amro operations in North America, the bank has, since the late 1970s, invested substantially in its operations in the U.S.A. We currently employ 17,000 people in the U.S.A. alone.

We have built up a bank in the Midwest, through an initial investment, the purchase of a bank by the name of Lasalle National Bank, and since the late 1970s, we have acquired banks continuously in order to expand our operations specifically in the Midwest. We cover four or five states bordering on Canada, so to speak, including Michigan, Illinois, Indiana and Missouri. We also have invested in a bank in New York and Long Island, the European American Bank, which is also a retail function. Next to these retail banks, as we have them, we have an extensive network of corporate wholesale banking offices under the name ABN Amro Bank in the U.S.A., and they serve the corporate banks in that particular market.

That is the freedom that we have in the U.S. We have extensive asset lending operations, including car financing. As ABN Amro Bank, in terms of residential mortgages, we are the fifth largest in the U.S.A.

The balance sheet of the bank is in excess of U.S.$150 billion. If we compare that with the opportunities that we did not get, so to speak, in Canada, then I think you know that that shows that, in terms of whetting the appetite of ABN Amro Bank, Canada has not necessarily helped.

Senator Angus: The chairman, in his opening question to you, touched on an area that I would like to develop a little further, if I may. I will try to get right to the broader question, and then we can become more specific after that.

In your opening remarks, Mr. Stammati, you said that your requests for the privilege of branching, and for the tax and other regulatory changes you are seeking, have nothing to do with the mergers that are on the table here in Canada. However, we have been holding these hearings for almost five weeks now on an array of topics that are not supposed to have anything to do with the mergers; but, inevitably, we start talking about the mergers, and there is a key word that comes up in all of the discussions, and that is "competition."

Indeed, you stressed competition in your opening remarks, and that is what the mergers are all about: competition. Against that background, we have been hearing that to fill the void that is perceived, and is real, in Canada because of the lack of players, if you will, or because there are very few players in the second-tier retail banks, unlike in the United States and the U.K., and unlike in many countries in Europe, there is a fear that in Canada, because we have not got a well-developed, second-tier retail sector, there will be severe competition problems if the mergers take place and the main retail bankers are reduced from five or six down to, say, three or four.

Moreover, we are hearing that implementation of the MacKay recommendations and opening up the playing field to foreign banks, as you have requested, will not solve the problem, and that, in fact, the foreign banks will not fill the void. Even if we allow the mergers and all these other liberalizations to take place, basically, the result will be a stifling of competition.

I know that that is a mouthful, but perhaps it sets a background on which you could comment.

Mr. Stammati: Well, if you look at the history of all this, we are at this very moment suffering because decisions were not taken some years ago. We feel that, if in the 1970s foreign banks had been allowed to come into a very free environment, competition would by now be alive, while instead we are still talking today of competition being inactive.

We cannot change the past, but we can change the future. I believe that foreign banks -- and I believe I talk for some of them -- that are asking to come to Canada with the status of branch will not necessarily dismantle their subsidiaries. We, for instance, are seeking the possibility of having a branch, a subsidiary or both. That goes to show that we are really committed to having a sophisticated market and to challenging the market in any segment. Our banks, notwithstanding the structure of our subsidiaries, are already challenging the big institutions in matters such as small business loans and retail operations.

If branches are allowed -- in the words of the chairman, "wholesale branches" -- we feel that there will be more opportunity for Canadian corporations to seek cheaper funds and to seek sophistication. Moreover, if a company has alternatives, it might invest even more and, therefore, indirectly the consumer will also benefit. So we feel that our role here is one of sophistication and of challenging the market and giving more opportunity to the consumer, both directly and indirectly.

I believe the two issues are definitely separate. We are, after all, witnessing other mergers around the world. In Europe the market is full of mergers. We believe that Europe -- and other countries, but particularly Europe -- is witnessing mergers because the market is changing. Europe is now going as one country, while before there were different countries.

I will not comment on issues that are outside of the scope of Schedule II foreign banks, but Canada, as of this very moment, is linking a merger situation, which is a typical Schedule I problem and desire and a Schedule I characteristic, with a Schedule II situation, namely the fact that the foreign banks have been requesting entrance into Canada for twenty or thirty years. So, in a certain way, we have been linked unfairly with the merger situation. I do not know whether any of my colleagues would like to add anything.

Mr. Harvey S. Naglie, President, BT Bank of Canada: I do not think we are being disingenuous.

Senator Angus: I am very glad you are commenting, Mr. Naglie, because it is important for us to have the complete picture. Am I correct that B.T. is based in the U.S.?

Mr. Naglie: That is correct.

Senator Angus: I gathered from your earlier statement that there might be a difference between what the European banks would want to do if they were allowed to come into Canada and what the U.S. banks would want. I know I have thrown a kicker in there, but I would like to know from you, Mr. Naglie, if you are you all on common ground.

Mr. Stammati: If you would allow me, Mr. Chairman, I would like to say that the committee representing the Schedule II banks is an odd committee in the sense that the banks that are together in the committee are not doing exactly the same kind of activity. However, we try to present a common front; then each of us has specific proposals or requests to make.

Senator Angus: So you are not the odd couple; you are the odd trio. Is that it?

Mr. Naglie: Senator, obviously, given the significance of the big bank mergers, that issue has repercussions and is a factor in anything that is taking place currently in the Canadian financial services sector. I think the distinction that my colleagues and I are trying to draw is that we believe wholeheartedly that, regardless of how that particular issue is resolved, we, as a group, would be able to make a better contribution with the added flexibility that a branch structure would offer us relative to our status quo, having to operate as subsidiaries in this country.

Mr. Stammati: Mr. Chairman, if you will allow me, I would like to add one word. I would like to quote from the testimony of Mr. Courville, who testified before this committee on September 29. He said the following:

The task force also recommends what we have called the bank-owning-a-bank model whereby a bank could choose to separate its retail banking operations from its wholesale banking business. The retail business would continue to be subject to regulation to protect consumers, while the wholesale business would be structured to compete with non-bank institutions that are unregulated and taxed at significantly lower levels than banks.

My point is that, if even the Schedule I banks are looking for a more friendly environment for their wholesale operations, then so much the more is that the objective of the foreign banks. As you can see, even the Schedule I banks are supporting our own vision for a better and more friendly environment for us to compete in.

Senator Angus: Thank you; that was very helpful. I might be wrong in reading into the comments you have made so far a negative response to my larger questions -- or maybe it is a positive response in the sense that, yes, the foreign banks will not fill the void in respect of the retail vacuum that exists.

In any event, what you want is more flexibility to do what you do best, which is to be in this area of wholesale banking, or near-wholesale banking as you have described it, and to be more in the commercial side, catering to the needs of small business persons, which is obviously something that is of interest in Canada, because we have had this issue before us for a long time. Indeed, you said that if you had been allowed, as you wanted to about twenty or thirty years ago, to come in and do these things, you might now have a branch on every corner.

The credit unions and the caisses populaires are saying the same thing. Now they see an opportunity, and it looks to us, for example, like that might be one area where the retail aspect would fit in. I am thinking of consumers and small businesses in rural areas that are not densely populated, where there is a genuine concern about filling the void and a concern that choice will not be available in a post-merger environment.

Mr. Bark: Senator, the world is not static. Perhaps 10 or 20 years ago we had the desire to open brick and mortar branches in this country in order to do the same thing as we do at home, but that is no longer the case.

More and more financial organizations are organized along business lines, whether they focus on the corporate side -- financial institutions, specifically -- or whether they focus on the retail side or on the small and medium enterprises. Each and every organization is different. For example, the Citibanks of this world have a very strong focus, as we all know, on the top corporate sectors and on retail banking, the consumers

In the case of ABN Amro Bank, we also have a similar organization that reflects perhaps a number of financial institutions that are active in this country. We have a corporate bank which, indeed, focuses on the top 500 Canadian names in the market. We also have an asset-based lending operation attached to our U.S. organization that is, perhaps, in the mid-corporate market. We also have small-sized leasing as an activity which focuses on transactions of $100,000.

Evidently, more and more institutions are focusing on their niches to ensure that they can make a proper living.

Traditional universal banking, as we knew it a number of years ago, no longer exists. Euroland, comprising 12 countries, will come into being on January 1. ABN Amro Bank has a market share in Euroland of 1 per cent. That is concentrated, of course, in Holland, although we also have substantial corporate and private banking operations in a number of other countries in Europe.

One must look at market shares and dominance in a wider context. Euroland is perhaps a bit further ahead in terms of its integration process than North America. Nonetheless, all of the banks there still have to struggle with how to attack that market. A number of banks have taken the route of niche products, whether those are direct banking, the introduction of call centres, the Internet network. It is an ongoing process to serve the customer.

You cannot and should not expect that foreign banking institutions in Canada will fill the void. Our market share in Canada is next to nothing. Let us be realistic. We cannot just take on the major Canadian banks in their traditional environment, whether they are standing on their own without mergers or whether they are being merged.

The Chairman: Is it reasonable to conclude that you would not buy blocks of branches even if, as a result of the decision by the Competition Bureau, the merger applicants were told they had to divest themselves of a significant number of branches and those branches were put on the market? Perhaps each of the three of you will have a different answer.

I ask that because Canada Trust told us, as did Hongkong Bank, that they absolutely would buy blocks of branches, but as I understand it, that is not the direction you would go if you had that opportunity. Would you build branches from scratch rather than take the opportunity to buy existing branches if they went on the market?

Mr. Bark: Obviously, we looked at the market and the merger issues to see whether there was an opportunity for us, and we decided that there was no opportunity. We do not believe that it is in our interests or in the interests of our shareholders just to buy brick and mortar, mainly because brick and mortar do not necessarily represent a faithful client base. There is no country in the world where we operate where we think we would contribute and would have a position which is independent from the major banks if it is less than 10 per cent.

The Chairman: When you say "major banks," do you mean major domestic banks?

Mr. Bark: Yes, I mean major domestic banks in each and every sector of the market.

Mr. Stammati: My answer is slightly different because we already do provide a retail operation. Our bank started mainly as an ethnic bank and we grew very well in the Italian community. Presently we have thirteen branches, two banking centres and two commercial centres; only one branch, that of Kitchener, is located in a non-Italian area. All of the others are located in communities of Italians.

If tomorrow some banks decided to put certain branches on the block, my first question would be whether they would allow cherry-picking based on location or would they allow everything or nothing. That is my first point.

My second point is that it depends very much on which branch we had the opportunity to buy, because if we buy a branch that is just in front of another branch that is consolidated, we are practically buying an empty branch because the customers move to the other side. Therefore, that investment might not be of significant importance to us.

My third point is that, if the product we have appealed to a community other than the one we already serve, we would be very glad, but we do not know if it would.

The answer is that we might or we might not, depending on the circumstances.

Mr. Naglie: I would simply point out for the committee that Hongkong Bank is, in fact, a member of the Schedule II group. Therefore, in effect, a foreign bank has indicated a willingness to buy up retail branches, should they become available.

As our chairman, Mr. Stammati, has said, the Schedule II banks are a very disparate group, and different members have different corporate strengths and expertise.

My own institution, Bankers Trust, is a wholesale bank. Even in our home market of the United States we do not do any retail operations. I think it would be fairly safe to conclude that we do not believe we have a particular expertise or value-added in that area.

However, a number of members in the Schedule II community, who do have clear expertise and a proven track record in retail branch banking, may very well find the Canadian opportunity, subject to the appropriate conditions and entry rules, to be attractive.

Senator Angus: However, they are not here today. I have just one last question. You mentioned that since 1987 there has been a decline in the number of Schedule II banks from 59 to 40. I am curious about those numbers.

When we held hearings in 1996 we heard evidence that the number of Schedule II banks had declined to substantially below 40, indeed to 27 or even 19. That is the number that sticks in my brain. Has there been a resuscitation here due to the MacKay report or the kinder and gentler environment which you are looking forward to?

Mr. Stammati: The number of Schedule II banks is 40, and that includes banks that recently came to Canada or became banks in Canada. For instance, MBNA came to Canada not as a bank, but then turned its operation into a bank; now, of course, it counts as a Schedule II bank whether or not it is a member of our association.

At first American Express also came to Canada not as a bank but for the purpose of selling its own credit cards, and then it became a bank. ING Bank is another example of an institution that came not as a bank but then turned into a bank. The reason they all became banks is that they felt that there were better possibilities for them to operate in a federal environment, such as being members of the payments association.

On the other side, however, the number of banks that came earlier to this country is decreasing for a couple of simple reasons. Some of the banks are experiencing mergers in their own countries. Therefore, you might see the Schedule II banks amalgamating here because their parents are amalgamating. Other banks, unfortunately, experience an unfriendly situation or have a track record that is not positive in terms of profits and so decide that maybe their capital would produce better return for their shareholders somewhere else in the world.

At this moment we have roughly 40 Schedule II banks, but as I said, people were leaving and there are newcomers in a different environment.

Senator Angus: We should not conclude, then, that the number of Schedule II banks is declining, for the reasons that you gave. Actually, it is probably more accurate to say that it is increasing again. My figures show that it has nearly doubled in the last couple of years.

Mr. Randle: Senator, 59 was the peak. I am honestly dumbfounded at your number of 29 or lower. It was never, ever that low. I do not know where you got that number, but I can tell you categorically that it is incorrect. The number was in the high 50s. It certainly increased. It began to go down in the mid-1980s. We have 40 now and that number has been stable for the last year or so.

Three factors contributed to the decrease. There were mergers, both outside and inside Canada. Hongkong Bank of Canada acquired the Canadian operations of banks such as A&Z, Barclay's and a number of others. There were mergers outside the country that led to a decline. Also, some banks, the Israeli Bank, for instance, decided they could not make any money in this market and left.

The other thing to consider is that a number of these banks have actually restructured their operations here and, in fact, are nowhere near as active as they were. They may still have a presence here, but they do not have as active a presence. For example, the Swiss banks and some of the American banks have reduced their operations here.

Your witnesses this afternoon will probably explain the reconstruction in this country. In terms of both numbers and types of activities, some banks have a less active presence now. Both numbers and activities have gone down.

Senator Di Nino: What is the size of all the foreign banks in Canada in total assets?

Mr. Stammati: The total assets of all of the foreign banks, including the Hongkong Bank, which of course is the strongest, are roughly $100 billion.

Senator Di Nino: What about capital?

Mr. Stammati: I believe that the strongest one in terms of capital is still Hongkong Bank, but I would be glad to supply you with that information at a later date.

Senator Di Nino: I am trying to see what kind of commitment the Schedule II banks, the foreign banks, have made to the Canadian economy.

Mr. Stammati: Directly or indirectly, the foreign banks coming to Canada created new jobs. I refer also to the association that some foreign banks have with local banks. For instance, Mellon Bank has an association with CIBC and that, of course, creates new jobs. It is safe to say that roughly 7,000 jobs have been assigned, created or promoted by the foreign banks in Canada. Foreign banks have opened roughly 250 branches, half of which belong to Hongkong Bank. The remainder belong to other Schedule II banks.

In addition to that, foreign banks now have automatic banking machines located in places other than their own branches and those are also points of sale. Unfortunately, at this moment I do not have in my hand the total amount of capital brought into this country, but I would be glad to forward that to you at a later date.

Senator Di Nino: What is the minimum required to be able to open up a Schedule II bank?

Mr. Stammati: If I am not mistaken, it is $10 million.

Senator Di Nino: Can we assume that it is at least $500 million or more?

Mr. Bark: The solvency ratio, what you need to have with a balance sheet of $100 billion, is likely more in the neighbourhood of over $5 billion, of which the bulk is the Hongkong Bank.

I should like to comment on what the foreign banks contribute to the Canadian economy. Apart from our domestic commitments on the retail side and other activities, for quite a number of foreign institutions, our competitive edge in this market is the fact that we serve the international activities of Canadian companies.

The Citibanks of the world, the investment banks of the world, operate in quite a number of countries where we assist to a great extent. We have a substantially larger market share on the corporate side internationally than we have on the domestic scene. That is where we contribute. I think we make our most valuable contribution to Canada on the export side as well as on the import side.

Senator Di Nino: In other words, you compete with the local banks and domestic banks in the international market as well as in the major corporate segment of the business in this country.

Can I assume, then, that other than Hongkong Bank and maybe three or four others, there really is not a great deal of competition that the domestic banks face from Schedule II banks?

Mr. Stammati: In the domestic environment, ethnic banks serving their own communities really challenge the larger Schedule I banks. I am referring to the Greek and the Portuguese and, of course, ourselves.

In the particular field of small-business loans, retail and consumer, we are an alternative to a big bank. Our presence in this market is sophisticated enough to give opportunities not only in the retail, consumer, corporate, and commercial environments, but also, as Mr. Bark said, in the international environment.

Senator Di Nino: Tell us how the MacKay task force recommendations and, if you wish, other suggestions on your part could increase the competition to the domestic banks by the foreign banks for the consumer.

Mr. Stammati: A point raised earlier this morning that is not in the report is that foreign banks should be allowed to provide retail services through branch banking, because we feel that we already do that in our own country and in other countries in the world. We are talking about major international institutions, not just small-timers. We provide this service in other parts of the world and we do not see why we should be restricted in a certain way in Canada.

We acknowledge that what the MacKay report says is a step in the right direction, but it does not yet give us completely the full freedom we hope to achieve.

Senator Di Nino: The Schedule II banks have a limitation on the total size of the pool of business that can be gotten from the Canadian market; is that correct?

Mr. Stammati: On this point, I acknowledge that the Canadian government took a step in the right direction, because in the 1980s we were linked to capital in such a way that a ceiling was imposed upon us. Because of international agreements that Canada has signed, including NAFTA and coming in June of next year the WTO, that ceiling has been removed. At this moment, there is no quota that limits our activity. We are, in a sense, free.

The ratio between our assets and our capital is equal in other parts of the world. What is different in this country is that, if we need more capital to finance our assets, we can import more capital from our parent, but we are taxed on the capital. We are trapped by that dichotomy. We want to do more business, but in terms of what we do in other countries, the more capital we import, the more tax we pay.

Senator Di Nino: What is stopping you, then, from competing with the domestic banks? What is it that you need, other than the branch network, to better compete or fully compete with the domestic banks? Is that branch network the only thing required at this point to enable you to go out there and give the consumers of Canada a better choice of banking services?

Mr. Stammati: First of all, as I said before, the tax environment, which is different for us than it is for the Schedule I banks, includes measures such as the withholding tax and that prohibits us from being more active. A second element common also to the Schedule I banks is that we are taxed not on our revenues but on our capital. The more capital we import, the more tax we pay, and that prevents us from growing. Furthermore, of course, there are restrictions regarding the governance of a subsidiary structure. If we were actively to pursue opportunities in the Canadian market for changing to a branch status, we would have to be flexible and more user friendly.

Senator Di Nino: It sounds to me like even if there were an opportunity to expand the branch network through the attrition of branches of amalgamated entities in Canada, there probably would not be a great deal of appetite, other than maybe the Hongkong Bank. There seems to be a conflict in what you are saying; on the one hand, you would like to be open more retail offices, and yet on the other, if they were available, you probably would not take advantage. Is this what I am hearing?

Mr. Bark: I think you should consider it from the point of view of the foreign banking institutions. They would like to offer niche banking. For the Hongkong Bank, niche banking is, indeed, in the market segment in which those branches operate. I am not speaking on behalf of them, obviously, but that is my perception.

I think we should turn the question, actually, if I may, Mr. Chairman, and ask: What would happen if the climate were not improved for the foreign banks in Canada?

If you had the three CEOs here from our main banks, the parent banks, from Bankers Trust, BCI and ABN Amro bank, you would get a very straight answer: "Well, boys, we close shop." There are insufficient return possibilities in this Canadian market for the marketplace. If legislation is not changed, not introduced sooner rather than later, ultimately we will face the question of whether the returns which we have seen on our operations here will, indeed, be sufficient to sustain those operations even as we have them to date.

The Chairman: Thank you.

Mr. Stammati: Mr. Chairman, I should like to add that Mr. Bark was right about niche marketing. Each of us has a particular specialty in a particular field. The more freedom we can get, the more possibilities we have in our particular niches. We can challenge the big banks and that benefits not only the big corporations, but also, directly or indirectly, the consumers and small business.

Senator Di Nino: Thank you.

Senator Tkachuk: Mr. Naglie, you answered a number of specific questions on conditions and entry rules for branch banking. I know many of you have said that banking has changed and that bricks and mortar are less relevant.

However, in Western Canada, and I use that as an example because I am familiar with it, as in many areas in Canada, we have a small number of people over vast territories. Those people require cash. I am thinking of the farmer who has ten sections of land and who needs lines of credit. It seems to me that buying a combine that is worth $150,000 or $200,000 would require some conversation with the banker, not conversation over the Internet.

You also mentioned conditions of entry. Of course, we are all very concerned about the mergers only from the point of view of competition itself, and we have heard about the withholding tax and the capital tax. You are not the only ones to mention the capital tax; everybody complains about the capital tax.

What other specific things would generate some interest in branches locating and foreign branches opening up in Western Canada, in, say, Regina, Saskatchewan, Saskatoon, Winnipeg, and Vancouver? What specific things does the government have to do to open that up and make it easier to access?

Mr. Naglie: When do the easy questions start?

We are profit-driven organizations. The capital, the expertise, the resources of all of our respective organizations ultimately will gravitate towards activities and markets where we perceive that, based on our own capabilities, we can earn the greatest return on that investment.

I think the situation we confront currently is that, for a host of reasons, the domestic institutions and primarily the largest five or six banks enjoy a very commanding market share and market presence in Canada. In the short term, notwithstanding additional capabilities on the branching front, to successfully compete with the domestic institutions is a very daunting prospect.

I think we all have to be very careful here regarding the possibility that the conditions of any ultimate approval for merger might include the requirement to dispose of branches. It is one thing to sell or to require an institution to divest of physical plants. It is another thing to be able to transfer the business and the customers that are associated with those branches. The fact of the matter is that the Canadian banks are so well entrenched as a result of their national networks and have such access to the wallets of Canadian consumers because of the range of products that they have, including mortgages, loans and credit cards, and the range of services that they currently provide that they represent, quite frankly, very capable, very excellent, and very tough competitors for a newcomer to face.

I think the answer to your question, senator, is that it is probably a very steep slope and you set the bar very high in terms of inquiring or suggesting that we, the foreign banks, should look to develop aggressively a retail network in the current environment. That is not to say that over time, foreign financial institutions would not begin to enter that market with a focused approach to the degree that opportunities existed there to earn a return on capital.

The Chairman: May I ask a follow-up question on that? In the United States, the American equivalent of the Competition Bureau has ruled in a number of merger cases that the merging banks have not only to get rid of a batch of branches, but that they also have to get rid of the customers that go with those branches. There are significant penalties for banks caught soliciting those customers they gave up within a two-year period. The acquiring banks have not had a bad history of being able to acquire the customer base. They do not get 100 per cent of the customer base, but they do get a pretty solid percentage.

Would it be fair for me to conclude from your previous response, Mr. Naglie, that, under a similar scenario in Canada, a foreign bank would be less likely to get the customers because of the existing brand awareness of the major banks? In other words, would transferring customers under the scenario I described, which has been reasonably successful in the United States, be much less successful, in your view, in Canada?

Mr. Naglie: In the short term, yes, senator.

The Chairman: Thank you.

Senator Tkachuk: Regarding all of the things you mentioned, like credit cards, the domestic banks, the Big Five, have told us that they have to merge because competition is really tough in those areas. Would the elimination of the 10 per cent rule be helpful?

Mr. Stammati: I believe that that specific question pertains more to the Schedule I bank environment; there is little impact on our own vision. However, we definitely feel that and we are experiencing in other parts of the world that there is an attempt to have a widely held institution. In our own country, also, our institutions are widely held.

I believe that you may be right, but I am not able at this moment to comment specifically on whether or not the elimination of the 10 per cent rule would lead to a more sophisticated market.

Mr. Chairman, may I ask Mr. Jeff Graham to add a couple of words?

Mr. Jeffrey S. Graham, Barrister and Solicitor, Borden & Elliot: There are a couple of things one might say about the leadership role this committee has played in helping to create a better understanding of the important role that international institutions and foreign banks can play in the country.

Canada has a terrible reputation internationally as an environment in which foreign banks can do business and contribute to the local economy. Frankly, if the government proceeds, and it looks like it will, to change that attitude, the history of what has happened in the past will not necessarily be an indication of what is likely to happen in the future. We have to send a strong signal, and the sooner we send it, the better off we will be.

With respect to the agricultural sector, there are a number of things I might add that are not necessarily all that visible. I am aware of two very specialized international banking organizations that have come to Canada in the last couple of years with great expertise in agricultural lending. One of them is a Dutch institution, RaboBank, and there is an American agricultural co-op called Agway that has come to Canada recently as a 521 corporation. In each instance, they are bringing specialized skills.

They see that there are opportunities to be successful in the Canadian environment. If this committee can send a signal to the international community that there are opportunities, I cannot but believe that there will be some positive surprises, particularly on a cross-border basis.

By and large, the American institutions that are here are major wholesale institutions. Some consumer, specialty and monoline institutions have come recently, while a host of others will look more closely at the Canadian market as an opportunity to extend both retail and commercial services if they think the environment is sufficiently attractive.

The foreign banks are not the total answer to the merger challenges, but in the North American context they can certainly make a significant contribution.

Mr. Bark: Regarding your question, Mr. Chairman, I should like to add that what you need in the market is of course economy of scale. You need to leverage previous investments in order to make a success of the new ones. There is a time limitation; for example, while you could buy brick and mortar and customers over a two-year period, if you start from scratch, there is no way that you could set up a proper organization within that same two-year period.

Finally, there is also the millennium problem to consider.

Senator Kroft: I would like to get a clear statement on the record. We have a great challenge in this country to bring effective lending services to small and medium-sized business. That is a component of the discussion about mergers, but it is also a subject that stands very much on its own. Much of what I have heard today has focused on branches. I do not necessarily want to be preoccupied with branches, although that subject is obviously important. I am also conscious of Mr. Graham's last comments.

Correct me if I am wrong, but what I have heard and the message I will carry away from this discussion is that, when it comes to the financing of small and medium-sized businesses across the country, particularly away from the financial centres, we should not look to the foreign banks as a particularly significant addition to that part of the financial institution structure.

Mr. Stammati: Indeed, we already have in our operation a segment that is dedicated to the small and medium enterprises. I am particularly sensitive to that area because my own country really lives on small and medium enterprises.

Within our ethnic community in Canada, our bank has already loaned about $100 million to these small and medium enterprises. It is not for me now to comment on what other banks do, but it is my understanding that others, too, have a particular experience in the field of small and medium enterprises. You might ask the same question tonight of the representative of Deutsche Bank.

For the ethnic banks, like the Greeks and the Portuguese, certain activity is limited to the ethnic market, and practically all of the business loans go to small and medium enterprises because their size would not allow them to lend to big corporations.

Regarding the ethnic market, I understand that foreign banks that do not do retail or finance small and medium enterprises in their own countries will not do that in Canada either. Other institutions already do those activities and there is no reason to believe that they should discontinue them.

Mr. Bark: In spite of the fact that ABN Amro Bank is a wholesale bank very much on the corporate investment banking side, we do have a viable leasing operation, as I mentioned earlier, with small ticket leasing of $100,000.

We have offices, or at least sales people, in all the provinces, including in the west. We even have an office with three people in Halifax.

Mr. Graham: Mr. Chairman, for the record, it is important to recognize that the foreign international banks that are organized here as Schedule II banks are only a segment of the foreign banking community currently carrying on business in Canada.

The broadly defined international banking institutions make a substantial contribution in the sales and finance sector. Banks such as Norwest, TransCanada Credit, AVCO, Household and a whole series of other institutions that are, for the purposes of our legislation, defined as foreign banks are very much involved in the consumer finance, small-business, personal lending environment. We ought not to forget that. They make a contribution and some of them have been here for a very long period of time. If for economic or structural reasons there are greater opportunities for them to participate, they will enhance their role in this economy.

Mr. Randle: The key point is that the regulatory structure you presently have has not worked. The numbers have gone down. The activities have gone down. With one or two notable exceptions, the presence in the market has gone down. It is not working.

Second, the MacKay task force and this group have said that they do not want branches at this moment to be allowed to do retail business. You cannot then say, "Well, you will not open a business in Lethbridge, Alberta or Annapolis, Nova Scotia, because we are not allowing them to do retail business."

Third, I meet with a lot of banks coming through the country and looking at the marketplace. The common message they send is that they are small regional banks or small European banks that are interested in a certain segment of the market, such as asset lending, for example. However, they are not willing to enter this marketplace if they then have to have a board of directors and a regulatory structure as if they were the Royal Bank of Canada and a tax structure as if they were a major bank.

If you have an engine that is not working, you need to change it. Therefore, the first step in a process that may need further changes in the future is to move ahead on direct branching. Allow wholesale branching, see how that works out, and move on from there.

The Chairman: That is exactly the reason that two years ago this committee wrote what is about to become the federal policy for foreign branching.

Senator Oliver: It is my opinion that the evidence these witnesses have been giving is among the most important that we have heard, given what the MacKay report says about competition. I just regret that we do not have another hour with you.

Having said that, it is my view that niche banking is certainly the way of the future. As several of you have said, universal banks are dead.

I want to ask if you agree with what the Hongkong Bank told us when we were in Vancouver on Thursday. They actually said that full functionality of automatic banking machine networks is a wonderful way for foreign banks to suddenly get into Canada.

Mr. Stammati: My personal experience is definitely that technology is the name of the game for the future, and you cannot stop technology. I believe that all of us are pursuing technology and are pursuing automatic instruments to maximize our costs and double our revenues.

However, I believe that a combination of personalized service and technology is the winning card. At least, that has been the experience of our own bank. It is my view that in the evening, with the remote control for your TV set, you can pick the best channel to get the best interest rate for renewing your RRSP. However, if you do not have a mortgage and you want to get one, you want to speak with a person and not with a machine.

My answer is a combination of the two. Technology definitely plays an important role not only in banking but in life. Five years ago, "Internet" was not even a word we used; now "Internet" is the name of the game. However, I believe that we should also put humanity back into the business. We need high tech and high touch.

Mr. Graham: Senators, there are restrictions in section 508 of the Bank Act which this committee may wish to review because, as I recall, they largely prohibit the ability of international institutions to do precisely as you would suggest on a cross-border basis without a physical presence here.

Frankly, that may be one way in which you could achieve an increase at least in the visibility, albeit ATM visibility, of international institutions this country.

Senator Oliver: The Hongkong Bank also gave an opinion on the proposed bank mergers in Canada, and I wonder if you could also give your comments on that in conclusion.

Mr. Stammati: My colleague Mr. Nazir is a great friend and he is brave and courageous, venturing in a field that is a mine field, but it is also true that he runs an institution that is practically, I would say, Schedule I and a half.

Senator Oliver: He has 117 branches.

Mr. Stammati: Yes, that is the point. The MacKay report makes one point very clearly: Whatever is done should be in the interests of consumers. Just looking at the pros and cons, I understand that there are good reasons to merge and good reasons not to merge.

I should like to borrow an expression that was used by Mr. Protti, the president and CEO of CBA. He said that Mr. MacKay in his report gave a yellow signal. Some Schedule I banks that would like to merge say that it is a green signal. Other banks that do not want to merge assure us that it is a red signal. However, we are colour blind.

The Chairman: On that note, gentlemen, thank you very much for coming. We appreciate you taking the time to be with us this morning.

Our next witnesses are from the Association of Trust Companies, led by Mr. Gerald Soloway, who is chairman of the Trust Companies Association.

In order that we use our time most usefully, perhaps, after introducing your colleagues, you would simply touch on the high points of your brief.

Mr. Gerald Soloway, Chairman, Association of Trust Companies, and President and CEO, Home Savings & Loan Corporation: Mr. Chairman, today I am accompanied by Warren Hannay, President and CEO, Peace Hills Trust; Mr. Glen King, Vice-President and Chief Financial Officer, Fortis Trust; and by Joseph Chertkow, Director of Legislation and Policy for the Trust Companies Association.

We will talk a little bit about what each company does and how it contributes to the Canadian economy. As you requested, I will skim over some of these items.

Briefly, Home Savings & Loan has established a unique, solid and profitable niche in the residential mortgage market for those individuals who do not qualify at the banks for residential first mortgages.

We operate primarily in Ontario, and we have started to do business in B.C. and Alberta over the last year. Peace Hills Trust has been extremely successful in pursuing a business strategy to provide financial services to members of the aboriginal community. They started in Western Canada and they now do business in all the provinces in Canada, together with the Yukon and the Northwest Territories. At the other end of the country, Fortis Trust serves the residents of Newfoundland.

I wanted to indicate to you that we are an association of 16 members. We are basically almost all of the trust companies in Canada that are not owned by a major bank or insurance company. We are part of the second tier of financial services companies in the country.

We feel that one of the main themes of the MacKay task report is enhancing competition and competitiveness and improving the regulatory framework.

We feel also, as a membership, that the only source of real retail competition must come from Canadian domestic institutions. We believe that the smaller trust companies and the credit unions with their community and regional focus are the ones that can provide the real retail.

There will be other retail from foreign companies, and we are not in any way diminishing their role, but we feel that domestic institutions can provide a real source of competition.

It is very important to us that the rules that are now in the regulatory environment not be structured. I would emphasize that point. They should not be structured to favour large over small. We believe that the cost of regulation must be a consideration so that small companies that do not have a large infrastructure can comply with everything and do so economically.

We would like to see this committee come forward with recommendations regarding tax laws and legislation. MacKay made a number of recommendations regarding the tax burden of smaller companies, and talked about a 10-year capital tax holiday for new institutions.

We would like to see a recommendation that the government go forward and eliminate capital taxes for smaller institutions, both new and existing. Capital taxes, in our experience, really deter the expansion of small companies.

The second issue also relates to income taxes. The credit unions now pay taxes on a small-business basis, and we strongly feel that the smaller institutions in Canada should pay corporate taxes on the same bases as the credit unions.

We would further recommend that the task force's recommendation of a new mandate for OSFI and its support of a more entrepreneurial and innovative approach to financial services be reinforced. We strongly recommend that it be put into legislation.

We believe that the task force does not go quite far enough in terms of encouraging a new environment, and we have several specific recommendations.

We recommend that the Auditor General be retained to identify the range of reporting and compliance obligations that currently apply to small institutions. We recommend simplifying the system. This is an important first step for streamlining and tailoring the rules. I might add that we want to accomplish this without, in any way, lessening the supervisory role that has to be in place for the protection of depositors across the country. There are ways to accomplish the same things in a more streamlined manner.

We also would recommend that a new small institutions division be established within OSFI, to be staffed by persons with specific expertise and experience in small institutions. It would be very difficult for a regulator who was used to supervising one of the five major chartered banks with assets of $100 billion to come in. Regulating a company like Home Savings with assets of $500 million requires a slightly different approach and a different culture. We are in no way suggesting that small companies not be regulated in a vigorous manner. We just think there is a far more efficient way to do it.

The task force included a number of recommendations that would encourage the credit unions with new powers, and we say that, where appropriate, the new powers that are being granted to credit unions should also be granted to the trust companies.

In that area, there is an opportunity for a small trust company, if it wishes, to convert into a community bank. The rules of converting from a trust company to the additional powers of a community bank should be incorporated in the new legislation so that it can be done in an efficient and timely manner.

In conclusion, we support the task force's vision for the financial services sector. We urge the Government of Canada to come forward with its vision. We believe that it is in the interests of Canadians for that vision to include a dynamic and competitive second tier of independent financial institutions.

We thank you for the opportunity of offering our comments on these matters, and I would like to now introduce again my two presenters who are going to take a couple of minutes, very briefly, to just chat about their respective institutions and the market niches that they serve.

First of all, Mr. Glen King.

Mr. Glen King, Vice-President and Chief Financial Officer of Fortis Trust: Fortis Trust operates in Newfoundland and Prince Edward Island and has been in existence since 1932.

We are a relatively small financial institution with $66 million in assets under administration. Our main products are residential mortgages and fixed-term deposits. We use our knowledge of the local marketplace and our size to our advantage.

We have created a niche in our market; in fact, our St. John's branch is consistently in the top five branches in Newfoundland for CMHC residential mortgage lending. Our mortgage approval guidelines are based on Newfoundland standards and not on a national scoring system.

We are known for our premium deposit rates. We ensure that there is an alternative to the bank's posted rates. We provide personalized service in the office without voice mail, without forcing our customers to bank on the front porch.

Fortis Trust is a niche player, offering specific products in a limited geographic market. We are a profitable, successful and competitive company.

Mr. Soloway: Mr. Hannay?

Mr. Warren Hannay, President and CEO of Peace Hills Trust: Mr. Chairman and senators, Peace Hills Trust Company is a full service, federally chartered national trust company founded in 1980. Its head office is in Hobbema, Alberta, located on the Samson Cree reservation. It was formed to deal with First Nations communities' lack of access to capital due primarily to certain interpretations of the Indian Act and lack of understanding by some of the major financial institutions in this country in dealing with the development of First Nations communities.

It was initially capitalized in the amount of $7 million for the Samson Cree Nations' oil revenues. Its present capital has grown to more than $40 million. The company assets exceed $400 million. Client assets exceed $300 million, placing the company's assets under administration at close to $700 to $800 million. The company has seven regional offices located throughout Canada -- two in British Columbia, two in Alberta, two in Saskatchewan and one in Manitoba.

We are at present looking to locate a regional office very shortly in New Brunswick. We have 150 staff, 73 per cent of which are of First Nations heritage and who are also qualified bankers at every level and in every management position.

Equal employment legislation is not an issue with our company. We are clearly a niche player, but we are a unique company for two reasons.

One reason, obviously, is the niche in which we deal. We deal almost exclusively with First Nations -- 93 per cent of our assets belong to them, be it deposits or lending activity.

We are a unique company not just because of our niche but also because of our ownership. We are 100 per cent owned by a First Nation in this country, which, again, creates some other interesting developments as we continue to work with the federal regulators.

We will, I suppose, get into some of the issues in that regard, but that is a quick overview of the Peace Hills Trust.

The Chairman: Thank you, gentlemen. I have three questions. On page 5 you made two points; the first is that you would like to have the opportunity, if closely held community bank legislation is introduced, to effectively change yourself from a trust company to a community bank or a local bank.

Certainly, my reading of the report is that that option is contemplated. Are you saying that you would like us to make that explicit?

Mr. Soloway: That is our recommendation, yes, sir.

The Chairman: The second point you are making is that you would like to have the same tax structure as the credit unions. As you know, going back 100 years in this country, the credit union movement has been taxed differently because of its structure.

That inequity, or to use a phrase the industry loves, that "unlevel playing field" has existed for many years, and you are suggesting that it be made level. You did not suggest that it be made level the other way, which would be to change the credit union tax structure so that it is the same as what you have now.

Are you looking for a level playing field or a tax break?

Mr. Soloway: We are probably looking for both. Some rules could be devised whereby any company that was not more than 5 or 10 per cent of the size of the average of the Big Five banks would qualify, whether it was a credit union or a trust company.

We feel that there is a need to encourage this tier, without imposing a great tax burden. I cannot provide you with figures, but for the number of companies involved, the amount of the tax break to encourage a second tier would not mean a subsidy. It would just mean extracting not quite as much tax out of this small group of companies.

The Chairman: Essentially, you are looking for a tax break, and you have picked as the level of the break the level that the credit unions now have.

Mr. Soloway: We think that would be appropriate.

Senator Kelleher: I would ask the clerk of the committee to please note for the record that Senators Kelleher and Meighen were not involved in the discussion with respect to Schedule II banks and, indeed, were not present in the hearing.

Senator Callbeck: On page 2 of your brief you talk about getting more competition in Canada, and you say that one possible source is foreign institutions. However, you say that, even with changes to our foreign bank policy in Canada, foreign banks express little interest in coming. What are your reasons for saying that?

Mr. Soloway: Specific banks will come in and compete in specific areas, but we do not think that community-type banks will come, and those are what we think are needed. Now, I will try to give a few examples.

In the credit card business, some of the American banks and people who have come in are very efficient, and we strongly believe that they will be there, and they will be very good and strong competitors.

However, to this point, we have seen no evidence of a bank coming forward and setting up in Newfoundland and trying to service the local residents. We have not seen any company like Peace Hills Trust, which focuses on a specific group of people.

Credit card companies can compete well but, in terms of local banks, we have not seen any evidence that they will come in and try to serve local needs.

Senator Callbeck: Is that because you feel they cannot compete? Why would a foreign bank not come into Toronto to serve the local people?

Mr. Soloway: I do not know the answer, but we have not seen any evidence of that. Perhaps my colleagues would care to comment.

Mr. King: Coming from Atlantic Canada, I somehow doubt, Senator Callbeck, that a foreign bank would set up a retail operation in Prince Edward Island or Newfoundland. The market share is not there.

They would compete over the Internet or via mass mail services but certainly not in our niche. We represent the little niches out there, maybe even in the downtown Toronto market.

Mr. Hannay: I just might add that the Schedule II banks have been in Canada for, I do not know, 20 years at least, like Chase Manhattan. Some have actually tried to do retail operations in Toronto, to actually go from the second storey, or whatever the case might be, to their niche market, and they have been unsuccessful.

I think that the Canadian banking system is, without question, one of the best in the world. Some people would say that Canada is overbanked, but it is a luxury that we, as Canadians, have enjoyed.

No one likes to lose some of those services, but I would agree that there is now a competition factor and an economy of scale factor. ING and some of the other virtual bank realities may come in through the Internet.

I agree with Senator Tkachuk that we are still very much community based as far as branch banking as we know it. I believe that while all this technology and the rest of it is important and is moving forward, there is still going to be a need for some personalized services, such as sitting down with individuals to discuss buying a combine, building a school or a medical health services centre.

While we recognize that technology is going to move us forward and there will be some pluses in it, we, as a community-based institution, believe that the hands-on approach with individuals is still not going to go away, particularly in the underdeveloped markets in our communities.

Some of the growing communities within the major cities are having difficulties with regard to the effects of globalization and the widening gap between the rich and poor communities in our major cities.

Those communities, which continue to grow, require some special consideration to meet their needs.

Senator Callbeck: You believe that the foreign institutions will not come in. That means that the competition has to come from the Canadian domestic institutions, including the credit unions and the trust companies.

Now, if the recommendations of the MacKay task force are implemented, how long will it take for the trust companies and the credit unions and other institutions to develop a strong second tier of banking?

We have heard various opinions on this, and I would just like to get an opinion from you people on how many years you think it will take to get this up and going?

Mr. Soloway: I think it is difficult for me to give you a time frame, but we think that the changes we have suggested would encourage it to happen faster. Let me ask the others. Have you any idea of a time frame?

Mr. Hannay: I think that, in Canada, our banking environment has been very different. As a Canadian banker all my life, I am kind of prejudiced and support that system versus our friends to the south in the United States, who have had community-based banks as they have gone through their transitional periods.

There have been more start-up banks in the U.S. in the last five years, and these are all state banks. They are very small, community-minded banks. I recognize, however, that there have also been some mergers, such as Bank America and Nations Bank.

They have the Community Reinvestment Act (CRA) in place; it is not working. However, they are opening state banks every day. The OCC, the thrifts, the Federal Reserve are all competing for financial institutions, trying to encourage people to start banks and license them.

There are community banks. In Canada, you do not see that because of some of the restrictions. You can start a bank in the U.S. for a couple of million dollars, depending on what you want to do capitalization-wise in the community.

In Canada, you are probably talking of a minimum of $10 million to start an institution. From a regulatory standpoint, it would be very difficult. Getting back to your point, I do not know whether 300 or 400 small community banks have started up in the last few years in the United States. In Canada, it is not happening. However, it could happen, and it could happen very quickly, but it will require some changes in regulation.

In the United States, FDIC insurance is US$100,000, which equates to maybe CAN$150,000 -- I have not checked the foreign exchange this morning. We still have a $60,000 CDIC limit outside of our credit unions that will, through their own insurance corporation, offer guarantees that match the guarantees offered by the provinces. It could happen very quickly. It is a matter of regulation.

In Canada, capital and entrepreneurialism exist, and they are needed to start community banks, if only the regulatory environment was more conducive, as it is in the U.S.

Mr. King: When will there be a strong second tier of financial institutions?

We are two or three examples of the niche players out there. We are not a growing market; we are certainly a declining market, but we are strong. It is becoming more difficult to compete in this regulatory environment and the unlevel playing field out there. Thank you.

Mr. Soloway: The answer is that there will be, at some time. Some changes are needed in the regulatory environment, but we do feel that, between the credit unions and the trust companies and the existing foreign banks, if there is the right framework, they will all move forward quite quickly, each in their own areas.

Senator Callbeck: Do you think that raising Canadian deposit insurance from $60,000 would help the development of community banks?

Mr. Soloway: Definitely. Our company, although it is not required to and is doing quite well, has taken the position that we do not want depositors to put more than $60,000 into it.

We have taken the position that we do not want to take any uninsured deposits because we do not want any of our depositors to risk not getting their principal and interest back.

I think that the public is quite aware of what the limits are and tends to deposit according to where the funds are fully protected. There is a group of Canadians at this time who will take the 4.5 to 5 per cent they get on a term deposit at today's rates, knowing that in a year's time they will have $105 for their $100 deposit. They will not put it in mutual funds and will not take the chance, whether they end up with $120 or $85.

I am not knocking mutual funds; they have a place in the financial community. A segment of the public wants to know that, for a whole variety of reasons, they get a guaranteed return on their money. Term deposits guaranteed through Canada Deposit Insurance are a form of doing that. I think that that would attract more capital to companies more efficiently, and it would really enhance the second tier of companies if the $60,000 limit were raised.

Senator Callbeck: Do you have a figure in mind?

Mr. Soloway: I think the United States has a US$100,000 limit. If our level were raised to CAN$100,000, I think that would be quite a substantial benefit to the whole range of second-tier companies.

I do not think it will be a cost factor because it is all insured. The companies pay premiums on that. For CDIC it would probably mean some revenue enhancement.

Senator Tkachuk: Why did the First Nations set up a trust company rather than a bank?

Mr. Hannay: This is where some of the association members differ from time to time. We like our federal trust licence. We would sometimes like to be able to call our institution a "bank" and ourselves "bankers," but we cannot do that.

They decided on a federal trust licence because there are some reservations in Canada that have some resources and have generated some of their own dollars, as opposed to depending on transfer payments and program dollars from the federal government.

These moneys have gone into trusts of one form or another. As a federal trust company, we manage a minors' trust and a Cree land entitlement settlement. The managed funds area is a very big business for us.

As you can see, our assets on that side are almost as much as in the company, and it is good business. Again, with the federal trust licence, we can act as custodians. We have signed an agreement with the federal government to represent the Department of Indian Affairs as an agent for the trustees on minors' moneys.

In our particular niche, there is a big need for assistance and expertise in helping them to properly manage their trust indentures and their settlement dollars. That was part of the reason why a federal trust licence was chosen and why it is probably the right one for Peace Hills Trust.

It could be a Schedule II bank tomorrow.

Senator Tkachuk: Is it less onerous to get a trust licence than it is to get a bank licence, or is it about the same amount of hassle?

Mr. Hannay: On a federal basis, I have not applied for a bank licence since Continental Bank of Canada days. From that federal trust licence aspect, I would think that it would be somewhat similar, other than that we would then have to proceed to register in individual provinces as well.

The Ontario one certainly created problems for some federal trust companies when we licensed in Ontario; that has since been getting sorted out. However, provincial trust companies are another story.

It could be a little bit easier to get a provincial trust licence, but a federal and a bank licence, I would say, are similar.

Senator Tkachuk: If you are serving customer needs, would anyone really notice a difference between a trust company and a bank; or would there be any difference? Could customers get all the same services at a trust company that they would normally get at the bank?

Mr. Hannay: Primarily, yes, but there are some restrictions. We do agricultural lending in Saskatchewan. There are some restrictions in the Bank Act with regard to certain securities, but there are other avenues and securities and you can securitize your lending differently. That might fall under the old section 88, or even the Agricultural Act, for all intents and purposes.

There are restrictions regarding size. Small trust companies, for example, would be restricted in the amount of commercial lending that they could do, under either a provincial or a federal licence. You are restricted, I believe, to 5 per cent of your capital up to $25 million.

When the Trust Act changed and the banks again were permitted in 1992 to buy trust companies as a business that they wanted to get in, trust companies over $25 million were then allowed to get into commercial lending on a much larger basis.

Some differences are very transparent to the customer, senator, particularly ownership issues.

Senator Tkachuk: Can you tell me how many trust companies there are in the country and how many branches there would be within those companies?

Mr. Soloway: We are just looking it up. It looks as though there are some 34 trust companies who have revenues of $5.4 billion, and they earn profits of $557 million. The trust companies employed some 23,000 Canadians.

The Chairman: That is non-bank-owned trust companies; is that right?

Mr. Soloway: Yes. However, that statistic includes one large trust, Canada Trust, which throws the numbers and makes them appear to be disproportionate. Other than that, the 34 non- bank-owned or 33 non-bank-owned and non-Canada trust companies are relatively small.

I cannot give you a specific number of employees or branches, but I could get that information for you.

Senator Di Nino: I am a little surprised at the number of companies that are not members of the association. Certainly, you membership has come down quite a bit. Why are the other companies not in the fold, so to speak?

Mr. Soloway: The majority of the ones that are owned by the life companies, like Mutual Trust, London Life Trust and Sun Life, do not join. We do not fully understand why they do not join the association.

Senator Di Nino: When you were speaking to us this morning, you were speaking on behalf of the 16 members who are members of the association. If you could paint for us a picture of what would help you create the competitiveness that you obviously believe is necessary in the markets that you serve, what is it that you would list as the five top items that you wish us, as a committee, to understand?

Mr. Soloway: I would say that tax -- both capital and corporate -- would be number one. The second item really would be -- and I cannot emphasize this enough -- an encouragement from a regulatory environment of the small companies.

It is no secret that the second tier of trust companies had a lot of financial problems in the early 1990s, and a lot went out of business. As a result, those who are there and are healthy and are surviving today are operating in an environment where not making any new initiatives is strongly encouraged.

If you are good in what you are doing and you want to expand or to do some commercial lending or some other things like small business lending, the regulatory environment does not encourage it.

If an individual or group is running a company successfully, it is no secret to say that the last thing they want to do is get into a regulatory dispute.

If the regulatory environment does not recommend that you do that, it is going to be highly irresponsible for the board or small company to branch into other areas.

We feel that there has to be regulatory encouragement to look at other areas, such as expanding branches and doing some small business and commercial lending. This is all strongly discouraged, and I am not criticizing the regulators. There are reasons because of the problems that occurred during the early 1990s.

The regulators had a very difficult time, and they do not want to see a recurrence. Somehow there has to be a balance between discouraging and encouraging some movement forward.

Senator Di Nino: Do you want one regulatory body?

Mr. Soloway: We think that it would be helpful to have one regulatory body. We want whoever is doing the regulation and the reporting not to favour big companies over small. That is something we all encounter. Somehow, small companies are dealt with much more toughly than big companies.

Senator Di Nino: I am getting the sense that, in effect, the regulatory regime discourages the local smaller companies from expanding, from growing. Is this what you are saying to me?

Mr. Soloway: It discourages the smaller companies from expanding into other areas. You are encouraged to stick exactly to what you are doing. I do not want to come forward and be critical of them because I think the regulatory environment, the people who are regulating the companies, are trying very hard.

They were faced with political pressures when all the companies failed in the early 1990s. They do not want that to occur again. They encourage companies not to take any new initiatives.

They are comfortable with what you are doing; they do not want you to take additional risks. That inhibits growth.

Senator Di Nino: Does that similar approach also apply to the larger institutions that you know, the larger trust companies, those owned by banks and life insurance companies and so forth?

Mr. Soloway: I think the regulators regard the bank-owned and life-owned trust companies as having a large pool of capital upon which to draw.

Senator Di Nino: What I am asking, in effect, is whether the larger trust companies are being treated differently than the smaller trust companies? Is this what you are telling us this morning?

Mr. Soloway: They are being treated differently in the sense that there are fewer barriers to them expanding their business or moving on. This is especially true of a bank-owned trust company because the bank could do something either in the bank or in the trust company. They cover the whole spectrum of services to the public.

Senator Di Nino: I understand that you also told us that if you were to be included in the kinds of changes that MacKay is recommending for the credit unions and the caisses populaires, if you were to be given additional powers or changes in powers and so forth, that that would be another step to help you create that competitive environment.

Mr. Soloway: Definitely. We feel that would. The tone of the MacKay report includes us, and we wanted to emphasize that we would be included in all those reforms.

Mr. Hannay: This is a complex issue. We must be careful that we are not comparing apples and oranges. There is no question that the credit union movement has been community focused. They have provided many services to Canadians.

Now, if they want to nationalize the credit unions in Canada, then that is a whole other issue; that is a different situation.

Senator Di Nino: You mean nationalize in the non-political sense, do you not?

Mr. Hannay: That is right. That is correct, and that group is to be commended. Getting to the MacKay report and its recommendations, what is clearly lacking, as evidenced by the shrinkage of trust companies in Canada, is the need for some community focus.

You have banks that are looking to merge, and in terms of serving those communities, if there is a Bank of Montreal and a Royal Bank, they will become one. As I read through the MacKay report, we need to encourage more people into niches and smaller institutions, not big ones.

Some of these niches are very different. When you talk about our membership here, some of the issues that I have to deal with in my niche are totally irrelevant to Gerry or to Glen or to some of the others.

Certain issues are specific to each of us. You must be aware that we each have our idiosyncrasies. We have one arm of government telling us, "This is what we want you to do with this particular niche that you are in," and we do what is requested. Then another group comes in and says, "You cannot do this." We say, "We are being told by one arm of government this is what must be done. You are telling us we cannot because the legislation does not fit or because our particular niche is not in there in words."

They are not saying, "This is not prudent; this is not the right thing to do. It does not fit." We have to drive a lot of our issues independently.

We do not agree on everything; nor do the Royal Bank and the Bank of Montreal, in spite of what you read in the papers. They are at the CBA.

Senator Di Nino: I have two other very quick questions before the chairman cuts me off.

The Chairman: I was just about to do that.

Senator Di Nino: I know. Is it true that a trust company could actually operate a community branch of the company cheaper than a bank could operate a branch bank?

Mr. Soloway: I would think so, yes. Our cost structure would not be nearly as high.

Mr. Hannay: Small has an advantage, particularly when you are dealing with communities. You can react to the community and you know whether your product is working. We say, "We are so flexible, some days we can hardly stand up."

Senator, we establish a policy on Friday; by Monday we know whether it is working or not. If it is not, we will change it. That is the advantage we have in being small and serving our community.

Senator Di Nino: You said that you wished you could use the words "banking" or "banking services." Is this a problem for you?

Mr. Hannay: It is something we have talked about.

Senator Di Nino: If you wanted to advertise, "Come and do your banking with Peace Hills Trust," you could not do that, right?

Mr. Hannay: If someone asks me what I do for a living, I cannot say I am a banker. I am a trust.

Senator Di Nino: If that adjective was available to you, would that help to define what you do?

Mr. Hannay: Yes. We are banks; we are doing the business of banking.

The Chairman: There are technical legal problems. Public use of the word "bank" implies that you have a federal banking charter, which you do not. Both this committee and the MacKay report argue for community banks to get around that problem. A lot of market research suggests that there is a significant brand value to the word "bank," in spite of what one may read in the newspapers.

Senator Di Nino: You make my point.

Senator Tkachuk: On page 3 you state that there are other regulatory initiatives that should be carefully scrutinized.

You talk about the CDIC's plan for a risk-rated premium regime for deposit insurance, and then you say at the end, "It could harm the interests of small companies by making them." Can you explain that?

Mr. Soloway: Yes. The rating system uses 60 per cent quantitative items and 40 per cent qualitative.

It leaves CDIC with a lot of discretion in rating the companies. Historically, there has been a belief that big is better, big is stronger.

We understand that all the legislation has been passed, but we feel that big companies rather than small ones will benefit from this initiative.

Senator Tkachuk: They are going to charge on the basis of risk for the deposit insurance?

Mr. Soloway: Yes. As I understand it, they have a rating system in which there will be four categories. If you are in the highest category, you pay the lowest premium; and if you are in the fourth category, you pay the greatest premium. There will be various gradations in between, such as A, B, C, or D. If you are a D, you pay the highest premium, while if you are an A, you pay the lowest. I think in large part, the rating system analysis will be skewed in favour of the larger institutions, which can always go to the market for more capital.

It does not mean the small companies cannot be in the business, but it makes it much more difficult.

Senator Tkachuk: On what will they base that?

Mr. Soloway: They have a rating system that they have done a lot of work on.

Senator Tkachuk: I realize that, but assessment of risk is based on such things as whether the institution or individual has declared bankruptcy in the past, did not pay bills, and so on. How will they assess risk? Will it be on what business the bank or trust company is in? For example, will they say that agriculture is risky so, if you deal in agriculture, you pay more?

Mr. Soloway: I am sorry I do not have it here, but they have a number of categories in the 60 per cent of quantitative, such as, if you have more than a certain percentage of your portfolio in residential mortgages, that is a plus. If you are too highly concentrated in certain areas or certain businesses, that is a negative. If you have certain industry exposure, that is a negative. There are 20 or 30 different tests.

They put out an explanatory booklet. The changes were in response to political pressures for co-insurance a few years ago.

That resulted in the risk-rated system. Our position has always been that, if the company is in good standing with the regulator, that should be sufficient and everybody should be charged the same.

There also is the 40 per cent that is not quantitative but almost entirely subjective. That part is very difficult for us because the regulators can suggest -- and for good reason -- that we are not as strong as one of the five chartered banks.

There are good reasons why they could rate a small company, such as any one of the three of us here, differently from a chartered bank. That is one area where we do not think it helps the small companies.

Senator Tkachuk: Well, the bigger they are, the harder they fall too.

Mr. Soloway: They may be too big to fall.

The Chairman: Gentlemen, thank you very much for your assistance.

Our next witness is Mr. Fred White, the president of First Annapolis, which is a Washington-based, or I guess technically, Maryland-based consulting company.

Mr. Frederick A. White, President, First Annapolis: I am the president of an U.S.-based consulting firm specializing in financial services, especially electronic banking products such as credit cards.

I come before your committee today to share my views on the competitive challenges that Canadian banks do face, and will face, in the credit card business. Although my prepared remarks focus on credit cards, I believe many of the issues, many of the same lessons, also apply to other product areas.

In the past several years, our consulting firm has been closely following the Canadian credit card industry. It is a very natural growth opportunity, both for consulting firms like us, but also for U.S.-based credit card companies and other financial services specialists in the U.S.

Over three years ago, we advised our Canadian clients to very quickly escalate their level of investment in the credit card business to prepare them for the heightened level of competition that would come from the U.S. credit card specialists. Today, three years later, we believe Canadian banks are at a distinct disadvantage against the leading U.S. credit card specialists, and I emphasize the word "specialists."

In our view, the Canadian banks simply lack the scale or the required depth of specialization to compete effectively against these new market entrants in this highly specialized business. Although the Canadian market is certainly competitive, it simply has not experienced the intense level of competition that prompted the growth of a small number of very aggressive U.S.-based companies.

The ones I will highlight specifically are MBNA, First USA, and Capital One; although there are some others as well. During this decade, the U.S. market has evolved into an almost Darwinian survival of the fittest, where many of the clients we previously served simply are not in this industry any more.

Until recently, the Canadian credit card business was fairly similar to what the U.S. market looked like about a decade ago, when nearly every bank could be successful and profitable in credit cards. In fact, credit cards earned well above industry-required rates of return.

It was one of the most attractive product areas. However, the U.S. markets experienced an increasingly intense round of price competition and an astounding number of offers of credit during the 1990s. There were about 3 billion offers of credit card credit to about 110 million households.

This year, the number of offers is running somewhat ahead of that, and we see no signs that these trends are abating. Just to give you some examples of the price competition, we currently see fixed rates of interest on credit cards as low as 9.9 per cent. We see "teaser" rates, promotional interest rates, of as low as zero per cent being offered for up to six months to induce customers to switch their balances.

This has been a mixed blessing, but for the public, by and large, it has been a very positive trend. Intensifying competition has forced credit card issuers to innovate and improve their business practices. The industry has become extremely high-tech. All the successful credit card companies have had to make quite large investments in capital, in systems as well as in highly skilled human resources, so that they can better predict consumer risk profiles and develop more sophisticated strategies such as risk-based pricing.

Technical disciplines such as data mining techniques and statistically based analysis are now at the heart of the credit card business in the U.S. These techniques are used to identify and target and expand existing customer bases by attempting to cherry-pick or skim the most profitable customers from larger or weaker competitors.

A number of the most aggressive competitors in the U.S., the same companies now entering the Canadian market, have made investments in technology, talented people, and new account acquisition marketing, quite disproportionate to the industry averages.

These specialists have invested at levels that very few even of the major U.S. banks feel they can justify in a single line of business. Just to give you one example, Capital One, which is insignificant compared to the major U.S. banks, and only the eighth largest credit card issuer in the United States, spent over U.S.$200 million last year to acquire new customers from other competitors.They and MBNA and First U.S.A., now part of Bank One, are all spending at or above those levels in 1998, as the competition continues.

The exceptional growth of these aggressive competitors, along with, in some cases, bank mergers, has caused the U.S. credit card business to become more concentrated, although perhaps lower numbers than you would see in Canada. In the last eight or nine years, the top 10 credit card companies have gone from about 45 per cent of market share to approaching 75 per cent, and we expect them to represent probably 85 per cent within the next two or three years.

In the U.S. at least, this consolidation of product line has been a very positive thing for the public. It has stimulated product innovation and operational and process efficiencies that have created consumer value, both in product features and in pricing and in service quality, all of which were identified as key goals by the MacKay task force, and are obviously good for the public.

Today in the States, consumers have far greater access to credit, probably too much some would say, and at substantially lower interest rates. They shop around for the best deal, and take advantage of very popular value-based and reward products, of which there is an almost mind-numbing variety today.

In search of growth, these same U.S. credit card specialists have begun to replicate their strategies in other foreign markets; indeed, they increasingly view the U.K. and Canada as simply additional zip codes for their solicitation efforts.

Looking briefly at the U.K. experience, although the banks there currently still dominate, the U.S. credit card issuers have been able to achieve about a 7 per cent market share so far. We expect the numbers to escalate rapidly as some of the additional U.S. companies begin to gear up their operations, and in most cases offer significantly lower interest rates than the established banks feel they can afford.

Of course, we see the same companies coming to Canada. Based on our work in the U.S., and to a lesser extent in Canada, we see that these companies have a distinct advantage in areas necessary for competitive success in credit cards. Specifically, they have expertise in many of the database techniques and statistically based risk assessment, and even the more sophisticated marketing and account acquisition tactics, all of which require significant investments.

Although the Canadian banks are quite large by world standards in terms of overall assets, in the credit card business, they are actually quite small compared to the U.S. specialists now entering your market.

Just to give you one example, Bank One, one of the largest U.S. banks, has recently announced plans to enter the Canadian credit card markets. Bank One has about four times the market capitalization of CIBC. If you look at their credit card business as compared to CIBC, including their recent acquisition of First Chicago and the credit card specialist First USA last year, they have about 12 times as many credit cards as CIBC. If you measure it by dollars of purchase volume, they are about five times larger. Obviously this applies to all the other major Canadian banks as well.

Looking at the other U.S. specialists, including MBNA and Capital One, the stock markets have also very positively endorsed their strategies. MBNA, a company with balance sheet assets only about a fifth the size of the major Canadian banks, has a market capitalization exceeding that of any Canadian bank. Capital One, a smaller but high-growth competitor, is also on its way to exceeding the market capitalization of any of the Canadian banks.

In order to satisfy the stock market's desire to sustain the high-priced earnings multiples these companies have achieved, they are constantly looking for expansion markets and you are very much dead centre on their radar screens. I agree with the MacKay Task Force's assessment that Canadian consumers will probably be well-served by this, and by a dynamic, competitive marketplace open to the world. Based on the U.S. experience, I think the public will be better off.

However, having opened your borders to the foreign specialists, you run the risk of having this major line of business dominated by foreign-based companies, simply because your domestic banks will have a difficult time competing, primarily on their ability to achieve a comparable scale.

Although I am speaking of credit cards, I think that in the U.S., at least, our experience is that the competitive battle is increasingly being fought product line by product line. Credit cards, as the consumer`s preferred method of borrowing and repayment, are an extremely telling example. Like mutual funds and other products, the business increasingly lends itself to a non-community-based, remote distribution that allows the emergence of these category killers.

The Chairman: Thank you. I want to ask you two very quick questions.

In your brief, I am unclear whether the economies of scale in the business are driven by the ability to segment the market so finely, that is to say, not all the way to the ultimate segment of one, but clearly in that direction, or is it driven by technology? Is there something unique? I understand the technology also makes the segmentation possible, but that aside, is the technology of the U.S. monoline credit card businesses different from the technology of Canadian credit card companies?

Mr. White: In theory, any company can get similar core data processing services. A lot depends on the expertise in applying the technology to these challenges.

The Chairman: Which is really the market segmentation issue.

Mr. White: The market segmentation, and specifically the risk management aspects of it.

The Chairman: Okay, which I took as part of the --

Mr. White: In credit cards, that is obvious.

The Chairman: Okay. The second question is, could Canadian companies buy these services via outsourcing?

Mr. White: No.

The Chairman: Why not?

Mr. White: The ones that are really at the heart of the competitive strategies are not available from a third-party vendor, at least not on an integrated basis.

The Chairman: They will not supply them as a third-party vendor.

Mr. White: The major U.S. specialists, MBNA and First USA, for example, do operate agent bank programs what are referred to as "agent bank programs," where a small bank may issue a credit card where all of the actual work is done by MBNA, but nearly all of the profit accrues to MBNA as well. To them, it is simply another marketing challenge.

The Chairman: You can outsource, but the fees are big.

Mr. White: The other guy makes all the money.

The Chairman: How did they manage to get 7 per cent of the U.K. market? I know a fair amount about marketing segmentation, and if it were well driven, I would have expected them to do better.Is there something about the value structure in the U.K. which would make a model based on a U.S. value structure, which is the way the segmentation is driven, not applicable in the U.K. but quite applicable in Canada?

Mr. White: I think the primary reason it is that low in the U.K. is the competitors are still in the fairly early stages of their market penetration. The experience to date shows these companies are very much transporting U.S.-based tactics, which appear to be working quite effectively.

That has also been Citibank's experience in issuing credit cards in over 40 countries around the world. By and large, they have followed fairly aggressive U.S. tactics, and have found those to work quite successfully in a wide variety of cultures and economic situations.

The Chairman: Thank you. By the way, are you working for any of the Canadian banks?

Mr. White: I certainly have Canadian clients. I am here today at my own expense and on my own initiative.

Senator Kelleher: Some of the tier-one bank chairmen who have appeared before us have already confirmed what you have indicated, that the credit card business is becoming increasingly competitive and that their market will be diminishing.

What is the bottom line in all of this for me as a Canadian consumer? For example, does this mean that I will have to give up my CIBC Visa card and pick up a card from one of these U.S. issuers; or do you think it is possible that one of these companies, by dint of competition, will join up with CIBC? What is your prognostication?

Mr. White: First, you will not be forced to give up your CIBC card. Like U.S. consumers, you will vote with your feet and you will have an increasing array of product offers. You will probably select for yourself which ones to use. Over time, I would see that shifting in favour of the U.S. competitors.

Yes, I do think that there is some opportunity for alliances, perhaps between Canadian banks and U.S. credit card specialists. We have seen this happen with smaller financial institutions in the U.S. that have been unable to compete effectively on a standalone credit card business. When that happens, however, the expertise, and most of the profits and revenue, accrue to the specialty partner.

In your example, the Canadian bank would be very much the junior partner, and as a matter of public policy, it might be undesirable to have such a key segment dominated by foreign banks, which I think is the risk.

Senator Kelleher: I do not disagree with your statement, so do you have any recommendations on minimizing that risk for Canada and Canadian consumers?

Mr. White: Again, looking at the scale of your banks, I think strategies that both encourage competition, but also allow the banks to get larger in this business, would be favourable for Canada as a whole. I do not have any specific representations for you, sir.

Senator Kelleher: Assuming that the mergers are not permitted, is there anything that we can or should do in order to retain some modicum of control over the credit card business?

Mr. White: If the two pending mergers were not approved, I think competitive conditions would, if regulatory permission were forthcoming, almost force those companies to look at somehow merging or pooling their credit card businesses separately from the banks themselves. Exactly how that would work, I do not know.

Senator Callbeck: Mr. White, you spoke about the tremendous competition in the United States in the credit card business and the resultant drop in interest rates. I am particularly interested in the method of calculating interest.

I always assumed that when you had a credit card, your interest was charged on your outstanding balance, but this is not the case with some of our major credit cards in Canada. For example, if you get your statement at the end of the month and you owe $5,000 and you pay $2,500, your outstanding balance is $2,500. I think that is what you should be charged interest on, but you will find, when you get the next statement, that they charge you on the full $5,000 because you have not paid it off in full.

In the United States, is there a lot of competition in that area? We had Capital One before us, and when I asked them the question, they said that they charged on the average balance for the month, so I would like to know your view of the situation.

Mr. White: When they said they charged on the average balance, in your example they would have charged you for the full $5,000 balance, although there are some nuances in the way average balances are calculated. Certainly we have "truth in lending" laws in the United States that present some relatively good guidelines on how that should be done.

By and large, the common business practice is exactly as you described. If you do not pay in full when you receive your statement, then you will pay interest on the full amount of the balance over that statement period.

Now, it is the business of a credit card lender to make money by lending money. They did, in fact, lend you the average balance over that period, and if you pay in full, you have received free credit for that amount of time. However, to compensate for that, if you do not pay in full, you really did borrow the $5,000 for that period of time. Obviously, that depends on the timing of the purchases, but if that was the average over that period of time, I think it is fairly legitimate that that is the amount you pay interest on.

In the U.S., most of the competition has centred on the annual percentage rates, not on grace periods or the way in which balances are calculated. I think from a consumer's point of view, you can end up at the same place. Competition on interest rates has been easier for companies to advertize and for consumers to understand. From the consumer's point of view, if you are not paying in full, you are getting a far better deal in the U.S. today than five or 10 years ago, regardless of how they calculate the balance.

Senator Callbeck: I have a question about the chart you presented on Canadian card issuers. I notice that the Canadian Imperial do billions of dollars of business in terms of volume, yet they have issued far fewer cards than the Royal and the Bank of Montreal and Toronto Dominion. Why is it that with 4.3 million cards, the Canadian Imperial Bank has such volume? Is it because of their targeting?

Mr. White: The chart might have been more meaningful if it had shown each bank`s outstanding loans. The CIBC does have higher purchase volume per card. Banks also measure what they count as an "active" card in different ways. I believe we would see a somewhat different ranking if we looked at the outstanding loans, but this was the only way I could make it comparable to the U.S. banks.

Senator Callbeck: I assumed it was the outstanding loans.

Mr. White: Yes. This is the annual purchase volume.

Senator Kroft: One specific question first, and then on to my particular area of interest. I understood you to say that there are no particular disadvantages to an institution focusing entirely on the credit card business; that being part of a broad-based banking operation with all the other functions does not automatically create any advantages over the monoline operator.

Mr. White: I will give you a slightly different answer today than I might have a couple of months ago, because it really depends on the availability of market funding for the loans. When the public markets are in some turmoil, as they are now, and it is more difficult to secure loans and raise wholesale funding, then I believe there is some advantage to being part of a broader financial institution.

When a lending specialist such as a credit card company has broad access to market sources of funding, that specialization creates a competitive advantage that far outweighs any benefit that there might be on the funding side.

Some U.S. companies, such as MBNA, began deposit-gathering programs to hedge against those risks. I would expect most of the credit card specialists to sustain their growth, but also to hedge their funding sources over time by broadening out into other product areas, including deposit products.

Senator Kroft: Having cleared that up, I wish to pursue the area that I am particularly interested in. You suggest there is the capacity for the large Canadian banks to take a run at this business, but you put some qualifiers or caveats on that.

We hear arguments that bank mergers are necessary to permit our Canadians banks to play in the big leagues. Yet when I look at everything you have put before us, it is difficult to see how anybody can compete with these large and probably American-based monoline institutions that dominate the market. All the indications are that that is what will happen, unless one of our large Canadian institutions gets motivated to make a commitment to this area. That does not seem to be in the cards right now and does not even really seem to be within their resources.

The credit card business is different from any other kind of banking, in that loans are made on demand. Once you receive your card, you do not have to meet any particular purpose. You add to your balance, you do not have to obtain a loan approval, you do not have to interface with anybody. You say, "I want that money," and you get it, and as long as you are in good standing, that is the way it works.

If we are satisfied that the companies in Canada offering the credit cards, providing this "utility," play by a basic set of rules that we consider proper, should we care? It seems highly unlikely that we can do much about it, but even more to the point, it is a mechanical function that goes on.

As long as they charge rates that are deemed acceptable and use the mails in a proper fashion and do not offend the laws of obscenity and other things like that, why should we be preoccupied with this issue as a matter of public policy? Why should we care whether it is an American company, a British company, or a German company providing that service? If the answer is we should not, then I have to disentangle that from my consideration of the need for larger-scale banks in Canada. It does have relevance for the merger issue, because it has been suggested to us that you have to be big enough to play in these games. If I listen to you, I am not so sure they would be able to anyway.

Mr. White: If I may give a multi-part answer to your multi-part question. I do not mean to make it seem that there are three or four credit card companies in the U.S. and nobody else is able to compete with them. We have seen a recommitment to the credit card business on the part of a few banks, with Citibank being a very large example. They were the largest in that business to begin with, and their decision is understandable. However, a medium-large regional bank called Fleet Financial bought a specialty card company and recommitted to being at least in the top tier of that business. There are some smaller ones as well, so I do not mean to make the market sound as if there are only three companies that can be successful. In the interest of the brief amount of time available for my prepared remarks, I chose to focus specifically on them.

I will give you three reasons why I think you should care. First, we are talking about a financial service business, not the manufacturing of widgets or something else that is a less integral part of any national economy. Credit cards in particular, precisely because of the convenience of writing yourself a loan and of the repayment vehicle, are becoming the dominant source of consumer credit, at least in the most developed markets. I think it would be undesirable to have credit decisions made almost entirely by foreign-based companies, unless there is a way to appropriately regulate that.

It is also a jumping off point, because it is where many investments have been made in the direct marketing of products. There are a lot of lessons learned in that business that are transportable to other financial services, and indeed to non-financial products as well.

Just to give one example, Capital One, that has testified before you and that I have mentioned several times, also sells a cellular phone service using the same direct response channels, and I think you will see MBNA and the other companies also broadening out over time.

Another reason is simply job creation. In the credit card business, most of the employees are in relatively lower paid jobs, such as customer service, collections and operations. The guts of the business driving the competitive success is in the analytic functions, and those jobs will be headquarters-based, and probably not resident in what would effectively be a field operation for these companies.

Senator Kroft: I want to come back to the first part of my question. Is my assumption that, on the basis of your presentation, there is not much we can do about it in practical terms, valid?

Mr. White: I do think both of the pending bank mergers give those banks some opportunity of growing to a size where they could make the necessary investments to be successful in this business. Whether or not they are number one in market share is less important than being viable competitors in the business.

Without the bank mergers, then I think for there to be successful Canadian-owned competitors in the credit card business, you would have to detach the credit card businesses from those banks and somehow permit them to form consortia companies. That is the only other way I can see it working.

Senator Tkachuk: When you spoke of the credit card companies, I also wondered, why should we really care? You say that it is very Darwinian, and the strongest and smartest will survive, but I note that in the United States, Chase, which used to be number two, is now number four. Bank of America appears to be static. In other words, the new players in the marketplace are growing and the old players are suffering.

Mr. White: Certainly, those highly specialized companies that focused on credit cards did not start off being large, but they are now the players driving competition, whether or not they actually have the largest market share.

Citibank is an example of a company that, although their share has been eroded, has recommitted to the business. When a company is that large, the sheer weight is a tremendous advantage, even if they are not as specialized or as focused as some of these other players.

Senator Tkachuk: How much of the market do these new players currently have in Canada? I imagine it is very small. It may slap the head of the big players, who have been overcharging, frankly, and the new players are better at their job. Is this not a normal cycle?

I hear the bankers expressing concerns about these monoline players, but we used to have American Express and Diners. What happened to them? They got big, arrogant, fat and lazy, and new players entered the market and gave them a beating. Now, of course, American Express is making a little bit of a comeback, because they have figured out that you have to please the customer to compete.

I think our Canadian credit card companies can compete very well, but these new players are a welcome addition to the market. Do they really have to merge to compete? I do not buy it. Can you convince me that if number one and number three amalgamate, and numbers two and four, that they will be better competitors? Or will they actually be worse competitors, because all of a sudden they will have a monopoly on the credit card business in this country.

Mr. White: Obviously, size alone will not make the Canadian banks more effective competitors. It is going to be a necessary step, in my view. From the way you worded your question, I think the shift in market share will be far more extreme than what one would envision.

These companies have perfected extremely aggressive tactics to shift market share in their favour. They are not entering the Canadian marketplace simply to give Canadian consumers a better deal. Their goal is to become as large as they conceivably can. Compared to their ambitions, the Canadian market is not that large a market. These companies will not, individually, be satisfied with single-digit market shares.

The U.S. is a very large market. It has taken these companies a while to get to where they are and now their appetites are large. We call some of their tactics "carpet bombing." They use hyperaggressive tactics to force the remaining weaker competitors out of the market as best they can. We see signs that they will use some of the same tactics here. Although they have the technology to be highly segmented and targeted, what they will do, in fact, is identify every credit-qualified household and solicit them many times a month.

Canadians have not experienced this yet. There are 3 billion offers to 110 million households. You can calculate how many pieces of mail each household will receive every week. That is the sheer firepower they will bring into the Canadian marketplace.

Senator Tkachuk: It seems like a lot but, if it were television, would we be claiming that they are advertising too much? That piece of mail is just an advertisement that comes to your door. It might offer the consumer a better service than what he was getting before.

Even if they do get large, is it not the same cycle again? They will become arrogant and will start to charge too much. New, younger players will come into the market and trounce them out. Is that not what happens all the time? I do not see a big concern here.

I think it is good for the Canadian marketplace to have these people here. The banks are going to start being more competitive because they will not want to watch the market torn away from them. We should do nothing about it and see what happens.

Mr. White: It certainly will force your domestic competitors to smarten up. I do not think they are going to be able to do it quickly enough, especially if they are starting at a smaller size base.

The Chairman: Further to Senator Kroft's last question about what would happen if the banks merged -- would they be able to compete, or would they still be outclassed -- you immediately responded by saying they would be able to compete. I do not understand the rationale for your answer. When I count the numbers of cards, I notice that TD and CIBC would have 9 million cards; BMO and Royal would have 12.4. That is substantially less than any of the American competitors.

Why are you so quick to say that it does not matter? Having 10 or 15 per cent of the large American monolines, or having 25 per cent of the large American monolines, matters quite a bit when it comes to looking at your competitive position. Do you want to think about your answer?

Mr. White: In response to a different question, I also said size alone will not make somebody a successful competitor. There are actually some very viable competitors who would be of the same scale as the merged Canadian banks. They are second tier ones, shown further down on my charts, but within the top 20 issuers. They look very much the way Capital One or MBNA did six or seven years ago.

The Chairman: We are now really discussing whether we want to be in the bottom half of the top 20, or in the top 30. I have difficulty understanding the difference.

Senator Kroft: Are the organizations you are talking about smaller and totally focused on the credit card business?

Mr. White: Yes.

Senator Kroft: In terms of size, our Canadian banks might look like they are a player, but are they ever going to have the kind of tunnel vision that has made these organizations so competitive?

Mr. White: That is an extremely fair question. I think much of what has made them successful was their single-mindedness of purpose. In theory, as a department of a larger institution, that is possible. The reality of the marketplace appears to be that the stand-alone companies have been more successful. However, I would point out that MBNA and Capital One both began as departments of broadly based commercial banks, and were only subsequently spun off.

I think you are correct, focus on the business is more important than size alone. However, in theory, it is possible to achieve it within a broader institution.

The Chairman: Thank you, Mr. White.

This morning, our last witness is Mr. Michael Mackenzie, the first superintendent of Office of the Superintendent of Financial Institutions in Canada. He is the immediate predecessor of John Palmer, the current superintendent, who will be our first witness this afternoon.

Mr. Mackenzie has circulated a brief. After Mr. Mackenzie's opening statement, we can proceed to questions. This afternoon, we will hear Mr. John Palmer, followed by Mr. Flood, CEO and Chairman of the Canadian Imperial Bank of Commerce.

Mr. Mackenzie, I first heard you a decade ago. Welcome back to the committee. Thank you very much for being here.

Mr. Michael Mackenzie, Past Superintendent, Office of the Superintendent of Financial Institutions: Mr. Chairman, thank you very much for inviting me. I am somewhat more independent now than I was when I last saw you. Once I have completed my presentation, I should be pleased to answer your questions.

I have read the task force report and, in general, I like it. It is a comprehensive document and may well stand up to the 1964 Porter commission. I hope it serves as a basis for discussion and consideration and puts many specific issues into context.

A few weeks ago, when I appeared before the House of Commons committee on this same subject, I suggested that it would be in the national interest to get on with the recommendations and not postpone dealing with the difficult ones in favour of dealing with the easy ones first. Last week someone asked what the easy ones were.

As I listen to discussions, and as I go back to 1991 and 1992, the time leading up to the last set of major legislative reform, I start thinking about changes in this sector and how Canadians can become very uncooperative. I do not think there is a single recommendation here that will not be attacked or contested by somebody, so I wish you luck.

The Chairman: Some of our reports generate that type of reaction as well.

Mr. Mackenzie: Yes, I am sure they do.

Briefly, the report tries to strike a balance between what I will call safety and soundness issues -- the need for more competition -- and the social or community responsibilities of financial institutions, that is, mainly big banks and how well they make these trade-offs. It will be open for discussion, but I admire them for trying.

I want to talk about change. I am concerned about the way the report deals with change. If you look at each of the segments, technology, breaking down pillars, globalization, competition, and so forth, it reads like an extrapolation from the past into the future. Market turbulence of the kind we have seen since the beginning of August is not factored in.

I think the financial markets are much more fragile today than they were when this report was drafted. On the whole, I find there is a note of complacency underlying a lot of the work in this report, complacency about the safety and soundness of the financial system. I would like to have seen more concern about this.

Because of my background as a bank inspector and chartered accountant, I am of the view that banks are inherently fragile, or have the potential for being so, because of the enormous leverage with which they operate. The more they grow, the more one has to be aware that small errors, which would not necessarily sink a steel mill, could sink a bank. The room for error is small.

I would like to see more concern for the need to have a financially powerful and demonstrably safe system. Although I hear the right words in this respect, I think it is no accident that, when we have this market downfall, bank stocks take the biggest pummelling. This is true in the U.K., in the United States, as well as in Canada. I think the markets understand fairly well the potential fragility of even large banks.

I will get to the recommendations I really do not like in the report and which will have to change. Two changes concern expansion of the responsibilities of the OSFI. First, in order to consider giving rulings, interpretations, licences and so on, the mandate must be clear that the regulator is to take into account competition, along with safety and soundness. I think that is dynamite. There are many people who like to push very hard -- push the envelope, as some people say -- and it may make it almost impossible for the superintendent to turn down some requests, because he is faced with an accusation of inhibiting competition or innovation. I think that is a very bad recommendation.

Second, I do not like the expansion of the role of the OSFI to include consumer protection issues. I think that muddies the water. The job is difficult enough to deal with the safety and soundness issues. In my view, it will become even more difficult with ongoing market turbulence and problems that will go on for some time. I am not in the forecasting business, and I do not understand markets, but I am pessimistic.

Having done some work with the World Bank and having been to Poland and Brazil, as well as a few other places, it has been my experience with regulatory functions around the world that, when you mix, as those countries have, functions that do not relate to safety and soundness with the safety and soundness mandate, you inhibit the ability of the supervisor to do his job. You also inhibit his credibility in the eyes of the people being regulated because they are confused about what agenda he is pushing. In fact, I think it is almost a conflict of interest or a conflict of function.

Another significant area that I do not like in this report is that the financial system is described as though securities dealers do not exist. All the suggestions and recommendations about what should happen are made from a federal point of view. Presumably, the members of the task force backed off because securities is a very sensitive issue of political provincial domain, particularly in two of our provinces. This is dangerous. They start off by saying that the status quo is unacceptable, but they have gone no further.

Within the last month or two in the United States, a number of big banks -- both commercial banks and investment banks, with major exposures to long-term credit, long-term capital corporations, and major hedge funds -- found it essential that the Federal Reserve and the SEC be able to work together to prevent institutions from going bust. I am not arguing now whether it was a good idea or not, but they perceived systemic risk. The Americans and the British have the capacity to put together securities and banking supervisors in one room to deal with problems of that nature.

I look at the exposures of some of the biggest banks in the world. The Union Bank of Switzerland, the Bank of America, Citibank, Chase, Goldman Sachs, Merrill Lynch, these are not small, naive players in the market, yet they had enormous exposures.

My next concern is that the OSFI is barred from being a security supervisor. I wonder how well we understood banking exposures to the securities markets.

Provincial-federal constitutional issues are skimmed over too lightly. These institutions are supposed to make community accountability statements. I do not like them very much, because they are going to be invitations to controversy, not contributions to knowledge. Is the Royal Bank of Canada going to include RBC Dominion Securities in making those community statements? I think the securities commissions of Quebec, Ontario and British Columbia will cry foul, but I do not see how a complete statement can be made without including securities affiliates.

As to mergers, I like what the report says about the public interest review process and the requirement that merger proponents put forward public interest impact assessments, and detail a number of areas they should cover. If these mergers proceed, I have four items I think should be addressed.

First, we need to understand how the merged bank will, in fact, be financially stronger on its balance sheet than the two predecessor banks taken separately. In particular, it should be demonstrated that the merged bank would have greater access to capital markets for its own capital requirements and its own ability to conduct the widespread business than the two predecessor banks taken separately. Will it improve its ability to get good credit or maintain good credit ratings, which are very important in this business?

Second, how will the merger affect Toronto as a major financial centre with international standing? If you look back 10 or 15 years, you see that more and more financial activity is migrating to fewer and fewer financial centres. Toronto is an important centre, and I think that it is fair to examine whether having two major merged banks will enhance or lessen its ability to be a major financial centre.

Living in the Toronto area, I may be biased on this account. However, the alternative to Toronto as a financial centre is not Montreal or Vancouver. It is New York, Chicago, London, and other places outside the country. I think there is a lot hanging on this.

Third, we have the enormous job of integrating many areas if these two banks are going to merge. I will focus for a moment on systems. You cannot operate on a merged basis with two parallel systems. The banks will have to move quickly on their systems at the very time when they are also trying to deal with the Year 2000 problem. I am concerned that the drudgery of just merging their systems over the next few years will inhibit their ability to realize the benefits. That may be a temporary issue, and I hope it will be.

Finally, the merging proponents say that employment will not suffer too much, that they will be able to maintain the levels of employment. In effect, what they are saying is that they will grow; that the way to maintain employment levels is by growth. When the financial incentives -- individual pay packages of people in the system -- are overfocussed on growth, and I believe they are, pay compensation arrangements in the banking system, even as it exists, are based on market share. Recently, I found a notice for an upcoming conference on marketing and the positioning of financial institutions. The headline reads: "Moving from a customer service to a proactive sales-oriented culture." That is happening now and will happen even more so in the future.

The question that should be asked -- and I have a suggestion to make to you in terms of witnesses you may want to call -- is how can a board of directors, a chairman of a risk management committee, and a chairman of an audit committee exercise risk management authority and influence to restrain the overexuberance of these compensation arrangements which could propel the bank into dangerous territory?

I suggest, Mr. Chairman, you might find it interesting to ask some of the people who are chairmen of audit committees or risk management committees of the banks to appear before you. They could tell you how they propose to do that.

Finally, before reaching a conclusion, I await the reports of the OSFI, the Competition Bureau as well as this process.

The Chairman: Thank you very much for a very thoughtful and helpful brief.

Senator Oliver: You raised the issue of securities regulation in your submission to the task force, and you raised it again today. Among other things, you were concerned that, should there be a solvency-threatening loss in derivatives trading like in the Barings Bank, foreign markets would become very concerned about the lack of a uniform integrated system in Canada. Have your views changed as a result of having read the MacKay report?

Mr. Mackenzie: No. However, I do a certain amount of work with the World Bank these days in various countries. One thing that comes across very clearly is how transparent, in an overall sense, the financial marketplace is to the world.

Global markets are a reality. I fear that, if we were to have a major problem -- and it is not just a Barings kind of a derivatives situation, it could be a situation similar to one the Bank of America just had with its exposure to a certain hedge fund -- the foreign markets might be hesitant to do business.

It is becoming much more difficult to determine what is really investment banking and what is really commercial banking. The responsibilities of supervision will be fragmented when you consider we will have 10 securities commissions.

Senator Oliver: Yesterday we had before us Mr. David Brown of the Ontario Securities Commission. He said that they are trying to address the very concern you raised, by coming up with a concept of a virtual securities system. As well, some provinces are moving to allocate prudential regulation to OSFI. Apparently two provinces have already agreed to that and, according to Mr. Brown, there will be more, including the Province of Ontario. Will this mitigate your problem in some way?

Mr. Mackenzie: On a status quo basis, from a prudential point of view and a capital measurement point of view, I have great admiration and respect for the operations of our securities supervision as it is today. I know that the Ontario Securities Commission and the Canadian Investor Protection Fund have done very good work and they operate according to national standards.

My concern is that, whenever the potential regulation of the Canadian Depository for Securities Limited came up, as CDS moved into money market and government security settlements, any move by the OSFI into a legally visible regulatory function was immediately opposed by Quebec and British Columbia. Ontario went along. There is no problem.

Senator Oliver: We have seen evidence on that as well. It is an ongoing problem.

Mr. Mackenzie: I think that there is a potential risk. I said so in my report to the members of the task force, but they have not dealt with this issue.

Senator Oliver: My next question concerns regulation. Mr. Baillie of the TD Bank was here yesterday and said, when they read the task force report, one of the things that concerns them is that, if it were implemented, it would really amount to overregulation. Mr. Flood has made the same statement publicly. They refer to very specific areas, such as the want to legislate rules and regulations respecting coercive tied selling, privacy requirements, accountability statements, and so on. Does this kind of heavy regulation scare you? Do you think it will take the competition out of the financial sector?

Mr. Mackenzie: I do not consider myself as any kind of expert on supervision and regulation with respect to consumer protection. I think that, if you look at regulatory bodies which have these functions -- safety, insolvency, and consumer protection -- the amount of time, energy, and personnel resources allocated to the consumer protection side will outweigh the other. I do not know whether this will result in too much or too little. I do not have the expertise to answer that question, however, I am concerned.

Senator Oliver: Concerned, because it will take too much time and too much money and will slow down the wheels of the financial sector?

Mr. Mackenzie: My concern is that, for example, based on the philosophy of the Ontario Securities Commission and the Securities and Exchange Commission in the United States, disclosure and transparency is critically important. The more effective your disclosure and transparency issues are, the less need for heavy-handed regulation. My instinct is to go for more disclosure.

Someone just described how credit card companies calculate balances on which they charge interest. As a credit card customer who is in the fortunate position of never having to borrow on my credit card, I do occasionally slip up. When I look at the interest charged, I have no idea how they calculated it. That is just one small example.

Senator Austin: Mr. Mackenzie, thank you for your presentation, which I find peaks curiosity at many levels. Given your responsibilities from 1987 to 1994, I would like to explore with you the proposition in the MacKay report that there exists a potential for second tier financial banking and financial institution competition in this country which, with a modicum of stimulation, will come on strong. As you know this subject well, and without giving us specific examples, could you summarize the experience of the smaller banks and trust companies, regionally and otherwise in Canada, in the 1980s? Could you describe the difficulties they had and tell us whether what happened in the 1980s remains relevant? In other words, could it happen if we brought on policies to stimulate similar activity in the first decade of the next century?

Mr. Mackenzie: At the beginning of the 1980s, there were five small banks. There were actually more than that, but there were five small Canadian-owned banks: the Bank of British Columbia, the CCB, the Northland, and the Continental and Mercantile. Within a few years, they all disappeared, one way or another.

The history of Canadian banking has never lent itself to community banking. Going back 150 to 200 years, they just have never survived. The present Big Six are the result of mergers of various banks across the country that have not survived.

You have obviously heard, as have your colleagues in the House of Commons have heard, Canadians have a general antipathy toward the banks. The unpopularity of these mergers, in part, relates to the fact we do not have a solid second tier system, and yes, one would like to see that.

Aside from the Canada Trust, and perhaps the Hongkong Bank and the retail business, the only reasonable second tier system is going to be the credit union movement. It certainly started with the Mouvement Desjardins in Quebec and it is moving across the country. I am hopeful that they might, in fact, be able to achieve something.

Earlier this morning, you heard about the desirability of opening more small banks with capital under $10 million, and so forth. Unless a bank that size had a very small niche market, it could not make any money. Operating in Willowdale, or near Toronto or Montreal, for example, it could not make money standing on its own. Why would somebody want to own a bank that small? You have to worry about other agendas that might play on that.

Senator Austin: Compared to a bank referred to this morning in the Schedule II bank group as ethnic banking, which has a special constituency, a broad-based community bank would be in difficulty. Would you give us the same answer for closely-held financial institutions, small or large? Could you give us your view of whether closely held or widely held results in more safety and soundness, and more prudential behaviour or otherwise?

Mr. Mackenzie: The problem with a closely held bank, trust company, life insurance company, or whatever, is to ring fence the institution against the business interests of its owners. Even with strict laws about related-party lending and investments, it is a tough business. I am pessimistic that they will survive very well.

The history of the savings and loan industry in the United States would confirm that it is a very tough game. Small banks, absent a niche market, just cannot make any money. There may be opportunities for some of them in niche markets, including ethnic communities, although ethnically centred small foreign banks have not been very successful in Canada. Unless you make money in this business, you are not safe.

Senator Austin: We have the example of Canada Trust as a closely held financial institution, which is quite successful. Is that a special situation or could it be more generic in its example?

Mr. Mackenzie: That is an interesting story. First of all, I grew up in London, Ontario, so I have a natural bias for the Canada Trust. I have an enormous admiration for Merv Lahn who built the company to its present size. From the beginning of the Canada Trust, there was a culture that put the customer and the depositor first. Merv was very explicit about this. In his opinion, depositor protection was what mattered and, if you looked after the depositors, you looked after the shareholders.

Canada Trust has worked because it has had intelligent owners and the Imasco people have been very responsible. It is great, and I would be delighted if there were more Canada Trusts that were as successful.

Senator Kroft: I invite you to elaborate on your concern about mixing up the functions of the regulator with maintaining the competitive elements, a concern I share.

Mr. Mackenzie: First of all, every successful regulator in banking and related fields must have what I call a "Mr. No." I was very fortunate in having André Brossard, who was very good at filling that function in my office. Many people out there did not like him, and I would get a host of complaints about him. However, André knew the Bank Act better than any lawyer in the country did. He was reasonable; he did his best, but he was constantly fighting battles. I know about his battles, because I got involved, too.

There are people who will look at the rule book and interpret it as narrowly as they choose, pushing as hard as they can, to get whatever they can out of the system. If, in addition to the already difficult positions that people like André and others have in dealing with those people, you give them the argument that they cannot say "no," because of the potential competition and innovation, I think it is naive, frankly, to put this in.

Senator Kroft: Thank you. As the world is changing domestically in complexity, in technology, and in forms of financial instruments, do you have a comment on the adequacy of the resources that are given to the regulatory bodies in our system to do the job they have to do?

Mr. Mackenzie: I am delighted you raise that question because I am not sure of the answer. I am interested in the proposal that there be a board of directors over the OSFI. In a sense, I like it. This is one of the things I asked for, as a matter of fact, when I was approached to take the job in the first place. I am told that they looked at the functioning of the Board of Supervision at the Bank of England to see what role it had. I would prefer to see it as a board of advisors, rather than a board of directors, but that is another issue. I think that it would be very helpful to have an independent group like a board of advisors, or a board of directors, look at that issue, because it is always a battle to increase your budget, the employment, and so forth.

There are two or three areas where I think it needs beefing up. The first two areas are common to every supervisory body anywhere in the world. The first is developing systems expertise. What cracker jack, super-duper systems person wants to work for a supervisor or regulator? He wants to get out there where the action is. The same situation applies for a capital markets specialist. These are two areas which are very difficult and could be understaffed.

The third area concerns our moving into more market turbulence. I do not want to write a headline now, but with an ongoing Quebec election and the possibility of a referendum next spring or summer, this could add immeasurably to market turbulence in the financial sector in this country. Because of that political possibility, I would like to see the regulatory body strengthened with people capable of working on contingency plans with the industry, the Ministry of Finance and the Bank of Canada.

Senator Kroft: Thank you. I certainly respect your opinion.

The Chairman: Thank you very much, Mr. Mackenzie for your excellent brief. We really appreciate your taking the time to be with us. It was very helpful.

The committee adjourned.